Dear Liz: We just refinanced our $100,000 mortgage into a 15-year fixed-rate loan at 3.75%. We have an extra $500 a month and want to know what we should do with it. Should we use the money to pay off the mortgage early, increase the contribution to my 403(b), or start a rainy day fund and try to save up to three months of my take-home salary? I’m 44, my wife is 35, and we have three kids ages 5, 3 and 9 months. I would like to retire in 16 years.
Answer: At least two of your children won’t be through college by the time you want to retire, so you may need to rethink your plans unless you have an exceptionally generous pension or a lot of money saved in that 403(b) already.
Most people have better things to do with their money than pay off a low-rate mortgage, and this is especially true for you, given your very low rate and your already short mortgage term. If you’re not already getting the full match in your 403(b), putting the money there is often your best bet. Even if you’re getting the full match, you might want to invest more in your retirement account if you’re not saving enough. You can play with a retirement calculator or talk to a fee-only financial planner to see if your retirement savings are on track.
Once you’re saving enough for retirement, you probably should prioritize that rainy day fund. The fact that you don’t have any savings is worrisome, particularly if you’re the sole income provider. Your initial goal should be to save three months’ worth of your must-have expenses — what you pay for shelter, utilities, food, insurance, child care and loan payments. You may want to expand that goal to six months’ worth of expenses or more if your spouse couldn’t easily return to work, should you lose your job.
Finally, you probably should think about starting college funds for the kids. College educations are all but essential these days if you want your children to make economic progress. (One example: According to the U.S. Census Bureau, incomes for men with only high school educations have dropped 31% in inflation-adjusted terms since 1989.) You may not be able or even want to pay the whole bill for their educations, but any money you save is likely to reduce the debt they would have to take on to get their degrees.