payments are not my favorite. Before I come across in a negative way, I want to clarify that I consider myself very fortunate to have the house that I do. I am in a position to provide my family with a safe, modern, comfortable, and spacious place to call home. Some could argue that in itself is worth every penny paid toward the mortgage. Something continues to nag at me though. That lingering, impossible to shake thought that I’m not using my money to its fullest capacity with regard to my mortgage.
I’ve been of the mindset that paying off my mortgage early only acts in my best interest if the interest rate on my mortgage EXCEEDS the amount I can earn if I invested that money. I picked this up somewhere along the way and have held onto the thought rather tightly. That is until, I let the nagging little voice in again. That little voice that I swear whispers just loud enough for me to make out the phrase – you’re being an idiot! I decided it was time for me to take a much closer and harder look at the numbers.
To finally put this to bed, I decided to run a scenario. The scenario is based on me starting to make significant extra payments on January 1st, 2019 until my mortgage is satisfied. Here are some things to know:
- The mortgage balance will be $247,000 in January 2019
- I have locked a 4% interest rate for the life of the loan
- My home is currently valued at $310,000
My first to do was to take a look at just how much money I’m going to spend in interest over the life of the loan if I DO NOT pay it off early. To do this, I pulled up an amortization schedule payment calculator. Fortunately, Microsoft offers one as a standard Excel template. You can find it HERE. After plugging in my numbers, I found a few items interesting.
If I DO NOT make any extra payments:
- There are 336 payments left to make
- We will not be mortgage free until 2046
- Interest payments will total just shy of $162,000
Just the amount of scrolling alone to get to the bottom of the schedule was depressing. But, before doing anything drastic, my next step was to take a look at just how quickly I could get the loan paid down. To do that, I:
- Determined how much extra I could pay each year ($3,600 per month = $43,200 per year) assuming no changes to current income
- Recalculated the payoff schedule using the previously mentioned amortization calculator
- Calculated that I would be mortgage free in 57 payments with just under $24,000 paid in interest
Appealing…but not enough. More research needed to be done.
the money I could use to pay down the mortgage early needed to be considered. This part of the equation alone has directed my thought process on early payment for years. As it stands today, I’m reasonable comfortable that 6% returns on money invested in the market are reasonable. So, 6% return vs. 4% interest rate = easy call on NOT making extra payments…or does it? Unable to find an online or Excel calculator that gave me the info I was looking for, I ended up creating an Excel calculator myself. Here’s what I did:
- Looked at a five year period (57 payments is just shy of five years but it’s close)
- Calculated the investment return on an annual basis using the $43,200 using 7% (being optimistic here)
- Compounding the savings for each year’s return (year 1 principle + interest = year 2 principle for investment return calculation purposes)
- Found that I will have “invested” $216,000 in principle with another ~$45,000 in interested earned (totaling just over $261,000) in the house rather than the market.
Then it was time for the bottom line comparison.
appears to be this. If I go ahead with extra payments, in just about five years I:
- could have had ~$261,000 in a brokerage account vs. in equity
- will have saved myself just over $138,000 in interest (this becomes the key for me – in five years I would have made just over $45,000 in interest vs. SAVING $138,000 in interest – that means I’m ahead almost $93,000!!)* see below
- will actually own my house outright – not a bad thing shortly after turning 43
- Position myself to be one step closer to reaching my goal of FIRE by 45
I’m not quite ready to move forward with the plan. To round out my thought process and research, I still need to:
- confirm with the mortgage company that there aren’t any prepayment penalties
- make damn sure the Mrs. doesn’t want to move anytime soon
- research historical average annual property value increases in the area
The last point is where I see, mathematically, the most uncertainty in this approach. Being mortgage free sounds great. Not having access to that much cash isn’t so great. I’ve done the math and based on the difference between investment return and interest savings, I could sell the house for 30% below its current valuation and be ok. By doing that at the five year mark, I would essentially break even and have the same amount of cash available. That makes me a little more comfortable.
*Finally, I haven’t run the numbers yet but I think I “lose” if I look out over the next ten to fifteen years. Let me explain. If I do not pay off the house early, eventually, compounding interest will provide me greater returns in a brokerage account than in the increased value of my house. This, however, becomes more a peace of mind issue. I’m not going to complain about money making me money but at a certain point, knowing that I could keep my family safe and sound in a very nice house without having to work (or perhaps consulting a month a year at most), brings with it a certain calm.
I will keep you posted on my decision in the internal argument that is to pay or not to pay.