Paying Down a Mortgage or Investing for the Long Term?

As I mentioned a bit last week, we’re currently debt free except for our mortgage and a student loan with such low interest that it would be financially reckless to pay it back early. The CD in which we were keeping the money to pay for our Prius matured (it was earning a higher percentage return in a CD than we could get on a car loan, so cracking the CD early and paying a penalty just to pay cash seemed like a poor move), so we paid off the full balance of that loan and own both of our vehicles now free and clear (we paid cash for our 2004 Pilot a few months ago).

Right now, we’re sitting at a decision point. Should we start prepaying significant amounts on our mortgage or should we invest that money elsewhere? I think we’ve come to a decision, but I also thought walking through our decision-making process.

Our home mortgage sits at about 5.5%. We are looking into refinancing it at 4.75%, but we haven’t yet fully run the numbers to determine if it would actually save us any money or not because of the cost of the refinancing and because of our intent to pay it off quite early. We’re already making payments that amount to about 50% more than what we owe each month.

Our question currently is simple: should we raise those overpayments to 100% or more or should we be investing that extra money into stocks or something else?

If we increased our payments to 100% of what we currently owe each month, we would pay off our mortgage in about seven years. If we exceeded that amount, we would be paying for even fewer years than that.

We view money put into the mortgage as being an investment with a guaranteed return of 5.5%, because that’s the amount of annual interest we’ll save by knocking off some principal. If we pay $1,000 early, it’ll save us $55 in interest this year and about $57 in interest next year and so on.

On the other hand, we could invest that extra mortgage payment each month into something else. We could put it into a savings account that would earn us 1.5% or 2% or so, but it would be very liquid.

We could also invest it in the stock market. It would be very liquid there and it would also have the potential to greatly beat the 5.5% we’re making on our home loan.

Of course, “potential to greatly beat” reveals the hard truth. Stock market investing, particularly in the short term, implies quite a bit of risk. 2008 was incredibly painful, for example, as were 2000 and 2001.

The truth is that stocks only pay off as an investment over a long timeframe unless you’re banking on some luck.

So, what’s our timeframe here? Our plan after our mortgage is paid off is to buy a piece of land in the country and build a house on it (and likely a small barn as well).

If we put the money into our home, we would be completely debt free in five years, buying land a year or two after that, and building a year or two after that. Let’s figure five to ten years is our time frame.

Is that “long term” in terms of the stock market? Sadly, it’s not. As Warren Buffett so eloquently put it, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” The simple fact is that over a period of time less than ten years, the stock market is notoriously volatile.

This becomes even more true when you consider that we won’t be investing all of it now and just waiting. Instead, we’d be investing small amounts regularly over the next several years. Large chunks of our investment would be in stocks for only a year or two.

That’s not the kind of fragile foundation we want for our next home. We’d far rather own our current house free and clear. It’s in a good location, rurally placed with great access to the Des Moines metro area, and similar houses have held their value or even gone up over the last several years. We feel, based on the evidence, that we’ll get out of it at least as much as we put into it when we sell it.

Thus, our extra money is going into our mortgage for the time being. I altered our automatic monthly mortgage payment to be 125% more than our normal monthly payment and may yet alter it again (I want to watch our monthly cash flow for a while). This leads us to paying off our house in just a few years and pushing us right towards the country home we’ve dreamed of.

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  1. Meghan says:

    Congratulations! I’ve been following your website for a while, and the progress you’ve made is inspiring. My husband and I have made changes to our wants/needs, and suddenly it was feasible for me to stay home with our first little one (who is due at the end of July).

    It’s commonly held (faulty) belief that the kind of success your family has achieved is only possible with a trust fund or huge income. We are now working towards similar goals.

    Thank you for your inspiration, advice, and patience.

  2. Jon says:

    Good call! Debt paid off is a sure thing, while money invested in stocks might or might not pay off. One is much more certain than the other, and advice like this goes a long way to helping readers…

  3. Robin Crickman says:

    Were I in your shoes, I would have made another choice. I would put the money into a savings account and go shopping for that piece of land you want to build on. Just hunting would be a fun thing. If you find the land and negotiate a good price on it, you can get a mortgage for it. If it is cropland or pasture now, you can likely rent it out for some income (not profit, but less of an alligator than raw land). Even if it can’t be rented, it would have value as a personal playground and as a place to dream about your future home. And you would lock in the cost of obtaining the land now before recovery (please let it be coming) starts the price of land up again.

  4. Leigh says:

    Congratulations on having two good options! I just emailed another personal finance blogger about this not too long ago (you know him) and he compared it to picking between chocolate cake and apple pie. Both good options in my opinion. My husband and I are in a similar situation. Pay off our house early (WAY early, we’re talking 20-25 years early) or invest the money. We have also decided to pay off our house since it makes sense for our current situation. Although we may re-evaluate that decision later, but for now paying off the mortgage is a better decision for us.

  5. Doug Warshauer says:

    This is a very well thought out analysis and decision. You got it right that five to ten years is not a long enough time horizon to invest in stocks. Even if you were to get lucky and earn 10% or so annually on your stock investments, you would only accelerate your ability to buy and build your new home by a year at the most. But if your stocks did poorly, you could set yourself back three years or more! Much to lose, little to gain.

    Additionally, if you decided to invest your extra money in stocks, you’d have the added challenge of deciding when to get out of the market. Your time horizon won’t be five to ten years forever – it will continually shrink. In a few years it will be only 2-7 years, clearly too short to be invested in stocks. But if you were to sell your stocks then, you’d have only been invested in them for three years, far from long enough to expect the historical market return.

  6. Hillarie says:

    A well-timed article, Trent. I recently went through a similar thought-process and also concluded to bump up my extra monthly payment rather than invest.

  7. Kacie says:

    Do you have enough cash set aside to pay off your student loan debt, like you did with the prius? Or is thatcoming out of your monthly budget? It might be a good idea to have money aside for that anyway.

    And This is going to sound really picky but I don’t like it when people say “we are debt free except for…” ok then, you are NOT debt-free.

    Your debts are your student loan and your mortgage. Far from being truly debt-free.

    Yes it’s semantics, but surely as a writer you appreciate how the structure can change the message.

  8. Kacie says:

    And the title of your new book bugs me– it implies you have no debt. That’s a bit misleading.

  9. Tammy says:

    You need to shop more for your potential refi. Veridian Credit Union (various locations in Iowa) is currently offering 3.875% on 15 year mortgages, 4.375% on 30.

    Heck, we got our mortgage in 2008 and it’s less than 4.5%.

  10. Matt says:

    Hey Trent,

    Long time reader, first time poster. I really liked this article. I have pondered the question myself as I am also debt free except for my mortgage. One thing to consider when making this decision is the percentage of your personal wealth that is tied up in one asset class (real estate) and a single asset (your house). Those in the financial field are always pushing diversification. I know you don’t count the equity in your house as net worth on your balance sheet, but if the worst happens and your house becomes essentially worthless due to a non insurance recoverable reason (think Love Canal, termites, a crack in the foundation or some other totally unforeseen problem) you may wish you were more diversified. I will freely admit that there is a small chance of something catastrophic happening that is not covered by insurance. However, if you can take another course of action that mitigates the risk, that might be a good solution.

    One possibility I see is investing in a diversified bond fund like the Vanguard Total Bond Market Index Fund instead of prepaying the mortgage. The risk of losing capital is very small and the historic returns have almost always exceeded your mortgage rate, 1-year: 8.13%, 3-year:6.83%. 5-year:5.26%, 10-year:6.25%. Once you are in a position where your assets have grown to the point where your house is now a manageable part of your net worth (personally, I’m aiming for 20-25%), you can then cash out and pay off the mortgage early. This may or may not be the most prudent move financially depending on your tax situation but I would argue that it significantly reduces risk overall.

    Keep up the great financial writing!

  11. Robert Muir says:

    I think you made the right decision, especially wrt the stock market for all the reasons that Doug mentioned. By turning the question around, it’s easy to tell that it was the right decision. “If your house was paid off, would you borrow against it to invest in the stock market for 10 years?”

    Robin makes a compelling argument. Saving the money separately so it would be available when the perfect piece of land becomes available at the perfect price. If the house were paid off, would you borrow against it to buy the perfect piece of land?

    Fortunately for me, I didn’t need to buy land, so I just paid off the house.

  12. Laurie says:

    I agree with paying down your mortgage instead of investing. It’s the old “a bird in the hand is worth two in the bush” thing. If you pay attention to the news, it’s pretty clear some economists think we could double dip in recession. An investment adviser I know believes the 2008 pre-crash level was highly inflated, and that it might take many years before we are there again.

    What I know is that my house is a for-sure investment. Even if the housing market tanks further, and it loses value, I still owe that mortgage. By paying it off, I would be permanently lowering my cost of living.

    There are other sorts of frugal investments people overlook. These things include bulk-buying groceries, investing in tools that will save more than what they cost to buy, and doing low-cost home improvements that will lower the cost your electric and fuel bills. I would suggest you NOT pre-pay your mortgage, until you at first do these basic sorts of things.

  13. PAy down your mortgage and run the refi break even point. 2 years or less, do it.

  14. JK says:

    Is there some reason you’re only paying your mortgage on a monthly basis? Paying every two weeks (not twice a month) knocks years off your mortgage, even if you don’t make any additional payments. Paying every 2 weeks means 26 payments a year rather than 24 if you pay twice a month. Those two extra payments are where you get the big benefit. We have auto payments set up for every other week, and rounded the standard payment up to the nearest hundred. Then on a weekly basis I make an additional payment with what ever excess is in the account after the pay arrives and the weekly bills are paid. The sooner the payment is made the more benefit you get.

    We’re in the same position with the decision to pay off the mortgage vs invest. We’ve decided to contribute to our retirement accounts just enough to get us to get our employer matches and get us each down to the next lower tax bracket. The resulting tax refund is immediately rolled into the account as the first contribution of the next year. We start each year making extra payments on alternating weeks to our retirement accounts and the mortgage. Once we’re reached the amount we need to contribute to retirement to obtain employer matches and get down a tax bracket, then we stop those contributions and just send all the excess weekly to the mortgage. We have our mortgage with our bank and I can make a payment on the mortgage just like paying any other online bill. The only difference is that it takes a day to be posted as they have to confirm the extra payment doesn’t put me over the annual limit for additional payments. I completely agree with paying down your mortgage but if your enquiring about reducing your rate you should look into changing the frequency as well. That would likely have more effect.

  15. Patty says:

    We are in a similar boat where our remaining debt being the house. We want to pay it off, keep a strong EFund and save for the long term but its a wonder what to do with the money. A refi wouldn’t save us enough compared to overpaying the mortgage (especially considering the fees and possibly locking in a higher monthly bill), savings accounts aren’t earning much and the stock market is volatile. I increase the mortgage payment a comfortable amount, wait a few months, then (hopefully) increase it some more. We are also adding sweat equity to the home as we can to maintain/increase value (have stayed stable last few years and not planning to move for many more).

  16. I would choose investing in the long term because you are actually making money instead of putting it into your morgage

  17. Julia says:

    If your time horizon is 5-7 years to pay off the mortgage – look into a 5 year ARM. Interest rates are around 3.8% for a 30 year loan right now, rather than 4.75 for a 30 year fixed or 4.25% for a 15 year fixed. The interest savings may allow you to pay off the loan in closer to 5 years, than 7. If you can’t pay it off before the loan adjusts – its probably not a problem in the first two years – we were looking at a loan with a 2% per year rate cap – so on year 6 you would at most adjust to the same rate you’re paying now. Also, the remaining principal will be relatively small by years 6, 7, etc.

  18. Sunny says:

    We paid off our house a year ago and the feeling gets better every month! Like Dave Ramsey says the grass really does feel different when it is yours and not the banks.

    If my investments tank or I lose my job I’ll still have a home and land to live off of.

    I think paying off your mortgage is investing in your future and your peace of mind. Of course this is just MHO.

  19. Patty says:

    Good points by all, one from me,

    Split it betwwen paying the extra on the mortgage and set the other amount for the downpayment. Just in case an opportunity comes along, having some ready cash can make it happen!

    Good luck!

  20. Another considering for us is selling the house and using the extra money for an investment greater than any return we’d have on increasing house prices.

    We’ve all heard the story of someone’s grandfather buying a house for $20,000 and selling it for $200,000. Isn’t that a GREAT investment? Well no because he bought it 50 years ago. If he had put $20,000 into a fund tracking the stock market, it would be worth well over half a million dollars now.

  21. Rob says:

    @JK — some of us only get paid monthly. Fortnightly payments would throw my budget completely out of whack. I just pay over the minimum monthly amount (as Trent is)

  22. Courtney says:

    Given that a mortgage is fully amortized over X number of years, can you describe how you calculated the interest savings? “If we pay $1,000 early, it’ll save us $55 in interest this year and about $57 in interest next year and so on” doesn’t make sense to me because you pay LESS interest each year of your mortgage. That’s why people often lose the itemized deduction after a certain number of years.

  23. Ace Davis says:

    I’m a little confused about the logic of prepaying mortgage principal on a home that you plan to sell well before the end of the mortgage term. Since your required payment remains the same each month, all prepayment does is tie up your funds for the sake of eliminating payments beginning with those farthest in the future. By then you would have long since sold the house paid off the mortgage balance with the proceeds.

    In your fortunate situation, I’d use those funds to maintain/improve the value of your house and amass up enough to buy the next lot outright and build on it with a minimum of borrowing.

    Given your timeframe, I’d also look into rates and costs for refinancing into a 7/1 or 10/1 ARM so you can really lower your payment and sock away even more money for the dream farm.

  24. K says:

    I would also look into a 5/1 or 7/1 ARM since you plan to pay it off so soon. The rates are in the 3%’s. But we looked into it and decided it wouldn’t save us much since we plan to pay ours off early too.

    We are paying about 3x our mortgage amount. We decided once we own our home outright, we are in a better position to make decisions about where/how much to work, which is especially important with small children. We will have it paid off in about 5 years or less.

  25. Nicole says:

    We’re in almost exactly the same situation, though we don’t know if/when we plan to move (if we move, it will be for a job, as we love the house). Right now we’ve also decided on pre-paying, although we’re also maxing out retirement accounts and putting $500/month in a 529.

    When we ran the numbers on refinancing, I think the break-even point was 7 years. If we try, we can pay off the mortgage in 4, though we probably won’t because we have other spending goals (such as a second child). But given that we might move before then and we might pay off before then, it seems like it’s better to just stay at 5.5%.

  26. Gary says:

    I disagree strongly with your conclusion. No offence, but this is outmoding thinking from the days when house prices only went up, and everyone had excellent income security. IMHO you’re taking a big gamble with the future wealth of your family by giving disposable income to the bank.

    You’re effectively betting your own money on the appreciation of equity in your home, and your continued ability to be able to generate the payments for your bank. You can bet (as has been borne out by many unfortunate people who have been foreclosed) that even after making accelerated payments against your mortgage for a few years, if you are unable to pay for a long time due to some crisis, you’ll also have to deal with repossession of your home and all the money you invested in it in addition to whatever crisis has rendered you unable to pay.

    Further, if the equity in your home decreases drastically… flood, hurricane, or the bottom falling out of your local real estate market through no fault of your own, you could easily end up paying 2 or 3 times more than the 5% you calculate if you spend $300,000 dollars and 10 years paying down a mortgage on a home the ends up being worth $100,000.

    It is far safer to make the absolute minimum payments against your mortgage (even interest only with a balloon payment if you can find a lender that still offers that), and invest the money you would have used to pay down the mortgage in a side-fund. It is not at all difficult to find annual returns of 4% or 5% compounding, and even 10% is available quite safely without dabbling in the stock market if you speak to a good CPA or IFA. The side fund will reach parity with your outstanding mortgage at the same time as it would have done if you gave the money to the bank, so you don’t have to wait any longer to own your home free and clear…

    BUT CRITICALLY:

    1. You also have the option to take a payment holiday in the event of a personal crisis that prevents you from making payments without risking repossession;
    2. If your house loses 50% of it’s equity while the side fund is growing, you are in an excellent position to renegotiate with your bank – “I’ll pay the current market value of the home plus early closure penalties and associated costs in cash today, or you can have the keys and the title”.
    3. If your house blows away in a hurricane, you didn’t lose the equity because you kept it in a side fund and let the bank take the risk.

    So, in the absolute worst case, nothing goes wrong, and you struggle to match the mortgage interest rate with your side fund ROI and it takes you a year longer to reach the crossover point where you can spend the compounded side fund to pay off your mortgage. Far more likely, nothing goes wrong, and you still pay off your home at the same time. In either case you have significantly more security and flexibility in the intervening years.

    Food for thought…

  27. Courtney says:

    Never mind my question @14. It doesn’t make sense intuitively but I put it in a mortgage calculator and it works out.

  28. TC says:

    Anyone who takes out an ARM will likely eventually give away their ARM and their LEG.

    Although it is tempting to take the low interest rates offered in an ARM (Adjustable Rate Mortgage), it lacks wisdom. Given the volatility of the job market, people who take out an ARM may end up getting stuck in their home longer than the locked in teaser rate of the ARM.

    Add to that the fact that eventually the Federal Reserve will need to increase interest rates or risk the collapse of the dollar and the ARM becomes a gamble that no homeowner should make.

    Many a homeowner in 2004 said to themselves, “I’ll just take out the ARM to buy this house; It’s a great rate and I’ve got a secure job,” only to find themselves defaulting on their ARM and losing their LEG to boot. Please, dear reader, never, ever take out an ARM.

  29. Randy says:

    An ARM, given the recent real estate meltdown, historically low rates today and almost sure interest rate increases to come, makes no sense to me.

  30. Kari says:

    I cannot grasp why paying off the student loan isn’t your first priority. You say that you have “a student loan with such low interest that it would be financially reckless to pay it back early.” How could it possibly be “financially reckless” to pay that off and be debt free except for your house? From my perspective, even if the interest rate is low and your education can’t be repossessed if you don’t pay it, it doesn’t seem worth the risk to have that debt lingering particularly when you are self employed and your wife will be taking time off from work. And paying interest is always financially reckless in comparison with not paying interest at all.

  31. JK says:

    #13 Rob – I understand your comment but even if I was paid monthly I’d still be paying my mortgage this way. I buy groceries weekly, fill my gas tank weekly, and pay property taxes and utilities monthly. My mortgage just happens every other week. They’re all predictable, recurring expenses so I don’t see any reason you can’t make two smaller payments rather than one larger one. Your monthly pay is likely already accomodating 4 grocery payments, 4 gas, 1 electricity, 1 phone, etc etc. Why not 2 smaller mortgage payments instead of one larger? Yes you’ll have to watch for two withdrawls instead of one, but you’ll get to stop dealing with mortgage payments years sooner. If you find you have excess cash at any point you can still make extra payments, but just changing the frequency of the regular payments gets you a long way toward paying it off sooner.

  32. I think you are making a wise decision Trent.

    As long as you are maxing out a Roth and have a fully funded EF, paying down the mortgage is a safe, guaranteed investment right now.

  33. Katie says:

    Why not 2 smaller mortgage payments instead of one larger? Yes you’ll have to watch for two withdrawls instead of one, but you’ll get to stop dealing with mortgage payments years sooner. If you find you have excess cash at any point you can still make extra payments, but just changing the frequency of the regular payments gets you a long way toward paying it off sooner.

    Not if the 12 monthly payments you’re making are as large as 26 weekly payments you’d make would be. If paying biweekly is a good way for you to pay the extra, that’s great, but you can pay the extra without paying biweekly.

  34. Robbie says:

    I agree, the title of your book is misleading if you haven’t wiped out your debts yet (student loan AND mortgage).

    Also, if you’re selling to buy another property in the next 5-7 years, why not save the extra in a savings account like another poster suggested so you have amassed enough to buy the right piece of land (even with a mortgage) as soon as you see it – then you can work towards paying extra on that. All prepaying your current mortgage does is tie up your funds in a very illiquid asset (your primary residence).

  35. Debbie M says:

    @Ace Davis (#15) – When you sell a house before it’s paid off, you don’t just lose all the extra money you spent on payments. You get the amount you sell it for minus the amount you owe (and all your selling costs). If you have been paying extra, you get all that back, and you also don’t lose as much in accrued interest. So, it will be as if you had bought a CD for the time period between when you made the extra payment and the time when you sell your house.

    Also, he’s tying up his funds for less time if he sells the house before it’s paid off than if he stayed in it the whole time.

    @Randy (#19) – getting an ARM does make sense if you will pay off the loan before the interest rate is adjusted.

  36. asithi says:

    I also choose to make bigger monthly payments than the 26 weekly payments. The amount is the same. With 26 payments, you end up making 1 extra monthly payment a year. I just take that same 1 extra monthly payment, divide it by 12 months, and add that amount to my monthly payment.

  37. sk says:

    We too are making nearly triple the mortgage payment each month with the goal to pay off the martgage several years before we retire. But in this position it is difficult to make improvements on the house (see Ace Davis’s comment above) For example we just completed some badly needed landscaping and we used our Line of Credit to pay for it. So when we clear the mortgage we will still have the LOC to pay off. Ugh. Trent, have you taken this dilemma into account when you persue being mortgage free?

  38. Josh says:

    @JK

    Trent is already paying well beyond the “2 extra payments” you are inferring — your method works to force people into making 2 extra payments who would not normally do so otherwise (and is a good thing for them), but for people who are disciplined enough to just pay more each month, as Trent is doing, the difference is inconsequential.

  39. Rick says:

    paying every 2 weeks doesn’t do anything. interest is calculated every month. paying every 2 weeks or more principal every month is the same.
    right?

  40. mb says:

    My wife and I had been putting the “pay-to-principal” money aside in an online-only savings account every month, then making one very large payment at the end of the year. That way, we could keep the cash liquid for the whole year in case something really big and unexpected came up. This has since changed and we’re now paying extra principal every month, because we’ve increased our emergency fund quite a bit. However, if you’re concerned about needing that money back at some point in the future, one big payment every year gives you less exposure to surprises.

  41. Jill says:

    We just went through this great debate in our house. We’ve also decided to knock out our mortgage ASAP. We moved cash from savings accounts (keeping a healthy emergency fund, “escrow” fund, and car fund that are automatically being added to) and knocked off more than 10% this month. Our payment won’t be doubled like yours, but all of our bonuses will go to the mortgage so we should have it paid off within a year or two! I cannot wait to be 100% debt free!

  42. This is a favorite topic of mine; I’ve done a fair amount of analysis and soul-searching on it myself over the years. A few thoughts on your situation – realizing you’re fairly well into the amortization schedule, while you may not be paying all that much toward interest as you would in the beginning, there’s probably still some mortgage interest in that payment each month, so while you’re at 5.5% now, assuming you qualify for the mortgage interest deduction, your real rate you’d be competing with is more like say, 5.0% or less. And if doing a refi, amortization schedule starts over, so the 4.75% is more like a real rate of say, 4%.

    So, with that in mind, the key question becomes whether or not you can realize a risk-free return of say, 4% or more. I say risk-free rate of return because even though equities historically return 8-10% annually over long periods, it’s not “risk-free” and given what we just saw, there are no guarantees of repeating historical performance. We’re up 60% off the lows, so it is probably unreasonable to assume stocks run 8-10% every year from here, but maybe they do.

    Regardless, you can’t make more than 3% in Treasuries, 2-3% in CDs and 1.5% in savings, so if your time horizon is relatively modest, you’re probably better off making the home payments anyway. And you can’t put a price on the prospect of being totally debt-free. Note that your investments will have tax implications and if investing in equities, there’s high volatility and no guarantee of a defined return.

    Personally, since my time horizong is 20+ years and I have some rather unique approaches to asset class diversification, hedging, etc., I actually choose to pay the standard amount on my mortgage and invest the rest. But I’m even beginning to rethink this given that the situation is looking ever more concerning to global economies and equities as a result (i.e. today’s NYT article on the Third Depression, G-20 output, etc).

    In short, if you don’t have a strong history of being able to return high single digits in any market, you’ll both a) do better and b) sleep better at night with the mortgage paydown IMHO.

    Let us know what you decide!

  43. Joe M says:

    I recommend paying off the mortgage. I struggled with this decision but made the last payment in May. It’s pretty comforting to know that my family will have a place to live no matter curves life may throw us.

  44. Tally says:

    I’m with Kacie #5 — I thought you were actually debt free! I didn’t realize you had this student loan and (until recently) a car loan as well. I don’t know — I feel rather let down. Maybe from a financial perspective it makes sense what you’re doing, but don’t call yourself debt free when you’re not. Say you’re taking on some financially sound debt (or whatever).

  45. Debbie M says:

    Sadly, just because your house is paid off does not mean you’re guaranteed to have a place to live forever. It’s only your house that is paid off forever, not your taxes, insurance, maintenance or repairs.

    Also, things can happen. A natural disaster can make you not want to live there anymore, even if you have insurance. Other things can change, too–your neighborhood could get worse or environmental problems could be discovered nearby. In my neighborhood, three of the four most useful highway entrance and exit ramps were actually torn up. (Fortunately for me, most changes have been for the better.) Failing health can turn you into a person who can no longer make it to the second floor. All your friends and relatives can move away.

    That said, I’m also paying off my mortgage early, though I’m mostly using the windfall approach.

  46. GoYanks says:

    I hope that all the people making “extra” payments and “adding” the extra amount to their mortgage payment are making sure that they are making these additional payments towards their “principal” balance. Banks by default don’t apply additional payments to the principal balance. You should double-check and make sure it goes towards reducing your principal.

  47. JK says:

    #26 Rick. Use any mortgage calculator you can find and test the same mortgage with monthly vs. accelerated biweekly payments. I’ve included a link to a calculator I like, but they should all tell you the same story.
    I entered the following test case:
    $200,000 mortgage, 5yr rate of 4.24%, 25yr amortization
    Here’s the summary it gives you:
    “You will have 566 payments of $539.11 every 2 weeks for 21 years and 10 months, plus one final payment of $263.47 to payout a $200,000 loan with a rate of 4.24%. Choosing biweekly accelerated payments will pay off your mortgage 38 months sooner, with a total of $18,067.57 in interest savings.” Don’t know about you but in my books saving over $18k in interest by doing something so painless is a no brainer.
    If you start with a higher mortgage amount and a longer amortization the savings are even larger. Be sure to also test the outcome with semi-monthly (twice monthly) and see that the savings aren’t nearly as dramatic. When setting up your mortgage don’t agree to bimonthly (24pmts/yr) when you really want biweekly(26pmts/yr). It’s a huge difference. There is also a weekly payment option but you only save an additional ~$200 and still finish in the same month using my example above. A lot of extra tracking for $a few dollars, so I didn’t go with this option.

    I believe the interest is calculated on the remaining principle so the sooner you make that extra payment the more impact it has. I find the advantage of this method is that this amount of savings will happen regardless of anything else I do. In addition to going with biweekly payments, I also rounded up the amount to the nearest even $100 just because it’s easier to enter on my spreadsheet and every extra dollar I throw at the mortage only helps. Then on a nearly weekly basis I make additional payments of whatever I can skim off the account when all the weeks bills are paid.

    I understand that many folks are committed enough to make extra contributions on top of a standard monthly payment, but I’m just suggesting you pay the basic amount biweekly to get the first level of savings and then as a second step make whatever additional payments you can. The sooner you get the extra paid the better the effect. If you’re making manual monthly extra contributions because you want to save up enough to make it worth the effort of making the payment, then perhaps set it up as an automatic bill pay on a weekly basis – the sooner the money gets there the better.

    Here’s the link:
    http://www.ontarioequity.com/cgi-bin/mortgage_calculator.cgi

  48. Adam says:

    We are trying to pay our mortgage as soon as possible as well. We are also buying $1000 CDs every other month at about 3%. That’s not going to beat our mortgage, but it’s a lot better than the 1% at ING and it’s available if an emergency strikes.

  49. My personal opinion falls in line with what I would deem common sense.

    If all of your debt is paid off, and your monthly net income isn’t taxed by more than 25-30% by your house-payment, then you have room to do both. I would take 15% of all of your income and stuff it away permanently in whatever long-term investment vehicle fits your personal risk tolerance (probably growth stock mutual funds for me.) Then, whatever is left over gets thrown at the house until it’s paid off.

    I wouldn’t stop investing solely to pay off the house unless you can do so within 18 months…

    Refinancing makes sense if you find a break even point on your re-payment time line and you intend to move through that point in time.

    How fast can you pay off the house if you poured everything extra into it?

  50. Julie says:

    I agree with your point that the stock market is for long term investments only. A few years back, I was trying to decide whether to pay off my mortgage or invest my savings. I decided to aggressively pay off the mortgage. Two weeks after I made my last mortgage payment, the Lehman collapse occurred. Boy, was I glad I hadn’t put my extra money in the stock market!

  51. deRuiter says:

    Great Trent! Anyone with a mortgage ought to get an amortization schedule and see how much of each payment is interest vs. principle. THEN START PAYING EXTRA ON THE PRINCIPLE, ESPECIALLY THE FIRST HALF OF THE MORTGAGE. You are actually earning more than the amount of interest you save, because in order to keep 5.5%, you would need to earn more than that to factor in income taxes.

  52. Ace Davis says:

    @23Debbie — Yes, Trent is buying equity in his house, but he is not saving any interest in a “CD” if he pays the loan off early with sale proceeds. If the Hamms plan to live in their current home while building the next, they won’t have access to any of their prepayments until whatever clears to them when they sell the home they’re in.
    I like Trent’s dream farm kinda thing. Maybe he should pursue it with that extra money he’s now giving the bank. Depending on refi costs vs timeframe, he could also feed them less interest and save that too. He’s likelier to reach the goal in five rather than 10 years. Hard to budget much of the project around the future real estate market.

  53. Brian says:

    I agree that making extra mortgage payments is essentially the same as saving money at a guaranteed interest rate equal to your mortgage rate. However, it only becomes money in your pocket in two ways:

    1) You reach the end of your mortage term early and the money you were using to pay the mortgage is now yours to keep.

    2) You sell your house and all that extra principal you had been paying is now back in your hands.

    But what if you are nowhere near the end of your mortgage and you do not intend to sell your house anytime soon.

    In my case, I just bought a house on a 30 year 5% mortgage. Sure, I could make extra payments, pay less interest, and reduce my principal. But what if in 5 years we need money to help raise the kids? My 3% CD will be there for me to take, but that 5% “investment” from making the extra mortgage payments will only be in my pocket if we sell the house.

    My point is, I think the extra mortgage payments is definitely something that depends on your situation, but may not be the best idea for someone at the beginning of their loan.

  54. Richard Ferron says:

    Don’t forget that revenue on the stock market will be heavily taxed so the interest you save on your mortgage is more like a 9% investment!

  55. Debbie M says:

    @Ace Davis, well it’s true that there is no option for early withdrawal. Good point.

  56. lynne says:

    I upped what I sent in for my car and paid off my car first, even though it had zero interest. I did it because at the time that debt was higher than the amount left owing on our home. The balance on our home was lower (& the payment) also, due to my having paid (like you) extra toward my monthly mortgage. Once the car was paid off I used the exact amount to add to what I was already putting on my monthly mortgage payment. This turned out to be one of the best things I did, since my husband died 3 months after the home was paid for.

  57. Trent I like a lot of the comments you have received I would suggest you look at the student loan. If I were in your situation that would be what I was attacking and getting rid of. We can make it to complicated trying figure interest rates and how we can beat the system.

    The FPU plan is proven and works. I would stick to the plan knock off the student loans, and work the plan based on what your are going to do with moving.

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