My comments on prepaying vs. investing
Many financial planners talk about asset allocation and in reality that is exactly what you are deciding. For example, say you realize that your checkbook balance is actually growing by $100 each month and you want to know what to do with it. Should you pay down your mortgage with it, or invest it in a no-load mutual fund. The answer is both, depending on your "risk-aversion" (another great financial planner term!). If you believe in low risk investments (CD's, money markets, T-bills etc) and are very hesitant about the rocking and rollings of the stock market, your answer will be very different from some single 30 year old who loves to day trade and load up on Internet stocks.
Think of prepaying your mortgage as a guaranteed fixed income investment, because it is (for the lender!). Your interest rate is the investment return your lender is receiving. So it does make a big difference if you are talking about a 6% mortgage or a 10% mortgage. You might say the mortgage interest is actually less because it is tax deductible, but on the same note the yield on a taxable bond fund (for example) is equally lower because its dividends and any capital gains are all taxable too. So a 7.5% mortgage may have a 5% after-tax rate, but a 7.5% dividend paying bond fund would actually only earn you 5% after tax as well.
So the question becomes how much of each. That is all due to personal taste. More aggressive investors who believe their after tax investments can easily outpace their mortgage interest should put more into stocks, for example 80% into stocks and 20% into fixed income investments, which here is their mortgage paydown. More middle of the road investors, might do a 50/50% split with most of their stock investments being based in mutual funds. And more conservative investors, well, they would probably find the 7-8% rate on a mortgage hard to beat (compared to CD's etc) so they should spend almost all their extra cash flow to pay down their mortgages until they are gone. Plus the feeling of being debt free is something many people would prefer to having thousands of dollars locked in a stock market that might crumble at any day. Others find that boring, just sitting on a big pile of home equity that could be doing something more exciting in this booming market economy.
To each their own. There is no right or wrong answer. That is something you must decide for yourself.
Addendum, July 2009: Prepayment makes even more sense these days with extremely low fixed income returns, an incredibly volatile stock market and unstable home values. It makes even paying down 5% mortgages seem like a reasonable idea. If you lose your job and need to sell your home, you will be glad you had been prepaying. It sure beats having to sell your house for less than your mortgage balance.
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