It's not an easy decision: You plan to sell your home in the near future and buy a new one a few years from now. You have extra money coming in each month. Should you send those extra dollars to your lender with each payment to whittle down the principal balance of your mortgage before it's time to sell your home?

Or does it make more sense to save that money so that you can use it for a larger down payment or to cover the closing costs on your next mortgage loan?

Not surprisingly, the answer to this question depends on several factors: How much money do you already have in the bank? Do you owe more on your mortgage loan than what your home is worth? Are you downsizing or upsizing with your next residence?

"There are many factors to consider," said Lisa Featherngill, managing director of wealth planning at the Winston-Salem, North Carolina office of Abbot Downing and a member of the National CPA Financial Literacy Commission. "And sometimes emotions can get in the way. People get emotional over their homes. And sometimes those emotions become more important to them the real financial facts."

Liquidity is king?

Brian Koss, executive vice president of Mortgage Network in Danvers, Massachusetts, says that it almost never makes sense for owners who are preparing to sell and buy to pay down the principle balance of a mortgage instead of saving money.

That's because buyers often need large sums of cash during the homebuying process, even if they are selling a home at the same time. They might expect to make a sizable profit on their sale, a profit that they can invest in the down payment and closing costs on a new mortgage. But the timing often doesn't work out: How can buyers cover their down payment or closing costs if they haven't yet received the cash from their home sale?

"There are so many needs for liquidity during the process," Koss said. "Even if you are going with a low-cost, low-down-payment mortgage, you never know what you are going to need money for. Maybe you'll need repairs on your new home. Maybe the fees or closing costs are going to be higher than you thought. There are moving costs to worry about. I never hear people say that buying a home was less expensive than they thought. And if you have savings built up to help cover these costs? That can make all the difference."

Koss said, too, that today's low mortgage rates means that it makes more sense to save than to pay off a home loan. If your mortgage has an interest rate of in the 3-percent or 4-percent range, and that mortgage interest is tax deductible, paying down your loan's balance might not provide enough of a financial benefit to make it worth your effort.

No equity - or negative equity - and buying up?

Of course, there are always exceptions. Couples who lack equity in their home - they might even owe more on their loan than their home's current value -- or who plan to buy a larger, more expensive home with their next purchase might do better to pay extra on their current mortgage's principal balance each month, said Featherngill.

These buyers might want to put down a larger down payment on their next more expensive home so that their new mortgage isn't too large. Owners who pay down their existing mortgage can build equity and earn more money at sale. They can then put these larger proceeds into a larger down payment.

Featherngill says that these same owners could choose to stow their extra cash in a savings account or other investment vehicle. The problem, though, is that if these owners want to sell in just two or three years, they might not have enough time to earn a high enough return on these deposits to make them worth their while.

"If you are looking at short-term options, even the best of the money-market accounts or savings accounts are paying out interest of less than 1 percent," Featherngill said. "Putting your money into the mortgage might provide you with a bigger impact."

Plenty of equity?

Owners who already have a significant amount of equity in their homes have more flexibility when it comes to any extra cash they are receiving each month. This is especially true for those owners who have enough equity in their homes to cover their down payment and closing costs on their next mortgage.

And if you have plenty of equity and you're downsizing, buying a smaller, less expensive home? Then you have loads of options when it comes to any extra money coming in each month.

Featherngill says that these owners should resist the temptation to pay down their mortgages and instead use that money in some other way.

That "other way" might mean investing extra money in a savings vehicle, money that owners can later tap to help furnish their new home. Or it might mean something else, Featherngill said.

"Are they maximizing their retirement savings? If not, they can use that extra money to add more to their retirement savings," she said. "Do they need to save for a child's college education? If they are going to have enough equity in their home, it makes sense to use that extra money for some other financial need, not to pay down even more on their mortgage loan."

In the middle?

But what if you're in the middle? You have equity in your home, but not that much. You'll make a profit on your home sale, but not enough to cover your down payment or closing costs on the next home you are buying.

Armando Roman, managing principal of Scottsdale, Arizona's Axiom Financial Advisory Group, says that he advises homeowners to be cautious: Save extra money for an emergency fund instead of sinking them into larger monthly mortgage payments. Why? You never know when something expensive in your current home will go on the fritz.

"What if your water heater breaks or you suddenly get a leak in your roof?" Roman asked. "You'll need to fix that before you sell your home. You need to have your home in its best condition. That can be expensive. If you don't have savings built up, something like a broken water heater can cause some real financial problems."

You can never predict when something will go wrong with a home, even if you're the type who remains vigilant with servicing and maintaining your home's expensive appliances.

"It feels good to pay down extra on the mortgage," Roman said. "I understand the feeling of accomplishment that brings to reduce your debt. But I always get nervous when people don't have a cushion. If you don't have a large enough amount of savings, what will you do if something goes wrong before you put your home on the market ? You might have to resort to putting those repairs on a high-interest-rate credit card."

Published on April 13, 2011