Is it better to pay extra on mortgage or buy a certificate of deposit?

[baby_bear]

I am a scientist and have spent precious little of my life studying finances. In my next life I will get an MBA instead of a Ph.D. In the meantime, I have to make financial decisions like it or not.

If I have saved a couple thousand dollars, should I put it on the principle for my condo or invest in the 2.5% 15 CD my credit union is offering?

So far I have been trying to pay down the mortgage, but I am wondering if I should balance that with other investments. We're not talking lots of bucks here, but still signficant to me.

Thanks for any advice to the fiscal dummy.

b_b

[unblock]

1. for the most part, you want to hit the higher interest rate you can

if you have debt at 8% but can invest at 9%, it's better to invest.
if you have debt at 6% but can only invert at 5%, it's better to pay down the debt.

taxes add a wrinkle. in your case, the mortgage interest is deductible, but the cd presumably is taxable. so, to make sure you're comparing apples to apples, adjust the mortage interest rate by lopping off your marginal tax rate.

so, your mortage rate might by 3% instead of 4%, or 4% instead of 6%, roughly.

most likely, your after-tax mortgage rate is still higher than a measly 2.5% cd, so you're better off paying down your mortage.



one point, though.

all this addresses is how to pay less interest and taxes, overall. there are other considerations. mainly, what happens if you change your mind and want the couple thousand back? with a cd, you'll pay a penalty, but you can get the money back. if you pay down your mortgage you cannot get it back at all, unless you're in a position to refinance, which is a time-consuming and expensive process, and possibly ill-advised with rates on the rise.

so, bottom line, is paying down the mortgage will probably be cheaper, but investing in a cd is more flexible.

[Yupster]

2. It's pretty much an arithmetic problem

If the mortgage interest is higher than the cd rate, pay on the mortgage.

You can probbaly deduct the mortgage interest though so you are really only paying 75 % of the mortgage interest rate assuming you are in the now 25 % tax bracket.

You do want to make sure you have adequate cash reserves though, so if you don't have $ 5,000? (depending on your circumstances), in the bank, you may want to keep it in the cd just until you have more liquidity.

Today a good one year cd is paying 3 %, so if you have an 8 % mortgage it's an easy call. Plus the cd interest is taxable.

[baby_bear]

3. You both make sense

The highest CD interest I could find is 3.1% for a minimum $5,000 investment. (Of course you can get a much better rate for 50 or 100K - what a gyp!). I do want some liquidity so I think I'll split the difference and get a 2.5% CD at my local credit union with 2K and put whatever else I can on the mortgage.

Obviously, it takes money to make money, and maybe that's what I inherently don't like about capitalism...and our tax code too.

Thanks very much for the suggestions!

b_b