Don't rush to pay off that mortgage

Establish priorities

You need to look first at all your other debt. Chances are, if you have any, it's accruing at a higher interest rate than what you're paying on your home loan. That's especially true for credit card debt: It makes no sense to save less than 6% by prepaying a mortgage when you're paying more, probably much more, in nondeductible interest on your plastic.

What if you're free of other debt? You can start to tackle that mortgage, right?

Not quite. There are other threats to your financial security you need to address, especially:

Financial inflexibility. Fewer than three in 10 households have enough savings to withstand even three months of unemployment. Half say they live paycheck to paycheck at least some of the time, according to a survey commissioned by the Consumer Federation of America. Having an emergency fund equal to at least three months' expenses (plus access to a home equity line of credit) can make the difference between a rough patch and financial disaster; that should be your priority after saving for retirement and retiring high-rate debt.

Then there's the issue of:

Inadequate insurance. If you have people financially dependent on you – minor children or a spouse who needs your paycheck to pay the mortgage -- you need life insurance and usually plenty of it. (You can use MSN Money's Life Insurance Calculator to see exactly how much.) In addition, you need adequate health insurance, since medical bills are a factor in half of all bankruptcies.

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Also crucial: long-term disability insurance, which most Americans don't have.

Fewer than 30% of all workers have long-term coverage, according to the U.S. Bureau of Labor Statistics. Yet your chances of disabling accident or injury are pretty high: At age 30, for example, you have more than a 50% chance of being disabled for three months or longer before you turn 65, according to the Council for Disability Awareness. One in seven U.S. workers is disabled for five years or more.

Wouldn't it be ironic if you skipped disability coverage to prepay your mortgage, then wound up losing your house? The bottom line: If you have access to long-term disability coverage at work, buy it.

OK, so what if you're maxing out your 401k and Roth IRAs, sitting on a pile of emergency cash and insured up the yin-yang? I still wouldn't necessarily attack that mortgage. If you have kids, for instance, you might want to be tucking more away into a 529 college savings plan to make sure they aren't saddled with student loans, as too many young graduates are today.

Again, assuming the money is invested prudently in a mix of stocks, bonds and cash, you should make a much better return than what you can get prepaying your mortgage, and the money is tax-free when used for college.

Of course, you could pay down your mortgage, assuming you'll be able to tap that equity later to pay college bills. But that's a gamble, because lenders are making it tougher to tap home equity as property values fall.

Who really shouldn't prepay

Some folks, of course, aren't dissuaded by counterarguments. They want those safe, guaranteed returns of paying down a mortgage.

There is one large group of homeowners whose returns may not be safe or guaranteed, however: those who are already underwater.

If you owe more on your house than it's worth, you're at high risk of foreclosure if you lose your job or suffer some other financial setback that makes it hard to cover your payments. You can try paying down your mortgage faster to build up equity, but continually falling home prices will make it hard for you to gain any ground. What may happen instead is that you lose your house anyway, along with all that extra money you paid. (Prepaying a mortgage could reduce the amount you still owe in some states; consult a bankruptcy attorney for details if you're nearing the brink.)

A smarter choice typically is to build up your emergency fund instead. That extra cash could help you make payments in the future if your financial life goes south or help you get a fresh start if you wind up losing the house.

What if you're approaching retirement? Now the math changes a bit:

• The tax benefits of a mortgage are typically minimized by the time you hit retirement age. Plus, trying to make mortgage payments in retirement often means having to take more out of tax-deferred accounts than you otherwise might, which can make your tax situation worse.

• Furthermore, paying off your loan tends to substantially reduce your living expenses, which is a great benefit on a fixed income.

I'd still contribute the maximum you can to retirement accounts and make sure you have a fat emergency fund. But if you want to make extra mortgage payments to be debt-free by retirement, that's not a bad choice. This may be the one situation where the price for peace of mind is actually pretty reasonable.

Liz Pulliam Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "Your Credit Score: Your Money & What's at Stake." Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board and helps middle-class families cope at Building a Brighter Future.

Updated Nov. 18, 2009

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