Q. We have lived in our home for 15 years and have refinanced several times. About 18 months ago I refinanced to a 5-year balloon note at 3.75 percent, amortized over 30 years. The original amount borrowed was $193,200 with a monthly payment of $895. In order to retire the debt in 5 years, I have paid $3,550 each month, applying the excess to principal.

With interest rates rising, I am now able to get a better return elsewhere, like a 4.5 percent 3 year bank CD or a 4.0 percent Internet account, both FDIC insured. I plan to reduce my monthly payment to $895.  I would like your suggestions for how to invest the extra $2,655 each month so that I may earn additional interest, keep control of my money, and still pay off my mortgage after 5 years. We are 50 years old, have a comfortable amount of savings, and plan to live in our home for many years.

---K.K., by email from San Antonio, TX

 

A. If the choice is between CDs and a quick mortgage pay down, keep on paying down the mortgage as fast as possible. You may be able to earn more with the extra money today--- like the 4.5 percent CD you cite--- but that interest income is taxable. So your after-tax return will be 3.24 percent if you are in the 28 percent tax bracket, or 3.00 percent if you are in the 33 percent tax bracket. (It's a good bet you are in one of those if you can handle a $3,550 monthly mortgage payment.)

As a consequence, you could go through a great deal of effort and receive very little real benefit.

I suggest you consider another option. If you are planning on working for a good number of years and have a secure income, you might start investing the additional money to build a diversified portfolio of equities. You'd still have the deductions for the low interest rate mortgage but most of the return on your equity portfolio would be either tax deferred or taxable at only 15 percent. It might also provide a higher return than your mortgage interest rate. Since equities tend to have higher long-term returns than CDs or bonds, this could work out very well for you.

The operative word here is "could." While the CD/rapid pay down tradeoff pits two certain results against each other, the equity portfolio/rapid pay down tradeoff pits an uncertain return against the contractual cost of your mortgage.

I'd treat it as a business risk and invest in equities, then review the situation when the 3.75 percent interest rate changes at the end of the fifth year. The higher your new rate, the less beneficial it will be to continue "investing the difference."

And remember, this is a reasonable idea if you plan to be working for many years. The closer you are to retirement, when you will no longer have income from work, the greater the risk.

 

Q. Someone recently suggested an alternative to buying long-term care insurance. The idea is to buy additional life insurance instead. If you need care, you pay for it yourself. The life policy ensures your heirs something even if all your money is used up in paying for your care.

What do you think?

---G.K., by email from Dallas

 

A. It's a nice idea with too many "yes, buts." The death benefit may increase your estate if you don't need long-term care. And, in a dark way, death is a better bet because everyone dies. Not everyone will need long-term care. Most men, for instance, avoid long-term care by dying. 

That said, the idea has some major limitations. Cash value life insurance is expensive. It is particularly expensive when you buy it relatively late in life. It will cost more per dollar of death benefit than a comparable amount of long-term care coverage.

As a consequence, you may be tempted to try a less expensive term life policy, gambling that you will die within 10, 20, or 25 years. Unfortunately, most people are most likely to need long-term care precisely when the term insurance period is running out and the life insurance premium soars.