Should I pay off my mortgage faster by adding extra principal?
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Question:
I have been paying my mortgage for 5 years and now some extra income. Should I make additional principal payments? My mortgage is a 30-year fixed at 6.25% interest.
And how does the taxation play a role here? I am in the 25% tax bracket.
Answer:
If you prepay your mortgage or increase the monthly payment to pay of quicker, then your savings are 6.25% annually. What would you do with the money if you would NOT use it to pay down the mortgage?
You could put it in CD accounts which will yield maybe 4 to 5% interest. The benefit is that you are more flexible in case of an emergency (loss of job, health related bills).
There is zero risk in paying down the mortgage, and also zero risk in buying CD accounts, but the return of the mortgage is higher than the CD accounts.
If you buy stock, your risk is substantially higher. It is basically gambling. Your possible return is higher as well.
Investing in mutual funds on average yields 9% in the long term. However, in the short term, you may take losses. The risk is substantially lower than buying stock though.
The right decision also has to do with your age and your life, its schedule and what you expect to do in the future.
Taxation plays almost no role in the decision of whether to pay off early or invest otherwise.
Let's say you pay additional principal. That means you save interest in future payments. The interest is tax-deductible. So one could argue that the real cost of the loan is not 6.25% but 6.25% * 0.75 (since you are in the 25% tax bracket) = 4.7%
However, if your mutual fund yields 9% profit, you also pay 25% tax on that. So the effective profit is only 9% * 0.75 = 6.75%
Similarly a CD account yielding 4% effectively only returns 3% (4% * 0.75 = 3%)
The only exception is if your investment is pretax as a 401k plan or a tax-exempted bond. In that case you should compare the bond's full return against the prorated mortgage interest.
In your specific case - 6.25% is a pretty low rate. If you wait a little longer, you may find zero-risk investments such as savings accounts that will beat that return.
And now a completely different perspective on this topic:
If your mortgage is fully paid off, and your house gets hit by a hurricane or earthquake, then you are in more trouble than your neighbor who had only 10% equity in his place. You just lost all your house and try now to get money from the insurance. If the bank has the equity (and you have the mortgage) then the bank will deal with the insurance.
And there is also the thought that free and clear owners may more likely be subject to lawsuits if something happens to someone on your property. Not sure how relevant this is but I thought I should add it.
If you have a 30 year fixed mortgage and double the payment every month, will it be payed off in six years?
2009-08-13, 17:12:02
[hidden] from United Kingdom
I just paid off my mortgage yesterday! I had my Mortgage for 8 years. In febuary 09 I decided to just pay the sucker off and started using 100% of my income to pay it off. It is the best decision I have ever made...With some savings and all my income it took me six months to payoff the balance of 111k. The peace of mind is priceless and its still sinking in. There were a few times early on in my mortgage where I almost lost my house (Company I contracted from went into BK). The reason I bring that up is you must remember when you have a mortgage you DO NOT own your house.If you get hurt or sick your up a creek because the bank is a business and will take your house away in a flash. If you can make any extra payments to principle DO IT!! You take off years everytime you do. I feel stupid I waited 5 years before I really started to make large principle payments. I should have done it from the beginning of my Mortgage. I have no Debt at all now. All of the money I earn from here and forevermore is mine!
PAY THAT SUCKER OFF ASAP>>>OWN YOUR LIFE!!
2009-08-16, 21:24:32
anonymous from United States
happygirl- your situation depends on the rate you can get for the 15-year mortgage you are looking at. chances are it won't be less than 5%, but you can ask the bank about that (you will also have to include the refinance fees when you calculate your 'new' interest rate). if this rate, that the lender can and will calculate for you if you ask them, is more than 5%, it makes more sense to stay with your current mortgage and use the 50K to pay down your principal.
keep in mind that 15 and 30 year products are the same idea. if you pay down your principal, increase your monthly payments, etc., you can turn the products into whatever schedule you want- the bank might not like it but prepayment risk is one that they have to take. if you want to pay off your remaining balance in 15 years, i would suggest checking an online calculator for a 15-year mortgage for your remaining balance (115K after your 50K payment) at your current 5% interest rate. you can then begin to pay those payments instead of your minimum and your mortgage will be paid off in 15 years (or whatever time frame you would like). if you can get lower than a 5% rate, NET of refinancing fees, and you know you can make the extra payments, then refinancing would be your best option.
craig@findahomeinutah.com from Salt Lake City, United States
Great String!!
After 35 years of paying mortgages, buying several houses, having been a loan officer and currently being a Realtor, I have a strong opinion on this matter.
It totally makes sense to pay off your home before retirement. Who wants to be burdened with a house payment after retirement?
The question is; how and when do we want to pay off the mortgage?
There are times when you can receive a better interest rate by investing your 'extra money'.
There are times when it is safer to just pay off your mortgage early with additional principle payments. I have tried both. The key is to not spend the extra money but to invest it.
I bought investment property with some of my home's equity and my tenants are paying off the new mortgage. That works great as long as business is good and I have no vacancies.
I invested in the stock market and got burned, big time. I would have been better off making additional principle payments.
I refinanced at a lower rate and had the Lender pay for the closing costs with his commission. I took a higher interest rate than I could have so he could pay my closing costs. It worked much better than refinancing and rolling my costs into the loan.
I currently have a 5.375% interest rate loan for 30 years. I double or tripple my payments with a goal of having it all paid off by the time I reach 65 or 70. I am currently 59.
If times get tough, I can make my low, long term payment. When times are flush I make additional principle payments. The key is, get out of debt and make investments.
Best Wishes & keep learning
Craig
Keywords:
2009-09-23, 14:02:04
anonymous from United States
Where do find a reliable mortgage calculator that keeps up with additional principle payments duducted from mort. and gives the final results of this?
I would like to know if paying a extra $300 a month on my $308,000 20 year mortgage is better than making a onetime payment to principal of $72,000.
2009-10-16, 20:00:19
ldane
I just refinanced from 30 yr (28 yrs left)6.625% to 20 yr 5.5% for $308,000. I am paying a extra $300 per month, but I am able to to do more. If I make a onetime payment of say $72,000 is that better, the same, or worse than paying the $300 extra a month? I forgot to mention that I'm 56 years old in relatively good health, and earn around $150,000 a year. I don't know a lot about this finance stuff, but I realise there are some things that can be done to shorten the life of the mortgage, therefore the amount of money paid out. I don't want to be 76 before my mortgage is paid off because if something were to happen it would burden my wife of 36 years.
2009-10-22, 17:37:20
anonymous from United States
if i take my amortization schedule an pay my monthly payment plus next month principle every month for life of the loan. how long would it take to pay off my loan. It is a 30 year mortgage @ 4.875 fixed
2009-10-26, 23:49:42
anonymous from United States
The rich rule over the poor, and the borrower is servant to the lender. (Proverbs 22:7)
Man was not meant to live in debt (Remember Jesus paid our debts to free us)... Get out of debt and THEN invest your money.
2010-01-05, 00:45:13
anonymous from United States
If one more person says PRINCIPLE I am going to scream. When talking about money, it's PRINCIPAL, for crying out loud.
2010-01-17, 19:54:35
madeline from United States
Are there any benefits to paying half of my mortgage payment in the beginning of the month and at the due date? Can I reduce my interest?
2010-02-03, 18:54:16
anonymous from United States
I HAVE A 125,000 MORTGAGE---PRINCIPAL BALANCE IS 122,500 IF I ADD 20,000
TO MY PRINCIPAL WILL I PAY MORE PRINCIPAL ON EACH MORTGAGE PAYMENT.
2010-02-10, 15:36:47
anonymous from United States
Will it be to my advantage on my variable ARM to pay off some principal to bring the loan pmt. down when it adjusts? Will the Mortgage company be agreeable to that when it is one of those bad negative amoritzation loans with us underwater?
2010-04-19, 18:04:33
anonymous from United States
we have a townhouse - not our principal home - that we rent out when we can. the purchase price was $330,000 and we put a downpayment of $130,000.00 Our equity was lost in the economic downturn and the assessed value is $159,000. Our mortgage interest is 6% for 30 years. we have a chance to get it refinanced at 5.1% but the closing cost will add $3000 to the debt and cut down the mortgage from the remaining 27 years to 20 years. Is it worth it to refinance given the fact that we will be retiring very soon?
The first few hundred a month each month till the end of the loan you can pay are MAGIC and shave off so much interest and years from the loan.
The first 100 are great the next 100 (200 a month) are great, the next 100 (300 a month are great) and so on... But after a certain number they are not as great anymore.
Just remember the first hundreds (in most cases up to 1000) are just fantastic in reducing the years and interest you pay the bank. just remember 100 more (1100 a month) will decrease your total, but not as much as the previous 100.
WHY??? because this numbers follow a curve that increases very fast for the first 100 and 200 adn 300 then slowly decreases as you put more each month.
If you put twice as much each month you dont shave off twice as much time or interest at the end.
There is a magic number to pay each month to mortgage principal that gives the maximum benefit and shaves off the highest percentage off the interest and number of years off your mortgage.
If you cannot make that magic amount, at least try to pay as close to that number as possible for the highest interest and years savings.
Example. In a 364000 mortgage at 5.375% month the following happens:
Paying 300 or 500 per month extra gives a great (the best) percent reduction in the interest and years.
payimg 1500 EXTRA per month gives the maximum benefit.
Paying 2000 extra a month, the extra 500 dont really help much lowering the interest or mumber of years. Of course If you have the money then just put it in principal.
A co-worker of mine has a monthly payment of 1200. Him and his wife pay 1000 extra. That is almost the best number in their case. They are 2 years away from paying off the mortgage and the title is theirs.
Fact : a graph can show what is the best extra amount per month to put down to payoff your mortgage.. That number is not even twice the monthly payment.
Fact : The first 100 dollars extra you pay shaves the highest percent of the interest you owe.
Fact : If you double the amount of the extra payment it does not duble the amount of interest you save.
Paying from 200 extra a month to 400 extra a month saves lots of interest but does not double the amount of interest you save.
The amazing fact is that many people can put 200 or 400 even 600 extra. Those amounts are just fantastic reducing the mumber of years.
If you want to learn more email me. Is not complicated, it takes maybe a few hours, but you can get the best number possible to maximize your money.