Pre-paying the mortgage
Posted on September 10th, 2008 – 1:44 PMBy Kara McGuire
So Matt and I have been thinking about starting to save more in cash, not only because of the point that Tom made in the last post about my job given the uncertain industry I work in, but also because if we do want to move in a few years, chances are home appreciation won’t be enough for a down payment on a new place.
But then I started thinking that if the primary point of the cash is for a down payment, then why wouldn’t I just double my mortgage payment, which in effect would mean we’d earn a nice 5.879 percent return on our money.
That’s BEFORE the tax break we get from deducting mortgage interest, however. Consider that savings and pre-paying our mortgage wouldn’t get us much further ahead than if we stuck the cash in our “high-yield” savings account at 3.5 percent.
According to this mortgage tax savings calculator, our after-tax rate is 4.057 percent.
And we’d have flexibility to use the money for other reasons if necessary.
Then again, I’ve been thinking lately that one sure-fire way of reaching a goal is no flexibility at all. My savings account balance ebbs and flows. My 401(k) balance rises, even when the market doesn’t, thanks to my regular contributions.
Also, the idea of paying off a mortgage is appealing to me. Call me old-fashioned, or crazy, but think about coming home to your house each day knowing you don’t owe a penny to the bank. Sounds nice, doesn’t it?
8 Responses to "Pre-paying the mortgage"
As long as you still have money in the savings account, I’m with you. You need that easily-accessible emergency fund. But as long as you have a reasonable mortgage on a house with a steady value, doubling the mortgage payment is a pretty good idea.
I like the idea of having the house paid off. Unfortunately, there’s always the taxes and insurance that a person has to pay 
We’re about 5 years (or less if we pay extra) from paying off our mortgage. I can’t wait!
If you planned to stay in the home long term (20 years or more), I would strongly encourage you to accelerate the mortgage payoff. Being debt free is one of the best financial moves any middle income family can do in preparation for retirement. However, it sounds like you may end up moving in the relative near future so I recommend accumulating cash for exactly the reason you cited - flexibility. You have a lot of immediate priorities and cash is always at a premium to help meet those priorities. Putting more into the house may make sense purely from a financial perspective (earning slightly more on your money), but getting that money out in the case of an emergency or an opportunity may not be as easy as you think. Other than setting up a separate account that is off limits, I cannot help with the financial discipline part of the equation where the cash you accumulate may get spent on non-priority items along the way.
It sure sounds nice to me, and I like your reasoning of sinking money into the house if you think you want to eventually move, since that equity will help you with the new down payment.
However, in our situation, where we don’t envision moving for at least 10 years (and at that point, if we still like the neighborhood as we anticipate, we’re more likely to just renovate and stay), I’m sticking with just a bit over the minimum payment. Here was one of the deciding factors for me: we’re not saving a ton for the kids’ college, and the retirement accounts are NOT considered in financial aid calculations. The house asset IS. So you work hard to pay down your mortgage and the financial aid folks ask you to take out a NEW mortgage to help you pay for your kids’ college! No thanks.
Kind of convoluted reasoning, I know. But it’s all part of the package for me. We don’t plan on paying for all of the kids college, but I would like to help with some. It’s just weird how the financial aid formulas affect our savings…(thankfully they’re being very reasonable with the 529 accounts)…
Clearly you ran the math, and it doesn’t make sense, why indulge in the fantasy of not owing the bank?
My wife prefers the thinking that kara expresses in her last paragraph. In 2005, 2006 & 2007 that really bothered me because our retirement savings plan was returning far more than our mortgage interest rate. This year, paying extra on the mortgage doesn’t seem so bad, because our retirement savings have given up a lot of the gains from prior years.
I think the best thing to do is what makes you feel better. If matt is solely measuring based on the analytics, he knows his answer. For my wife, watching the principal fall every month is not only rewarding, but adds to her piece of mind - knowing she could handle the mortgage alone, should something happen to me. To her that is more valuable than watching the retirement balance rise.
Don’t forget that you pay tax on your high-interest savings earnings, so that rate is actually lower, too.
I’m a Dave Ramsey fan, so I see paying off the mortgage early as a step I hope to reach eventually. He says that it makes sense to pre-pay after you’ve eliminated all other debt and are saving substantially for retirement and kids’ college. I think that while putting the same money into investments is likely to have a higher result, prepaying a mortgage might psychologically influence greater saving because it will always lower the principle owed.
Individuals who are able to save are advised to allocate a portion of their invest assets to different asset classes; at a minimum equities and non equities (usually bonds). When I had a mortgage I always keep my eye in the interest rates being paid on short-mid term CDs. When interest rates on CD’s were low, I would make an additional mortgage payment. I felt that by doing so I was investing in the non equities portion of my asset allocation. I realize that such an investment may tie up one’s funds for years. In a situation like yours, however, you might compare the yield on a 3-5 year CD to your mortage rate and invest accordingly. Our goal was to pay off our mortgage before our two daughters started college. Your goal may be different, a new house, but you still should look for the best return on investment for non tax deferred savings.
