Should I pay extra on my mortgage?

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Should I pay extra on my mortgage?

Post by goflyers13 »

My wife and I were recently married, and we're still in the process of combining our finances and adjusting how we allocate our money now that we have two incomes and only one residence. I purchased a condo 2.5 years ago, about 3 weeks before I met my wife, and I've been making the minimum payment on the mortgage since I bought it. I don't have a crystal ball, but I expect to stay in the condo for another 3-5 years before selling it and purchasing a house. I expect the house will cost between $225k and $275k, and I hope to have a down payment of at least 50%.

In the break-down below, you'll see that we have about $20k annually to contribute to our future down payment. I'm trying to decide what to do with these funds. Option 1 is to put the money into savings accounts and CDs with interest rates between 1.25% and 2%. Option 2 is to put all of it on the mortgage with an interest rate of 3.75%. Option 3 is to do a mix of options 1 and 2. If we only consider dollars and cents, option 2 is the clear-cut winner with the 3.75% interest rate, but I'm wondering if there are any advantages to option 1 when it comes time to buy our house. Will lenders look more favorably on a larger pile of cash than a smaller mortgage balance? Can we somehow gain extra leverage by having more cash on hand? If we choose option 3, is there a certain ratio to shoot for? Any thoughts or insights are greatly appreciated!

Our situation:
Me: 26
Wife: 27

Estimated home value: $155k
Mortgage balance: $95k
Mortgage rate: 3.75%
Currently making minimum payment

Non-mortgage debt: none

Cash balance: $35k
Retirement account balance: $100k

Combined salary: $116k
Annual pre-tax retirement contributions: $29k
Income is very stable and expected to increase modestly as we both complete graduate degrees in the next 18 months

Annual take-home pay: $71k
Annual Roth contributions: $11k
Estimated annual expenses: $35k (probably more like $30k in reality, but it doesn't hurt to make a conservative assumption)
Annual car fund contribution: $5k (we buy cheapos and run them into the ground, so this is plenty)
$71K - $11k - $35k - $5k = $20k left over
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Re: Should I pay extra on my mortgage?

Post by bengal22 »

How about option 4: invest in a stock/bond index mutual funds in a non-retirement account. This will help you have a sum of money that you can access for kid's college, bigger house, etc. But I am not a proponent of paying off a mortgage that has a good interest rate.
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Re: Should I pay extra on my mortgage?

Post by barnaclebob »

Personally I'd split it. Its nice to have cash on hand and to pay down a mortgage. My wife and I are rapidly paying down our mortgage which has a 2.75% rate. We would have been maybe $50k better off had we invested in a taxable account instead but we really enjoy not owing money to someone else.
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Re: Should I pay extra on my mortgage?

Post by chevca »

I think the key is when you will sell the condo compared to buying the house, and how easily the condo will sell.

If you were to sell the condo before buying the house and the condo sells easy, then paying down the mortgage is the better move. If you're trying to sell the condo at the same time you're buying the house and the condo sits on the market a while, having cash on hand and not tied up in the condo is the better move. Of course, how long it sits can be solved by how low you're willing to go no matter what the housing market is like, so...

I would keep cash on hand just to feel safe about the house purchase. But, I'm pretty conservative about things like that.
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Re: Should I pay extra on my mortgage?

Post by tedgeorge »

I would not pay it down. In less than two years you are going to graduate and may have some exciting new options open to you that may not be in the same location you are at now. Also, you may appreciate having that cash in hand rather than in a condo. What if the house you really want comes up but you have to sell your condo to purchase? Sure, it may sell quickly now but that may not always be the case.
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Re: Should I pay extra on my mortgage?

Post by marklar13 »

Given those options, and your desire to have 50% down... If planning on purchasing the house before selling the condo, then I would plan on having 20% down saved up, with the rest going to pay off the mortgage balance. If planning on selling the condo first, and using the proceeds for down payment, then I would just put the majority of it towards the mortgage balance.

If it were me, due to uncertainty around what you will actually do with the condo, I would lean towards trying to save up 20% for your down payment, and then having the rest (if any) go towards the current mortgage balance. Given the short timeline, I don't think you are going to see a huge benefit from eeking out a few extra percentage points. And having the cash on hand gives you more flexibility.

We recently bought a house while in the process of concurrently selling. We end up purchasing before we sold (somewhat risky I suppose, but a separate discussion). We were fortunate to have a down payment of 20% without the proceeds from our sale. When shopping for a loan, I asked about the down payment affecting the rate, and everyone I asked told me that your rate won't go any lower after you have 20% down (e.g. doesn't matter if you are putting down 20% or 50%... you'll get the same rate).

We ended up putting around 20% down, and then when our sale was finalized we put a portion of the proceeds towards the new loan (re-casted) so that in effect we ended up putting the desired amount down. Our home purchase was actually delayed, so it ended up all being in the original mortgage terms, but when I asked the question to my lender I was told there wouldn't be a cost to re-cast the loan if we wanted to put the proceeds from the sale towards the new loan after close. The re-casting cost probably differs per lender, but I doubt it is enough to actually make a difference in your decision. The part about the rate not lowering after 20% down, I think is pretty universal among lenders (at least from my inquiries).
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Re: Should I pay extra on my mortgage?

Post by Olemiss540 »

I will play devil's advocate:

How much tax advantaged space is remaining? It appears you both max the Roth IRA's, and at $29K, you are $7k short of maxing your 401(k)s. It is not mentioned whether you have an HSA available for additional tax free investment.

I would MAX all tax advantaged retirement accounts prior to saving for a maybe, sometime goal. The money you save in these has the benefit of tax free contributions (20% min tax savings), and your Roth IRA contributions can be tapped to make up for a small shortfall on your down payment if necessary at a later date.

You are in a situation that could potentially SET your future family situation up for life, and make the remaining years of your marriage much less stressful in regards to finances. Try your best to get as much money in the magic of compounding and take FULL advantage of any tax advantaged space available before it is gone.....

Once ALL tax advantaged space has been maximized, personally I would pay down the mortgage. That ensures the money has a name and it WILL be used for that purpose. I am much more focused if I put my money to work immediately, and much less likely to make a poor financial decision if I do not have a slush fund accumulating.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.
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Re: Should I pay extra on my mortgage?

Post by badbreath »

I am with Olemiss540 you will do better to max out 401k and Roth's then think about the house.
“While money can’t buy happiness, it certainly lets you choose your own form of misery.” Groucho Marx
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Re: Should I pay extra on my mortgage?

Post by badbreath »

“While money can’t buy happiness, it certainly lets you choose your own form of misery.” Groucho Marx
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Re: Should I pay extra on my mortgage?

Post by Salada Dinero »

This is a tough question as we don't have a crystal ball to predict expected returns should you choose to invest it.

On one hand, paying off the mortgage is a known quantity. You can determine exactly what the value will be based on normal and extra payments, and the market will not determine the result. In a greatly improving market, you'll do much better investing it, but then again you could also lose 20% or more of the investment in a down market, which could start tomorrow. Any given mix of investments may do better or worse.

I made the choice to do both, but I am already on track for savings and am maxing out IRA/401's already. I pay $1400 add'l into the mortgage each month and about $1800 (varies a little bit) investments in my taxable account. I determined the exact date in which the mortgage would be paid for, and I'm comfortable with that date as it aligns with my desired retirement date. Then we will sell the house, downsize with no mortgage and add the proceeds to the taxable account stack.

If you look at historical long term equity gains and use that figure, you'll always convince yourself to invest it if your timeline is long, but it's a gamble whereas paying down on the mortgage you'll get very predictable results.

I noticed there is not a mortgage payoff doc in our excel files. I have a very nice one I can share that will calculate the details for do I have it reviewed and uploaded here?
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Re: Should I pay extra on my mortgage?

Post by freedomseeker »

Agree with Olemiss. Max out tax advantaged 401k first especially during times of low interest rates. Also another perspective is from an overall wealth portfolio standpoint you would not want the majority of your wealth tied in 1 illiquid asset (condo/home equity). Once you have maxed out your 401k then the decision becomes different. Last point of consideration is to make sure you have enough liquid assets to access in case of emergencies.
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Re: Should I pay extra on my mortgage?

Post by Toons »

Pay Down,
Pay Off,
The Mortgage

"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
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