We closed on our mortgage refinance about a month ago, the old loan has been paid off, and we are just about to make our first payment on the new loan. Still, I always seem to go back and forth between different possible scenarios of paying down the house quickly or according the “minimum payment” as I call it. Technically, I could just about pay off the house now, if I chose to liquidate my taxable investments and empty out my emergency fund reserve.
I decided to go back and reconstruct a chart of our home equity over time, and compare it to a couple of alternate scenarios.
The red line represents our actual home equity, as a percentage of our purchase price. We use the purchase price because our home is currently worth about the same as when the bought it. An appraisal done for our refinance last month came in at 6% above our initial purchase price. Before the big refinance, we did a haphazard combination up of throwing in a few hundred extra bucks each month and one big lump sum prepayment. Currently, we’re right at 35% home equity.
Just for fun, the dotted red line is an exponential trendline of the red line. It has the loan being paid off somewhere around 2020.
The blue line represents our theoretical home equity if paid according to the normal 30-year payment schedule of our initial 6% fixed mortgage, starting from when we bought the house in the start of 2008. This would have had the loan paid off in 2038.
The green line represents our theoretical home equity if paid according to the normal 15-year schedule of our new sub-4% fixed mortgage, starting from this month. This would have the loan paid off in 2026.
I definitely still want to pay it off in under the current 15-year term, but as usual I like the flexibility. If children come into the picture, we’ll probably cut back on work and slow things down. But for now, I’m still hacking away. We hit the 401k cap already for 2011, so we have some extra cashflow.
By the way, I am only a proponent of paying extra towards your mortgage if you are maximizing your available tax-advantaged accounts like 401ks and IRAs as well as have a nice cash cushion. Although now I do think everyone should consider 15-year mortgages. Who wants to take 30 years to own a home? Most other countries don’t even offer 30-year mortgages, and the government support of 30-year mortgages here simply inflates property prices.
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I’ve thought a lot about whether I should get a 15 or 30 year mortgage when I buy a house. I’m nowhere near ready for that yet, so I don’t know what my financial or family statuses will be, but I think being able to afford a house with a fifteen year mortgage is a good filter for what you can really afford. I would love to do a fifteen year mortgage, but my fiance worries about the possibility of something going wrong with one of our jobs, so we may stay in a price range where we can afford a 15 year mortgage but go with a 30 year term and pay it down faster.
Congratulations on the progress you’re making. I think it’s really smart to get through your tax advantaged savings first before accelerating your payments on your mortgage. Are you concerned about losing out on employer matching on your 401k by reaching your limit before the end of the year?
Jon,
I am a big fan of your blog. You are doing a great job.
However I disagreee with paying off the house ASAP.
With all the inflation being in the air and low mortgage rate ( I have 4.875% because I am under water on my house) and interest tax deductions that u get isn’t it better to keep paying your mortgage forever? Assuming that you are not throwing away money but putting it in some mutual funds or anything else that can produce more money for you in the future.
best,
Eugene
What I’ve found in my own situation is that once I paid off my house, the additional disposable income I had allowed me to enjoy life more. One of the things it did was it allowed me to take more risk since I felt more secure, and those risks paid off. Had I not done that I think I would have been more conservative, and ultimately my life would be probably less exciting and I’d be making my payments as planned.
In my case, getting debt free as fast as possible paid itself back in spades. I could have compared rates of return to “free money at these rates” and all that jazz, but there is an almost immeasurable value to being debt free which people don’t factor in.
@Penny – The 401k match concern is a valid one, but thankfully my plan does what is called a “true-up” contribution to fix things early next year. I usually try to make sure I put in the max ending in November or so – not too early. I wrote about it more here:
401k True-Up Contributions
@Eugene – Inflation hedging is a benefit of a long mortgage, but you’re still paying interest to borrow money. I just can’t see paying more interest for 30 years just to have some inflation hedge. If inflation rises, bond yields will go up as well, savings account will stop paying 1%, and hopefully other investments will also rise.
Jonathan,
I don’t know what your tax bracket is, but if your tax liability last year (state and federal) was (just for example purposes) 25%, then that mortgage is only going to cost you 4.5% net assuming you can itemize the interest paid. In today’s market, you can easily find investments that will net out more than 4.5% or gross more than 6%. If you were to do that, then the sense would be to let the mortgage run the course instead of paying it off early. For example purposes, let’s say you have a $500k house note (6%) from January 2008, in which today you have 35% paid off after Nov 1. That would mean you have paid an additional $2500 per month for the last 40-something months, and have thus paid an additional $117,500 since January 1 2008. If you could have gotten compound growth of even 6.5%, you would have a little under $140,000 in an investment account at the four year mark. At the end, even at 6.5%, you would have walked away (with no additional $2500 payments to mortgage or savings since Nov 2011) $780k in your investment account. Subtract the $580k in interest from a $500k loan over 30 years at 6%, and you just cost yourself a quarter of a million dollars. Even if you stuck it in a non-compoundable investment (ie bonds) and you were able to make a spread, you cost yourself $40k or $50k if the spreads were low.
Besides, paying off the mortgage early isn’t good for cash flow. I know you mentioned having a good cash reserve beforehand, but you never really know what you’re going to need. Sure people talk about a three month or six month or year cushion, but until something happens you really don’t know what is appropriate.
My last comment is on the “only pay down the mortgage if you’re maximizing tax-advantaged accounts.” The reason why is that today there is an option for a generation skipping tax for a Roth IRA (one-time transfer tax free up to $5 million), but I don’t believe you have grandkids, so that doesn’t do you (or your average reader probably) any good. When a person dies, a retirement account is the worst thing your estate can have. And, if anything happens in the short-term and you need that money, there are only a few items that are allowable where you won’t be penalized to death.
Just some ideas for thought. Keep on keeping on.
It’s always amazing to me on posts like this one (or on the one several weeks ago with the Macro/Micro US government finance comparison), how people come out to defend debt! It just shows how over the last 50 years being continually in debt has come to be so ingrained in our psyches.
Think 30-year mortgages are bad? Try 40 years in Australia, 100-year mortgages in Japan, and even 50-year mortgages in the US!. I think the Japanese and US experiments have been consigned to the wastebasket, but still going strong in Australia.
Ty, you wrote:
“In today’s market, you can easily find investments that will net out more than 4.5% or gross more than 6%.”
EASILY?? How, where?
Jblink- So if somebody offered you 1 million today, and said that in 10 years you had to pay them back 1 million dollars and 25 cents, you wouldn’t go for it? There is good debt and there is bad debt. Any debt that is less than the interest you can earn on the money is good debt in my book.
+1 xmasy
I’m torn. Even with my low 4.25% rate, paying off my mortgage is the best use of my extra money now…especially as I’m concerned my reward checking account will be going away. My 403 is maxed out, as is my roth ira. However there are other variables.
1. Will there be better investment options in 3 years? 5 years? 10 years? 20 years?
2. How long will I keep my house? The sooner I’m planning to sell, the more sense it makes to pay it off, since the opportunity of having that low loan down the road diminishes.
You don’t want to put your money in a 1% account for too long instead of paying off your mortgage, so guess how long you will be living there, and guess how investing rates will go, and there is your answer.
For some people it’s an emotional question, since they just want no debt. For a logical person good debt is more about passing the coin from the left hand to the right hand and we don’t mind good debt.
I just can’t imagine having that much in taxable liquid assets sitting around. I continue to be amazed by how much money you’ve socked away even after purchasing and upgrading a 600K house just three years ago. I also can’t believe that your house is worth 6% more than what you paid. We purchased a house last year and it’s worth 15% less than what we paid and we are in a no-frills “safe” area. You’ve definitely hit the jackpot several times!
These examples assume, of course, that you are “guaranteed” to have an income stream for the next 15+ years to maximize retirement savings, tax advantage accounts AND to pay off debts…. or, hopefully, just pay off debts.
Want a nice tax break? Think about the tax-free imputed income of living w/o payments.
xmasy – Simply look in the bond market or an index that tracks the bond market if you want the quick and easy way with the lowest risk.
Or, buy a property with some trees. Those have shown over time to return in the 6-8% range with very little risk and a tangible asset you can own.
Always go for the 30 year fixed… If you want to pay it off in 15, that’s great but you have the flexibility should hard times hit to make a smaller payment.
Also, money that goes into your house is nearly impossible to get out. If you lose your job or have a big emergency, good luck getting your home equity back in your pocket. (Or if you do, it will be at an outrageous interest rate.)
I like the inflation hedge of a 30 year fixed. Sure, there aren’t easy alternatives out there where I could make 4.25% right now, so I might throw some extra money at my home, but my suspicion is that the historically low interest rates we are seeing won’t be around for 30 years. If the government starts printing money, you can expect to see better alternatives for your cash down the road. You’ll be borrowing at at tax-deductible 4.25% and hopefully getting paid more than that in interest.
Lastly, if you want to do something like start a business, etc. that cheap money could come in handy. Where else will you get someone to loan you $100K – $300K at 4.25% (and tax deductible!)? Use the extra money your saving by not making larger payments to start that biz and your essentially getting a biz loan at 4.25% It’s almost like having a cheap line of credit. (Your credit limit is simply the amount you save each month by having a 30 year fixed instead of a 15 year fixed.)
Some people argue thata 15 year mortgage forces them to save… That’s not a good reason. Set up an autopay to a savings account if you want that feeling and keep the flexibility.
Hi Jonathan,
Do you receive company match on your contributions? If so, you are probably leaving some match on the table if you max out too early in the year. Think about spreading out the $16500 over 12 months to max out the match you receive from the company. Of course you have to run the #’s to see if it makes much of a difference…let me know what you find. JJ
I’m not a fan of paying off a mortgage “early” for many reasons – flexibility, inflation, loss of income by putting the money to work elsewhere, etc.
One of the real advantages of a mortgage is leverage. I don’t plan to be in my current house in 30 years, so given that I will sell it at some point, I’d rather have the gains be based on the minimum investment necessary rather than use the house as a piggybank that I move from house to house.
I know that Jonathan sees putting money into a mortgage as a safe “investment” like a bond, but for me, until I get to the point that I never have to work another day in order to pay all my bills for the rest of my life, I don’t believe in putting much money into ultra conservative investments and unlike a bond, there is no guarantee you can get your money out of the house if you need it (i.e. lose your job, no loan for you).
Is that 62% of purchase price or 62% of the laon amount (including 20% downpayment)?
Either way, it’s very cool.