In the past couple of years my wife and I have been able to dig our way out of debt – and a couple of years ago we paid off our last debt, a student loan for my college education. It was an amazing feeling being able to do that – it was a weight off our shoulders.
Over the past two years since our debt has been paid off we’ve been through quite a few rough patches. My wife has been hospitalized twice with unrelated problems, and is now expecting our first child within the next month or so. Needless to say having my wife be in the hospital 3 times over the past 2-3 years hasn’t been cheap, and has set back our investing and wealth building phases back a bit.
We are now in a phase of our financial lives, however, where we’ve saved up a sizable 10 month emergency fund, and are ready to embark on the next steps in life. Building wealth and paying off the mortgage early. So today I thought I would talk about the idea behind making extra payments on your mortage in order to pay it off ahead of schedule.
When Would I Want To Pay Off My Mortgage Early?
One thing that I want to stress right off the bat is that I think there is a progression you should probably follow when considering paying extra on your mortgage. Among things that should probably be a priority before paying extra on the mortgage:
- Making sure all non mortgage debts are paid off
- Making sure you save 15-20% of income towards retirement
- If you plan on helping children with their education, save towards that
If all those things are being done, and there’s still money left over, I might consider paying extra on my mortgage.
How much of a mortgage should you have in the first place? Dave Ramsey suggests getting no more than a 15 year fixed rate mortgage that is no more than 25% of your income. Having a 15 year mortgage means you’ll have higher payments, but it also means you’ll have it paid off sooner, you’ll pay less in interest, and you’ll be forced to stay disciplined to pay it off in 15 years or less.
At our house we ended up with a 30 year mortgage because when we bought the house we wanted the flexibility of the lower payments, and we knew we had the discipline to be making extra payments as we could. We have made extra payments when we have extra. So far this year we’ve paid an extra house payment completely towards principal, and hope to do a couple more at least.
Ok, so we’ve simplified the idea of paying extra towards your mortgage, but there is actually a lively debate as to whether it is a good idea or not. I want to look at some of pros and cons around paying your mortgage off early.
Reasons Why Paying Off The Mortgage Early Is A Good Idea
There are a lot of people who think that paying off your mortgage early is a great idea, and is an indicator that you’re heading down the right path. Here are some of the reasons they give for paying extra.
- Paying less interest on the mortgage: When you pay extra on your mortgage principal it ends up meaning you’ll shave months or years off of your mortgage, and you’ll save thousands of dollars in interest. For example, on a 300,000 dollar mortgage over 30 years, with an interest rate of 5%, you’ll end up paying over 309,000 in interest. Cut that to a 15 year mortgage and you’re only paying 143,000 in interest. The more extra payments you make, and the faster you pay, the less interest you’ll have to send to the mortgage company!
- Less risk, more peace of mind: With less debt on your balance sheet, you have less risk in your life. You’ll have less to worry about when your only bills are food, taxes and other necessities. Add to that having the burden of debt removed from your shoulders. The psychological benefit of being free of debt isn’t to be underestimated.
- More freedom: When you don’t have a mortgage payment you’ll have more freedom. Don’t want to take a job – you don’t have to because your monthly debt obligations are next to zero. Instead do something you love! Want to have one spouse be a stay at home parent? Do it! You can afford it!
- Eliminating debt is a sure thing: While investing in the stock market isn’t a sure thing -having a paid off house you can live in IS.
- Extra money to save, invest and give: When you have a paid off mortgage you’ll have a lot more money left over every month that you can use to save invest and give. Can you imagine how fast your nest egg would grow if you had no debt obligations -including a mortgage?
To me the benefit of having a paid off mortgage can’t be overstated. With no mortgage, and no other debts you’ll be free to pursue things that you enjoy. You’ll be able to work less doing things you enjoy. You can take the money you’ve saved in interest and build wealth. Why not!
Want to hear the story of someone who paid off their mortgage early, and seems pretty happy about it? Check out this post: How We Paid Off Our Mortgage in Under Ten Years
Reasons Why You Don’t Want To Pay The Mortgage Off Early
There are those that say that while it’s a nice idea to pay your mortgage off early, there are reasons why you shouldn’t.
- Liquidity of your assets and flexibility: One argument against paying off the mortgage that makes some sense to me is the idea that putting all your extra cash into your mortgage means you’re going to have a lot less liquidity in your assets, and if a situation were to arise where you needed money fast, your money would be all tied up in your house. This argument is the reason why I suggest that people first save up a sizable emergency fund, and invest and save first.
- Higher returns by investing your money: Many people argue that you would get higher returns on your money if you simply invest it. If you can get 7-8% on your money, you will end up coming out ahead. On the other hand, there is risk with investing as well, and there aren’t guarantees.
- Inflation works for you: As inflation goes up by 3-4% annually, by not paying off the mortgage and paying it over time, you’re essentially paying less for the same amount of house every year. You pay the same today to live in the house that you do 30 years from now.
- Tax deduction: You can deduct the interest you pay on your mortgage, on your taxes. Taken by itself it isn’t a good idea to keep a mortgage, but when taken in concert with the rest, it might be the straw that broke the camel’s back.
So for some people it seems that just holding onto their mortgage ends up being the preferable option. For a story of someone who didn’t pay off their mortgage early, read this post: Why I Didn’t Pay My Mortgage Off In Full
Why We’ve Decided To Pay Off Our Mortgage Early
When you talk about paying off your mortgage early there are a lot of pros and cons on both sides of the equation. If I were to simply make a decision based on cold hard numbers, I might have to admit that maintaining a mortgage for 30 years would be the best route. But since I know that we have a goal of not owing anything to anyone, and we long to have the freedom and peace of mind that comes along with having a paid off mortgage, I can’t rationalize not paying extra on the mortgage – even if it is mathematically the best choice. And the savings in interest speaks for itself.
So after saving and investing, we’ve made what totals to one full extra payment towards our principal so far this year. As the years continue we hope to accelerate the rate of payoff to make the day we can say we are truly debt free come that much faster.
When making your own decision you need to weigh the factors listed above, think about your risk tolerance, and make a decision that you feel is best for your family.
Are you considering making extra payments on your mortgage in hopes of paying if off early? Do you have a paid off mortgage? Not paying it off? Tell us your thought process of why (or why not) you want to pay off your mortgage early.
Rainy-Day Saver says
I feel the same way about it as you do — as long as you’re saving money for your emergency fund, savings and retirement goals and have some left over, why not chuck it at the mortgage? Although I have one more “con”: if you’re going to sell your home within a few years, I wouldn’t bother.
We’ve been putting a bit extra toward the mortgage principal since we bought our home last June — $28 extra/month (so it rounds to a nice number in my checkbook. I’ve now upped it to $48 toward principal each month, and the mortgage would be paid off 2 years early if we keep it up for the life of the mortgage loan. And we’ll save $20,000 in interest. The tax deduction isn’t worth it to us, in the end. I’d rather not have a mortgage looming over our heads when it’s time to retire.
Peter Anderson says
I agree, if you’re planning on selling soon, it’s most likely not worth it.
Question, though: why wouldn’t someone want to pay off the mortgage if they’re selling their home? Doesn’t that mean they get to pocket the profit from the house, plus improve their credit score if they’re buying another home?
If you put all your cash into the principal of the house then you won’t have anything for a downpayment. You might have to sell and rent while shopping for a new house in order to get your cash our of the house. Avoiding that would save you the hassle and expense of moving in and out of a rental (though if it’s long distance that may be necessary anyway).
My understanding is that it’s not always easy to get a loan to cover the downpayment. That’s when you’ll wish you had the cash on hand. Some retirement plans will let you borrow your principal but not all so that’s not an option for everyone.
very nice analysis. I don’t have a mortgage yet, but my student loans are pretty hefty. I heard Dave Ramsey talking the other day about the mentality behind his debt snowball and part of the reason why it works is not because mathematically it makes the most sense, but that because psychologically it makes sense. Paying off a loan is a huge psychological boost, I know it has been for me. I feel that ONCE you do pay this off, it will not only be a huge relief financially, but psychologically as well. Sometimes that’s more important I feel.
Casey Stubbs says
I am working on getting out of debt with college loans, credit cards etc.. After that I was thinking about paying off the house as a goal and now after reading this post I think I will for sure.
Thanks for the article it helped and congratulations on your upcoming child. Children are a great blessing
Financial Samurai says
I kinda throw disposable income at my mortgage whenever I feel I have too much income if that makes any sense.
With savings at 1% now, best to pay it off as much as possible!
Financial Samurai says
Pete, am I blind? Where’s the Tweet button?
Peter Anderson says
I chose not to add the tweet this widget as it was slow loading and was causing the site to slow down at times. I figured that most of the people were sharing the article off of my original tweet anyway, so it just wasn’t worth it to add the widget. The same goes for a variety of the other social sites, and their widgets.
Money and Risk says
Ironically, I’m reading this post at 3AM after I wrote about a house as investment yesterday.
A home and mortgage is an emotional decision and you covered all the bases pretty well here already. Paying off your mortgage or not is going to depend on the emotional needs of each individual. There is no right or wrong answers. It’s just what makes you happy. That’s what is going to be right for you.
I’ve been there and paid off my house. However, I chose to have a mortgage when I moved. The decision to pay off the house was imposed upon me and it was not the right decision.
For me, the major concern is inflation, value of money today vs. tomorrow, and a large enough liquid reserve to cover major health issues. I just prefer to pay the interest and maintain enough liquidity to payoff a mortgage if I want to.
This made a difference when we had to have $164,000 for a medical issue recently. No amount of money can offset a life. The difference in perspective may be due to the age difference and just luck. We’ve been hit with 5 catastrophic medical situations in the last 20 years.
Matt Peebles says
Money and Risk,
Another idea would be to pay off the house and get a Home Equity Line of Credit (HELOC) as a backup. The HELOC can sit there with $0 balance and $0 payments (except an annual fee). If you have an emergency, then you can draw from the HELOC to pay for it. This way those mortgage payments can go into a better investment (or cash reserves) and you won’t be paying interest unless you actually need to use the money.
That’s a fantastic idea that I had never thought of, and I haven’t seen anyone else recommending it. It makes complete sense.
If your mortgage is paid off, then you aren’t paying any interest. If you then take out a HELOC, your interest rate will be somewhat higher than your mortgage rate was, but not much and certainly lower than just about any other interest rate on a loan. But you’re now only paying interest (which is still tax deductible, potentially) on the amount that you have borrowed, not a much larger mortgage balance. It seems like the optimal solution for many to me.
Given all of the financial issues going on in our nation and globally, I think that a global depression is likely to occur at some point in the future, though it may be a number of years before it does. At any rate, if it does occur, you absolutely do not want to have a mortgage on your home. Ask anyone who went through the Great Depression (much worse than our ‘great’ recession) if they would rather have had money invested somewhere and a mortgage balance or neither. And even if no financial issues arise, you still own your own home and don’t have to pay banks for it any longer.
exactly why I chose to pay off my house, nothing more secure than a roof over your head come what may…
I take my first position 150k mortgage. Then I use the heloc and pay principal to the first mortgage at 10k increments. This 20k heloc start still gave me 10k in available emergency funds. Rather than pay a minimum interest payment in my heloc…I deposit all my money back in to the heloc and reduce calculated interest. I’m never concerned about paying off my helOctober Balance because if I need money I can get it back instantly. In the beginning it took me about 14 months to pay off my 10k heloc Balance. Then I paid another 10k to my mortgage and noticed that i was already 7 years in to my first mortgage. It only took me 6 months to pay it back again because I got really excited about the quantum jump of my first mortgage. I will have the whole loan paid off with 6 years of start. Have no issue with mortgage interest because I found out bank of America will give me an extension up to 100k on my heloc. Plan to use it for a down payment with ano investment property soon. 401ks and iras are not my thing. I want to see and control my portfolio starting with my own house first.
Not to get too far into our budget, I’ll just say that we live on my weekly paycheck and save his twice-monthly paycheck.
I have several ING accts. One is for our $1K emergency fund. That account “doesn’t get touched”, if you know what I mean. Another is our “we’re debt free” account. We transfer money out of it as needed for “emergencies, opportunities, etc”. Quarterly, we have a meeting to decide specifically what to do with the money in that account. It could be home improvement, *new* vehicle, extra on principle, etc., or simply let it ride for another 3 months.
WolfBridge Financial says
I enjoyed reading your post, I think it was very well thought out.
I also think that your post demonstrates that each person’s journey is different. I don’t have a mortgage yet. I just graduated from college and I’m trying to save up a reasonable down-payment on a house! :)
Thanks for the great post!
Its compicated, but simply put, if the return on your investments is higher than the interest you pay on your mortgage, then invest!
Randy Redd says
Peter, Thanks for another great, thoughtful post. Very sound advice. Hope your wife’s health improves.
good luck with 18 years of child support
LESS RISK, MORE PEACE OF MIND. My favorite paragraph of the post. I had never thought of it quite that way but you are absolutely right!
My number one reason for wanting to pay off a house early would be more flexibility. Once it’s done you are able to have flexible choices with your entire paycheck. Or, able to reduce worked hours to pursue other things. May God bless in whatever you choose. Sounds like you are choosing a life to honor Him.
I first bought my house in 1997 with a 30 yr mortgage. After 3 years I refinanced for 15 yr fixed lower intereste rate than the first mortgage. I’ve been trying to send at least 100 extra a month on my principal. (at first it was $50). And I’m pleased to say that when I retire within the next 4 years, my house will be paid for. And from 30 years it will be paid for in 16-17 years. It is what I’ve been striving for since I know that the retirement money won’t be anything near what I am making. I just wanted to be sure that when I retire I won’t have to be put out of my house because I wouldn’t be able to pay. I can deal with the taxes and bills and as you say it will be a relief to not have a house note on top of that!
Would this be advisable? I started with a 30 year mortgage that I’ve paid almost 15 years on now with an interest rate of 8.25%. I refinanced this and a HELCO into a 10 year conventional loan at 4.5% for around the same payment that I had before so I’m saving nothing but 5 years of interest. I believe strongly that I can get this 10 year loan paid for in 5 years. Once this is done, I can increase my 401k contributions to the 15-20% range and I’ve saved 10 years of interest. I will have a small emergency fund and the only debt I have is the house that I’m tired of paying for. Any ideas? Thanks
I was so glad to read about reasons to pay off AND not pay mortgage off early. I have decided to keep on working on paying off my mortgage early. I had a mortgage for $140,000, five years ago @ 5.875% fixed loan . Now it is down to $46,000. Any extra money, I pay on principal whether it is $50-$1,000 a month. I put my entire tax return on the mortgage each year. My income is $65,000 a year . I cannot wait until my mortgage payment is paid off and that extra money is freed up. Other loans such as college and old credit cards were paid off fast with the pay on principal method also. I am almost debt free. Thanks for giving me an affirmation on this.
I think I will start. I looked at how much I would save by using an online amoritization calculator. I can save a lot by putting just $25 extra on principal. I do plan on puttng a little in savings too..
Mathematically investing is the way to go, but if you can pay off your mortgage early and avoid having to make monthly mortgage payments you do so.
Paying off your mortgage is the sure thing, investing is not.
I agree, paying off mortgage give you sure return while investing does not. Recently a coworker asked me this question and I wrote about this on my own blog,http://path2top.blogspot.com/2010/06/pay-off-your-mortgage-or-invest-in.html
Keith Conrad says
I am in a similar situation with my mortgage and thinking about paying it off even earlier. Several years ago we changed our mortgage from a 30 year at 6.875% to a 15 year when interest rates went down to 5.25%. The move to a 15 year mortgage cost us about $200 more per month in mortgage payments, but it cut 15 years worth of mortgage payments and interest payments for us. The extra $200 did not hurt us since we built our home in 2001, and we stayed well below our means price wise. Now that our son has started school we are thinking of taking the money we are now saving without daycare payments and doubling up on our house payments.
We are currently funding out retirement accounts to the max, have a Roth IRA as well, no debt, and we have a decent amount of cash in the bank. My question is would I be better off saving the extra money every month and then sending a large payment in twice a year towards the principal, or should I just send an extra $1000-1500 a month in with my regular payment? Also, should I be very aggressive and take $15-30K out of savings and take a chunk out of the loan balance, or should I leave it there and just double the payments? If I double the payments starting now I can pay off my mortgage in about 4-4.5 years, and the only downside I can see is that I will lose a tax break. Thank you in advance for any/all advice on this matter.
I would not touch the $15-30K in your savings, you may need that for an emergency. Continue to put extra every month on principal even if it is not a double amount.
Save the extra monthly payments and make quarterly payments or bi-annual payments. In that way, your monthly payments will not be spread to principal, interest, tax and insurance (PITI) on a monthly basis and thus gives you less bang for your buck to lower the principal. On a quarterly or bi-annual basis, write that the extra money are for principal only. Emergency fund should never be touched to pay extra to mortgage for whatever reason.
Leave your savings be. Double your mortgage payment and forget about making one or two large payments per year. You’re young. You need that savings with a little one. If you try to save $ up for 1 or 2 extra payments each year instead of just routinely paying $1000 – $1500 each month, that money will get absord into things you think your child “has” to have. Force yourself into having a tighter budget. You will NEVER regret it. Kids can and will suck the life right out of your budget – cause who really can say no to the little one they adore when they “really, really, really want to do this, that or the other.
Before you focus on wiping out your savings and pay down your mortgage, take the following analysis.
Is your job or income possibly at risk in the future?
Can you afford and have enough savings for 2 yrs of unemployment.
Can you afford the change if your income gets cut in half?
Have you plan out extra costs next year that are beyond your control?
Unless you have enough savings to weather these situations, anything else is a risk. Too many bloggers and financial advice focus only on one thing. Pay down debt. I have not seen many discuss planning for the unexpected in life as well as for macroeconomics which you have no control over.
The bank will not cared how much your mortgage is paid down. If you get in trouble and can’t pay the mortgage, they foreclose.
I heard of saving for 6 months of emergency savings and recently I heard of saving a years worth. Since some are unemployed for over a year, I think saving for 2 years would be great if you could do it.
Gary Oliveira says
I owe $80.000 dollars on our $600.000 house. I have $220.000 in our saves. I am retired with an annual income of $53.000 p/year. I have no debts. Should I pay off my house or keep using the $420.00 p/month interest on the house as tax deduction. I am confused on what I should do. My wife says “pay off the house” i say “Let’s leave our savings alone”. Help us.
Pay off the house!! The money you’ll save outweighs the tax deduction. And you won’t be wiping out all of your savings, do it!
My wife and I are tired of the rat race…yes, we own our own business and that gives us a lot of flexibility, but it also creates a lot of stress as we are responsible for our business and you never clock out (it’s 24/7). Last week we went away on vacation and did a lot of thinking and decided to finish up our mortgage early. We have a 15 year mortgage and over the last 3.5 years have managed to pay a little bit extra toward it and if we just make the minimum payments of $2,700/month then we’ll be done in 11 years and 3 months, but we’ve realized that we can afford to pay $3,700/month without making major changes to our standard of living, so these extra $1,000/month will allow us to finish paying off the mortgage in 7.5 years and save us a ton of interest payments to the bank.
It’s funny how things can be addicting. I’ve already programmed the higher payment amounts to begin in a few days (January 1, 2011), but I’m already thinking of how we can increase them again in the next few months. Maybe going out to dinner less, turning off more lights when they’re not being used, etc. All of these sacrifices obviously with the long-term goal of gaining what I most value: Freedom!
If we can manage to pay off the mortgage in 5 years instead of the projected 7.5 years then I will have my house paid off before the age of 40…my wife will be a young 34 at that time, so that’s not too bad. If we can live a long life, then we may possibly live half of it mortgage free.
Back to Freedom: I love my life and don’t feel that I’m a slave to anything, but wouldn’t it be nice to know that if you wanted to, because you have very few expenses, you can work part-time…maybe even just 2-3 hours per day? Imagine that?!?!?! At present my wife and I work 40+ hours per week so changing that to 10-15 hours per week sounds amazing.
In the end, it is not about money but rather about freedom and the ability to do with your life what you want and not feel that you owe your boss, your work, your bank or anyone anything.
Congrats on taking the plunge and paying off your house early, and since I started the thread I have been more motivated to pay off our home early as well. One thing I would suggest doing is writing down your monthly budget or plan before the month starts(Dave Ramsey’s) method. I found that when I give name to every dollar it really helps to identify where your money is going. One thing that they suggest is to put more in your food/eating out column since people typically under fund this area and it puts them over for the month. The other thing I do is take that money out each Friday when we get paid and we use that for all food expenses for the week – when you pay for things with cash you feel more of the pain rather than charge it and let them pile up until the end of the month when you get your credit card statement. At that point you look at your wife and say “did we really eat $600 worth of food this month at restaurants? :)
Our reason for paying off our mortgage is pretty much the same reason you have stated – it will give us the freedom to do what we want whether it is work, vacations, or charity. We can and do all of these things now, but without having a $1600 a month payment to deal with along with the extra payments we can potentially save $3000 or more a month. Also, our house would be paid off, and if we wanted to move up to a large house or find one that better suits our needs we would have the entire amount of our home sale to use as a down payment. Not only would we be able to put down a sizable chunk, but having the confidence and knowing that you have already done it once would be very motiviating to do it again. I can state from experience that when we refinanced 6 years ago and went from a 30 year to a 15 year it was the best decision we have ever made. For an extra $200 a month we cut off 15 years from our mortgage – we went from a 6.875 interest rate to a 5.25 – currently 15 years are in the low to middle 4’s.
Congrats on your decision and best of luck with your mortgage paydown! Have a safe and happy new year, and best of luck with your business.
Go early. I find the reasons not to do it far more speculative than the reasons to go ahead and get’r’done. I actually found a mortgage company to refi me for a 10-year loan at 4%. Hurray! Before my kids are done with high school, I’m out of the debt game (if all goes according to plan.)
I also challenge the math that you can get more out of investing than you can out of early payoff. Investing isn’t a steady, perfect world – to make more than 4 or 5% you have to take risks. Paying off your mortgage is a risk-free way to build wealth. The inflation argument has another side to it. Yes – paying your loan in future dollars is “cheaper” – but the house you are living in should be more “expensive.”
I was all set to pay off all my debt and house until I read some of the comments. I am thinking now that I should invest. My original plan was to payoff my house within 5 years and start saving. With my house paid off I could save $20,000 a year. BUT If I lose my job or if they make drastic paycuts I will not be able to afford my house and the bank could take my house even though I have already paid down over $100K towards principal over the last 5 years. I am kind of nervous because I have been dilligent at paying off bills, car, and paying down on my house. I only have $600 left on a credit card and $36,000 on my house, nothing in savings, and very little in 401K (under 10K). I should be able to retire in 10 years. Please can someone offer me some advice on what to do.
If you’re looking to retire in 10 years – get that 401(k) cranked into high gear and let the mortgage take care of itself with time. I would, however, throw $600 at your last debt and NEVER buy on credit again. You need some serious savings and investments for retirement. With no savings and less that 10K in a 401 I don’t think you should be thinking about retiring in 10 years if you can avoid that.
I can’t give you advice (regulations) but I brought up questions for you to consider in a comment above.
Our real estate division sees many foreclosures that has huge equity in the home but that people are losing because they are unemployed for a long time or lost their job and got a much lower paying job. These people had no savings at all to cover their situation.
In terms of emergency, do you have the funds to pay for health care? Do you want to choose between life and death for yourself or someone in the family because you didn’t have the savings. A simple boat ride and seasickness was enough to trigger a $3000 emergency room cost for my sister. She would have died from shock if she hadn’t received the care immediately.
Paying down the mortgage is just one small part of financial planning. It’s mostly an emotional response. You always have to plan for other needs as well.
Here’s what you should ask about retirement. If you only have $10,000 for your retirement, how are you going to retire in 10 years? Let’s assume that you have the discipline to save $20,000/year for 8 years after you pay off your mortgage. Let’s assume that you’ve built up to $180K by the end of 10 years. What is your living expenses now without your mortgage?
Are you going to be able to get enough income from $180K to support yourself yearly without ever touching the principal? If you’re not working, that $180K will not grow unless you’re taking out less money than it makes. It will be worth less and less each year as you get older (inflation).
Can you generate enough income from your savings to give yourself an increasing paycheck for 30-40 years?
No more intrest says
Did you know your low interest rate is only low if you pay it off in the first year? Otherwise it can be as high as 92%! Don’t believe me? Take your mortgage payment and multiply it by 30 years and subtract escrow and PMI. Now does that add up to only 4-7%? You’d be better paying off your mortgage early saving tens of thousands of dollars. And that tax deduction, Uncle Sam will give you 0.28 for every dollar you pay your bank. Wouldn’t be better to pay the government the 0.28 and keep the 0.72 in your pocket. I know I simplifying things here, but nothing beats the security of knowing if something happens to your livelihood no one can take your home. Also, can you imagine placing that mortgage payment in your account and not the bank’s? How much could you save for retirement, who else could you help, or what else could you accomplish, if that money was freed?
Derrik Hubbard, CFP says
I am going to suggest an alternative to extra principal payments….payments to yourself through a “side fund”. Instead of paying additional principal to the mortgage company, put your additional payment in a conservative side fund that will generate compound interest. At some point in the future, the side fund balance will grow to pay off the total mortgage balance.
Some potential advantages of the side fund route include:
First, the side fund is liquid. By this I mean that you have immediate access to the funds in case of emergency without penalty and without interest cost. Recapturing money put into extra principal payments is not as easy as it requires borrowing the money out of the home through a loan…a loan you must qualify for and that you must pay interest on.
Second, each dollar that is put your side fund has compound interest working for you. Each dollar you put toward extra principal payments reduces your mortgage, but that money does not earn a rate of return. It pays down a simple interest loan.
Third, the more you pay down a mortgage balance, the less you have in interest deductions. When paying money into a side fund, you end up paying a greater amount of interest on each mortgage payment, maximizing your tax deductions. Now before you get on my case, I do understand that it is better to pay off a mortgage than to continue to pay interest for a tax deduction. But all things being equal, you’d rather have more of each payment be interest than principal for the tax deduction, if you can still have the same (or fewer) payments.
Payments to a side fund actually reduce the total number of payments as compared to paying extra principal payments. At some point in the future, the growth of the side fund will pay off the total mortgage balance.
As an example, a $350,000, 30-year mortgage with an interest rate of 4.5%. has a payment is $1,773.40. You have $500 of additional discretionary dollars per month that you’ve decided to use toward paying off your mortgage. You need to decide whether to pay toward the principal or to a side fund. In this illustration your rate of return over 30 years on your side fund is 7%.
Let’s look at the final results.
Extra Payments To Side Fund Mortgage Principal
NUMBER OF PAYMENTS 210 231
TOTAL PAYMENTS $477,414 $523,549
TOTAL INTEREST $225,582 $173,049
TOTAL TAX SAVINGS $78,954 $60,567
TOTAL NET HOUSE COST $398,460 $462,982
TOTAL SAVINGS $64,522
In this case, with the assumptions that I use in my illustration, my total mortgage costs are 15% less using a side fund than paying extra principal payments.
There is one major mistake that virtually everyone who has commented has made, and that has to do with the tax deduction. They’re looking at the wrong side of the coin.
One side says, “Why pay a mortgage of $1,000 so that you can save $300?” That certainly seems to make sense. Unfortunately, you need to turn the coin over.
With a rate of 4.5% in a 30% tax bracket my NET COST OF BORROWING is only 3.15%. Meaning, as long as I can earn more than 3.15% on the money that I would be applying to principle then I win. Guess what? You don’t need to earn 7% and put it at risk. You can earn 5% in a guaranteed and predictable environment and kick the banks butt each year.
If you disagree then you would also HAVE to agree that banks have a bad business model because they do the EXACT same thing. They have a cost of money (what they pay you for depositing your money) and then they simply go out in the marketplace and earn a spread. It’s very simple. It’s even easier when you have a 3.15% rate LOCKED for 30 years.
Look at the other side of the coin and you’ll begin to earn like banks do.
Investor Junkie says
I agree.. see a recent post of mine.
If the tax deduction disappears (or you don’t itemize) it might be another story. For our situation it does not make sense.
What a nice article. How can you quantify on all those financial analysis the piece of mind that comes after paying off a mortgage? By maintaining a bill free from any loans like cars, students, credit cards etc, it makes it possible to concentrate on paying off a mortgage early. Going from 30 yr to a 15yr mortgage your total interest payments are reduced from over 100% to a little bit over 30% in today’s low mortgage rates. And even if those 15 yr loans are paid earlier the total interest payments can be reduced to under 20%. Of course everybody’s condition is different and every investor has to do their DD, but paying off a mortgage early can end up in big savings and stress relief in the long run. GM.
We have been doubling our mortgage payment every month for the last 2-3 years. We have a healthy 8 month emergency fund and are saving for our next car. We don’t have any children. I like your comment about funding retirement 15-20%. We are at 10% now. Will make a tweak.
Nicely done on the ER fund and paying off extra on the mortgage – BUT, without kids, there is no excuse for not fully funding both your retirements. Bump it to 15% asap. Get used to living on that long before you have any kids ’cause once they come along you have to get started on a 529 for their college. Mortgage interest rates are too low right now not to putting some of that “mortgage” money into a Roth IRA or 401’s. You do not want to lose the compounded interest that comes with time.
The interest deduction is really good at first, but when you get into the final third of the payments, the deduction also goes down dramatically. But, since it’s hard to payoff the whole thing early, I’d agree — don’t worry too much. We’re looking to build a cash fund over time with our emergency fund and look for a time around the 10-13 year mark (of our 15 year fixed mortgage) to then just write a final check and be done with it. Good article.
We just bought a $287.500 1BD CoOp and put down 20% ($57.500.00) fir which I used $28,750.00 in cash savings and took a $29.000.00 401K loan. We got a 4.25% fixed mortgage rate on the $230.000.00. Are we better off making addtl mortgage payments or, investing surplus in mutual funds? I am 51 and suppose I’ll be working for 20 yrs. more to pay mortgage. Also, I have 15 years to pay for the 401K loan which scares me more if I ever lose my job. There are no penalties for paying either mortgage or 401k loan sooner.
Kelly O'Connor says
@alfie – your answer to this question is important: if the bank offered you a 30 year mortgage with a rate of 0%, would you pay off your loan if you had the extra payments or the cash to do so?
My first house was a starter house. I paid off my first house in five years and stayed in it 10 years; I sold at the top of the boom for double. Paid cash for my next home. I could have dollar cost average into the stock market or put it all in. But I love the peace of mind I have owning my house and it also give me peace about my money in the stock market – Paying off my house gives me peace and options.
I had a house built me and my wife and kids moved in in April 2011. The house cost me 345,000 to build thats including 35,000 for the lot. I got a bank loan after my down payment for 190,000 with a 30 year fixed at 4.75% monthly payment just the house is $1,328 a month. I have 36 grand in savings, own my own business and make over $100,000 a year. My question is I got a large government order which will give me a profit of $321,000 Should I pay off my house?
Free Dental Care says
Yes and great for you! What a blessing! If you have the ability to pay-off the mortgage, do it. I worked in the mortgage industry years ago and although the rates seem good, consider this – you will pay a majority of your interest up-front. If you are paying $1.328, I suspect a overwhelming majority goes to interest each month ($700+). In the end, you will save big time and if you ever need money for anything major, simply exercise a line of credit on the house. Take care and God Bless!
Pay that house off asap!
Kelly O'Connor says
Thought I’d apply a little math to your question. We have family in town and I’ve taken a few weeks off (i.e. I had the time) and decided to make a video for you regarding your numbers.
Check it out: http://www.youtube.com/watch?v=cicbCB4NDeM
I have one strong cautionary tale regarding paying down the mortgage instead of putting the money in an investment. (Yes, I do mean to say that a home is no longer an investment.) I had always subscribed to the school of thought that said paying down the mortgage early was a good thing. You build equity faster and can get out of the mortgage earlier, which meant you would save interest. So, that is what I did. I paid extra every month on our mortgage. I did this for 10 years and made good headway against the mortgage. Then my other half got a new job and we needed to move and sell the house. Then the market crashed and took all of the equity that I had built by making those extra payments down the drain with the loss of home values. Prices in my area had fallen so low that instead of getting money from the sale, we had to pay. We might as well have put that extra mortgage money in a pile in the backyard and burned it with the fall leaves. I think if you never plan to leave your home and can pay it off within 5 years, it might still be a good idea. Anything outside of that is a gamble these days.
Eye opening comment by Marie. I have to agree with her.
joe bally says
We are married, we live on her salary monthly…which accounts for everything but a few small spending habits, Ive been banking my paycheck for a about 3 years, have save almost 100k, plus 75k in assets, collectibles that i could wash out of at any given time. We owe 37k on a 150khome (realistic value) she has a 401k, i do not. I have a small traditional IRA. only worth 16k presently……ive been pounding the mortage with 200 dollars every month on the principal, not up too 500 a month. DO you think that is smart? this money is basically coming from are cash savings…..I have enough to pay off the mortage but i like the security of the 100k , even if its earning 1%.
steve vennemann says
I think if you save extra money for reserves it is a no brainer if you want piece of mind so you can do more things in life retire early extra with out having a large mortgage payment. though you will still have to pay taxes on the home and association dues if you live in a town homes or condo..
alohafrom hawaii says
All I can say is my last three houses were paid off and there is nothing that can make you feel as free as having no monthly bills, other than utilities etc. Nothing!
Pay the mortgage, you will never look back….
Thank you for your honest opinion. I had to make this decision and have the funds to pay off my mortgage and still have a decent nest egg left over plus a retirement annuity for my current retirement.
I am about to be mortgage free as of tomorrow and so happy about it. We have a little of $400K in retirement savings, and our house is realistically nearlt $400K, no other debt. We are taking 52K to pay it off. We have been here 15 years and plan to life here for good. We own our own business, so not having a mortgage adds to our peace of mind. We are going to bank the $1580 monthly payment and invest and keep the same lifestyle.
This is the magic question we ask ourselves and others have asked us once they see what we have sitting in our emergency savings when I post our monthly Net Worth. I know to most it seems odd but we didn’t want to rush this rather research was more on our minds. It’s not an easy decision to make but for all the reasons you pointed out I’d say we’d likely pay it off.
Thanks for a great post, lots to think about.
I am 61 and paln on working until I am 70. We refinanced in 2009 to a 30 yr mortgage. We have no other debt. Since our first payment we have been paying a fixed amt extra on the mortgage each month. By this rate we will only owe 1 1/2 yr on the mortgage by the time I retire.
At the present I am buying 10% of my pay in company stock at a 15% discount and investing 10% in a 401k. We only have 60,000 saved between the stock and 401K.
We feel that going into retiremnet debt free is a smart thing to do.
My story is small potatoes, I suppose.
I was blessed with a great job five years post bankruptcy. I came out the other side very lucky and hopefully tried to learn from my mistakes. I bought a house in Fall ’08 for 110K, took out a mortgage for 87K. I make around 80K per year. I decided to go modest and conservative, even though the banks qualified me for 340K mortgage. I save 1.4K a month for retirement, by maxing out the 401k with 5% matching. In Ohio 340K buys a decent McMansion or the likes, but I opted for a baby-boomer suburban 3 bath 2 bedroom 1K square foot ranch in a decent neighborhood. And a payment (722/month) that I could afford even if I had to go to work in fast food, not that anyone should above the extreme hard work that goes into our value meals. Instead of the McMansion, I’ve been obsessed with paying down the mortgage. I now owe 21K. I become elated every time I pay 1K every two weeks or so and watch months and years drip away from the amortization schedule. I think I am pretty disciplined by not living according to my income. My 401K is about 100K already.
Having that modest house free and clear is going to make me feel like a millionaire. My only downfall is that I don’t have an emergency fund. But at this point, I could sell the house at a loss, or rent it out and not have any liabilities left. That’s worse case. I still reserve borrowing against the 401k, I’m 33, so I do have some time to make it up, or accessing the HELOC that I have not touched. The bank insisted that I had a reason for taking out the HELOC, and I told them I needed it for emergencies. I even told them that I plan on agressively paying down the mortgage and only have a year and a half left until it’s paid off, so I’m not going to deal with their petty savings interest rate when they’re getting more in interest in me by delaying the mortgage payments. I plan on staying in the house, and doing a major renovation and paying in CASH for it once it’s paid off, to make it truly my dream home.
I don’t want a gimmick, a tax write-off, or a line graph. I want to walk into my home and know it’s MINE! :). I think it will also make me feel better about work, knowing that I’m not working as a slave to debt, but because I want to be there instead.
The only way of having more money, to my knowledge, is by earning it or saving it. Out of the 2 options, saving it, is the most controllable. Therefore, by paying off debts as quickly as possible, the money saved in interest will be greater than other types of investments. For example $300,000 mortgage at 5% 30yr fixed = a total repayment of $609,000 vs. investment at a 10% return per year will need 7 years to double itself. The banks want us to keep the mortgage as long as possible, and inflation has historically doubled every 10 years. I can’t force my boss to give me a raise, but I can force myself to be cheap and make higher mortgage payments. Also, in the real world, an emergency fund is called a credit card. Let’s get real. The banks want us to keep the mortgage as longgggg as possible. (Whisper voice) And they’ll tell you just about anything to keep it because they want interest. But Shhh we don’t want to upset the people getting that huge tax return on the interest payments. Frankly, I will gladly give anyone a 25 cents for every dollar they make me…… Just my opinion, waiting for someone to change my mind
From my experience I can say, there are financial calculators which show you in detail how to payoff mortgage early. The calculator which I use is ” Smart Loan Calculator Pro ” which is available in app store for 2 bucks. It is awsome. It is not for one time. It is life time useful smart calculator. Give it a try. I guarantee, you would thank me after you download and check it. After checking this, I realized how easy to payoff martgage early.
Richard Cosola says
I need some help and advice…
I have the ability to pay off my 6% 100K mortgage in one shot. There is at least 15 years left on that. My wife is now disabled and I have my own medical issues. We plan to be in the house forever and leave it to our only child. The house happens to be in my wife’s name only and we remoldeled it completely over the years so it’s very comfortable. We have no other debt. We don’t even file taxes anymore because of our income doesn’t meet the minimum requirement to do so. Because of this, we don’t even get to deduct the interest on the mortgage.
I think we should pay it off–Any good advice out there??
Jamie (@va_grown) says
Paying off our mortgage is a major goal for us. We have no other consumer debt at this point and we want the freedom of TRULY owning our own home. We’re also choosing our mortgage over college savings, for several reasons–one being that without a mortgage when the kids go into college, we’ll have more options for helping them. We’re putting a minimal amount away for each of them for college and definitely putting our retirement $ away, then focused on paying off our house before they are out of high school.
We’re trying to implement a best of both worlds plan where we put the extra money we would put toward our mortgage in a savings account. We have it available for extreme emergencies, but when it equals our mortgage amount, we plan to pay off the mortgage. We won’t save quite as much in interest as if we paid it along the way, but we’ll maintain the liquidity. We’ve also figured out some major milestones of savings where we plan to come back and consider refinancing with a major pay down.
I have 21K left on my mortgage with a interest rate of 6.35% With concern about my investments and the market, I would like to pay off the mortgage completely. Mostly it would give me peace of mind and I feel the risk would not be as great for me. Any ideas out there?
I’m in the same situation you are. My blog is below. I believe it’s best to go ahead and pay it off as Whitney wrote below, sure would be a nice feeling!
Paid my mortgage off. I could not be happier. I love having that extra money. I am about to go on a few cash paid trips to celebrate then I will start doing some heavy savings.
Robert venito says
I’m 46 yrs old my wife is a few yrs older then me. I recently decided to pay off out morgatge of 330.000 at 6.7? interest rate it cost me 2.900 a month when I calculated the math it would save me and my family a estimated total of 477.000 in 22 yrs can’t think of any other investment that can guarantee me that much savings in 22 yrs .if anyone has any better idea that can top this I would really love to hear about what you think . sincerely Robert a Venito.
Need sound opinions advise here. I just retired at 56 yrs of age. I have $1M saved up in my 401K. My 30-year fixed VA loan mortgage balance is $284K with a 3.75% interest rate. 28 years left on this mortgage due to a recent refinance. If I pay off this balance and withdraw the funds from my 401K they will withhold 20% ($56,800) for IRS taxes. My monthly payment on this loan is $1670. So the choice I have here is: a) continue paying off my 30-year mortgage or, b) withdraw the $284K plus tax loss of $56,800. Sure would be nice to be debt free if I paid it off, however, I would then lose out on end of year mortgage interest claims for future tax returns.
Thoughts? Need everyone’s second opinion please.
Forgot to add that I also have a life insurance policy for $350K for my beneficiaries to pay off the remaining balance on this 30 year mortgage once I kick the bucket!
I don’t know if this board is still active but I came because in 2 weeks I am buying my first home at 50yrs old. I plan to pay it off by the time I collect SSI.
The 401k withdrawal would cost more like 30% – 40%. Regular income tax plus 10% early withdrawal penalty.
I would wait until 59.5 to avoid the 10% penalty.
Even at 59.5, the $284k lump sum in 1 year could raise your IRS tax bracket.
What I would do in your situation:
I would continue paying mortgage until 59.5yrs old so I could use the 401k without the 10% penalty. While sending sending extra principle if possible.
Then make smaller yearly 401k withdraws (3yrs – 5yrs?) to keep the 401k income spread across multiple years to keep income taxes as low as possible.
This would also keep more in the 401k each remaining year to (hopefully) keep earning.
285K at 59.5yrs old / 715k in 401k to grow / 285k+other income = ?tax bracket?
95k/yr for 3yrs / 905K, 810k etc in 401k to grow / 90k+other income = ?tax bracket?
This is just my 2 cents. You would have to do your due diligence based on your situation.
I have $100,000 in investments and another $50,000 in my 401K…I owe $54,000 on my home. I want to pull that money out of my investments and pay off the mortgage. Is that the way to go or should I leave the investment money alone and continue paying the bank? (Knowing I could save $11,000 in interest to the bank)
Peter Mueller says
When I bought my home in 2010 it was near the bottom of the market here in Mesa. I had to file Bankruptcy in 2012 but was able to keep my home. Since then I have been getting on a winning track. All my debts will be paid off in 4 months except a used car I bought my wife. I will pay off the car and have a one year reserve in cash by next year. I converted to a 15 year loan at 3.62 percent. The home has almost doubled in value since then.
My question is I would like to pay off the home early. Probably in 7 to 8 years. At that time I will be 73 or 74. Then what I would like to do is take out a 30 year mortgage at a low interest rate and put the money in a safe retirement account. It could be in the range of $250,000 to $300,000 dollars. Then I would use the money as a retirement account and paying off the mortgage.
Good idea or bad idea?
We paid off our mortgage a few years ago…such freedom! we have been taking what we were paying in a house payment and saving it in a ROTH IRA and buying more property as it builds and a tractor! Next we are using it to develop the property and put a small home on it to rent (a single wide) I’m a bit of a land amasser I guess..