Best way to shorten the life of a mortgage

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camiboxer
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Best way to shorten the life of a mortgage

Post by camiboxer » Thu Oct 13, 2011 8:29 am

I have read many posts about whether it is a good idea to pay off a mortgage early and there are many varying thoughts.
My question is a bit different and I couldn't find any specifics to it.

We have a 30 year mortgage with a balance of $118K @ 4.5%.
Is it better to make additional principal payments monthly or to do a larger lump sum payment once a year? I understand the benefit of reducing principal sooner and think the monthly route is the way to go but am not sure. If the lump sum yearly payment is the wiser choice the money would sit in a traditional low interest bearing savings account during the year.

The additional money would be above and beyond emergency funds.

**I may have put this in the wrong forum. My apologies to the mods. if it needs moved.

Furynation
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Post by Furynation » Thu Oct 13, 2011 8:37 am

Hard to say without knowing some actual numbers. Have you tried running different scenarios through a mortgage calculator? For example, using your numbers as fresh loan starting Nov. 1st of this year, if you were to add 49.82 a month as extra principal (thus making one additional mortgage payment a year), you'd pay 80,901.49 vs 97,239.92 in total interest over the 30 years.

On the other hand, let's say you made one lump sum payment of a normal payment (still one additional payment only) half way through the year. Then you'd pay 80,742.75 vs 97,239.92 in total interest. Probably best for you to use a mortgage calculator and run some numbers.

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Post by texas_archer » Thu Oct 13, 2011 8:45 am

What I do is make my mortgage payment on the first day of the month. After it post, I see what it would take to reduce the principle to a even thousand and I pay that. This allows me to pay extra on my mortgage every month and continue adding money to my investments.

So, if my principle is $215400 and my monthly payment brought it down to $214800 I would pay an extra $800 that month and put it on my principle.

However, this year I made two large principle payments (yearly bonus) on top of my monthly additions.

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mas
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Re: Best way to shorten the life of a mortgage

Post by mas » Thu Oct 13, 2011 8:55 am

This is very easy. From what I understand, your mortgage rate is significantly higher than your savings interest rate. Whenever you have "extra" money that you are targeting towards mortgage principal, pay it right away. If you have saved up part of a lump sum already, then use it as a lump sum now, and then pay extra every month as cashflow allows.

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Post by Yuba » Thu Oct 13, 2011 9:10 am

How many years are left on your mortgage. The quickest way to drop years and interest is to refinance to a 15yr fixed rate. Then make additional payments monthly as available.

Rick dba Yuba

dhodson
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Post by dhodson » Thu Oct 13, 2011 9:10 am

assuming no additional charges, it would seem to make the most sense to reduce the balance as quickly as possible since that should reduce the amount of interest charged. Thus in your situation, whatever money you have extra should be applied as quickly as possible unless you need it for an emergency fund or it is invested in something that when you take into consideration the tax advantage of home ownership interest provides a greater return. deciding on whether or not to pay off early is a slightly seperate question although im in the camp to do so.

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Re: Best way to shorten the life of a mortgage

Post by porcupine » Thu Oct 13, 2011 9:26 am

mas wrote:This is very easy. From what I understand, your mortgage rate is significantly higher than your savings interest rate. Whenever you have "extra" money that you are targeting towards mortgage principal, pay it right away. If you have saved up part of a lump sum already, then use it as a lump sum now, and then pay extra every month as cashflow allows.
This is the right answer. Saving up to make a lumpsum payment makes no sense if it is earning less interest than you are paying on your mortgage.

- Porcupine

camiboxer
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Post by camiboxer » Thu Oct 13, 2011 10:20 am

Saving up to make a lumpsum payment makes no sense if it is earning less interest than you are paying on your mortgage.
That was my thinking.
I have always added the same additional dollar amount each month but then realized with constant adjustments to property taxes/insurance costs each year in escrow the payment is forever going up. This route doesn't always allow me to put a specific dollar amount directly towards principal. I guess continued tweaking is in order.

blocky97
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Post by blocky97 » Thu Oct 13, 2011 12:07 pm

DISCLAIMER: i'm a newbie in investing :)

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.

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Post by archbish99 » Thu Oct 13, 2011 12:10 pm

Watch the interest rate on high-yield CDs (5yr is currently 1.98% at Ally). When that's above your mortgage rate, take out a CD every month (or quarterly or whatever) with the money rather than paying down your mortgage. When it's below your mortgage rate, as it is now, pay down principal with that month's money.

When a CD matures, same choice -- make an extra principal payment if the renewal rate is below your mortgage rate, renew the CD if you can renew for more than your mortgage rate.

And....
blocky97 wrote:DISCLAIMER: i'm a newbie in investing :)

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.
You're mixing apples and oranges. Paying down a mortgage is a near-riskless investment. Proper comparisons are CDs and short-to-intermediate Treasury bills. Stocks bring much higher risk of loss of principal.

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Post by camiboxer » Thu Oct 13, 2011 12:36 pm

DISCLAIMER: i'm a newbie in investing Smile

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.
I'm new to investing (or learning how to do it wisely). Since I am no expert by any means your advice sounds good in theory however I think I'd need a higher yield than 5% to account for taxes, *if* in a taxable account plus the desire for a debt free lifestyle takes priority (for me) over additional investments especially those with no guarantee.

blocky97
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Post by blocky97 » Thu Oct 13, 2011 2:01 pm

You're mixing apples and oranges. Paying down a mortgage is a near-riskless investment. Proper comparisons are CDs and short-to-intermediate Treasury bills. Stocks bring much higher risk of loss of principal.
@archbish99 ... true it is mixing apples and oranges ...in a sense...but if you invest in something secure(ish) ... then i don't see the advantage...Maybe an example will help in how i'm thinking....

lets say I invest in a stock that has a dividend... Lets say the history of the stock for the dividend is pretty consistent...and its returning 5% a year right now.... to simplify it lets say its in a non taxable account. Then you are up .5% overall....unless my thinking is way off.

@camiboxer you could be right, i didn't do the math to check (would have to figure it out) just used 5% because I figured it would be at least a break even point...

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Post by marco100 » Thu Oct 13, 2011 2:14 pm

blocky97 wrote:DISCLAIMER: i'm a newbie in investing :)

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.
Yes you're correct.

And if you pick the right stock, buy it @ 5% div. yield, and then if the stock price drops in half your dividend yield will double to 10% and you will look like an absolute genius.

This is an excellent plan.

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Toons
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Post by Toons » Thu Oct 13, 2011 2:15 pm

I would apply any saved and "found" cash every month to the mortgage and pay it off as fast as I could :D :D
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Post by Harold » Thu Oct 13, 2011 2:28 pm

marco100 wrote:
blocky97 wrote:DISCLAIMER: i'm a newbie in investing :)

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.
Yes you're correct.

And if you pick the right stock, buy it @ 5% div. yield, and then if the stock price drops in half your dividend yield will double to 10% and you will look like an absolute genius.

This is an excellent plan.
Be nice, he said he was new to investing.

blocky, if you were to take that approach, you'd be effectively borrowing at 4.5% (with a presumably near-certain obligation to repay) to put money in a stock whose price and dividend will vary. Sure you may make money on it, but it probably won't be a consistent 5%. And you could very well lose money. -- if you lose, you'll still need to pay that 4.5% mortgage.

So, no it doesn't make sense to do that. At least it doesn't make immediate sense without some reflection on the risk you're taking.

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Post by dhodson » Thu Oct 13, 2011 2:38 pm

while i agree it isnt appropriate to compare low risk to higher risk investments, one should consider that he is in essence paying a lower interest rate when you consider the tax deduction. I still think in todays investing environment Id pay off the mortgage but i still think we need to fair on the actual return rate he would need in order to compete with this interest rate.

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Post by Sunny Sarkar » Thu Oct 13, 2011 2:44 pm

blocky97 wrote:DISCLAIMER: i'm a newbie in investing :)

With a rate a 4.5%, wouldn't it make more sense to invest the money that you would use to put toward principal into a stock with a dividend that has a net yield of 5% or more.
No. A penny saved is a penny earned. Paying $x towards principal of a 4.5% mortgage is equivalent to buying a bond with a 4.5% yield and no risk of losing your principal (treasuries). Stocks are completely different ballgame because both the value of the principal (stock price) and the dividend will fluctuate. The biggest distinction is that putting towards the mortgage principal is guaranteed money saved (=earned), but putting money in a stock has no guarantees whatsoever.

p.s. Welcome to investing. We're all learning something everyday here even after several years of investing.
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Post by guitarguy » Thu Oct 13, 2011 2:48 pm

dhodson wrote:while i agree it isnt appropriate to compare low risk to higher risk investments, one should consider that he is in essence paying a lower interest rate when you consider the tax deduction. I still think in todays investing environment Id pay off the mortgage but i still think we need to fair on the actual return rate he would need in order to compete with this interest rate.
Related point...but this assumes he takes the deduction, right? For instance, my wife and I taking the standard deduction works better in our favor than deducting our mortgage interest.

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Post by dhodson » Thu Oct 13, 2011 3:04 pm

yes that is correct
again i just think it should be considered in any evaluation

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Post by lightheir » Thu Oct 13, 2011 3:08 pm

I had a lot of those 'buy a higher-yielding stock/bond instead of a mortgage and use that to pay the mortgage' ideas before I actually got a mortgage. Especially in my younger years where mortgages were far away, and stocks were in their heyday.

If anything, the great recession should sober you up quick to the fallacy of such an approach. Actually, the approach is completely reasonable, but you're not going to find a reliable long-term security that yields enough after-taxes to equal your mortgage year after year.

I'm a big believer in market efficiency in areas where there are a lot of buyers and sellers and lots of liquidity. Which means that if it was indeed true that you could snap up a no-risk security (like a CD or gov't bond) that would give you yields higher than a typical mortgage, the mortgage brokers would promptly change their rates so this would no longer be the case. No free lunches out there - when you actually start shopping for a mortgage in earnest, you quickly see this at play, and these ideas quickly no longer even are considered.

If you're into high risk, and don't worry about the possibility of being short on your mortgage (any possibly WAY short), go ahead and invest in stocks in lieu of paying your mortgage. I wouldn't recommend it though.

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Post by Harold » Thu Oct 13, 2011 3:09 pm

dhodson wrote:yes that is correct
again i just think it should be considered in any evaluation
Yeah, to me the best way would be to calculate the true effective rate -- 4% or whatever. Then just do any evaluation based on that number.

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Post by texas_archer » Thu Oct 13, 2011 3:17 pm


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Post by blocky97 » Thu Oct 13, 2011 4:11 pm

hmmm i dunno...based upon @texas_archer link for yahoo finance calculator...still seems a better deal to go and invest in stock returning 5% dividend. YES its more risky, ....but I don't see it as being that much more risky then anything else...(granted i'm a noob and haven't really been burned yet)

correct me if i'm wrong...but based upon the number i'm putting in, i'm better off. (and way better off if i put it in an IRA....once again i'm a noob so I don't know if i'm doing it right)

Numbers:
RATES AND ASSUMPTIONS Input
Interest rate on debt: (%) 4.25
Is the interest deductible? YES
Before tax return on investment: (%) 5%
Is the interest taxable? YES
Marginal tax bracket: (%) 33%
Monthly funds available 1000

This gives me:
$1,000 monthly surplus to your debt would result in a one year after-tax interest savings of $158. The same $1000 invested at a hypothetical rate of return of 5.00% could result in an after-tax amount of $186.

@lightheir ...this isn't a question of being short on my mortgage to buy stocks,.. i dunno though my whole thought process could be wrong on this

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Post by Harold » Thu Oct 13, 2011 4:29 pm

blocky97 wrote:hmmm i dunno...based upon @texas_archer link for yahoo finance calculator...still seems a better deal to go and invest in stock returning 5% dividend. YES its more risky, ....but I don't see it as being that much more risky then anything else...(granted i'm a noob and haven't really been burned yet)

correct me if i'm wrong...but based upon the number i'm putting in, i'm better off. (and way better off if i put it in an IRA....once again i'm a noob so I don't know if i'm doing it right)

Numbers:
RATES AND ASSUMPTIONS Input
Interest rate on debt: (%) 4.25
Is the interest deductible? YES
Before tax return on investment: (%) 5%
Is the interest taxable? YES
Marginal tax bracket: (%) 33%
Monthly funds available 1000

This gives me:
$1,000 monthly surplus to your debt would result in a one year after-tax interest savings of $158. The same $1000 invested at a hypothetical rate of return of 5.00% could result in an after-tax amount of $186.

@lightheir ...this isn't a question of being short on my mortgage to buy stocks,.. i dunno though my whole thought process could be wrong on this
If you're going that direction, why stop at 5%? There are investments out there where you could earn 50%.

Of course you'd be taking a risk, and that's the point. Not everyone wants to take risk with their home. Maybe you do, but that's worth some reflection. It's not an obvious financial choice -- and it really isn't a financial choice at all.

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Post by texas_archer » Thu Oct 13, 2011 4:29 pm

blocky97 wrote:hmmm i dunno...based upon @texas_archer link for yahoo finance calculator...still seems a better deal to go and invest in stock returning 5% dividend. YES its more risky, ....but I don't see it as being that much more risky then anything else...(granted i'm a noob and haven't really been burned yet)

correct me if i'm wrong...but based upon the number i'm putting in, i'm better off. (and way better off if i put it in an IRA....once again i'm a noob so I don't know if i'm doing it right)

Numbers:
RATES AND ASSUMPTIONS Input
Interest rate on debt: (%) 4.25
Is the interest deductible? YES
Before tax return on investment: (%) 5%
Is the interest taxable? YES
Marginal tax bracket: (%) 33%
Monthly funds available 1000

This gives me:
$1,000 monthly surplus to your debt would result in a one year after-tax interest savings of $158. The same $1000 invested at a hypothetical rate of return of 5.00% could result in an after-tax amount of $186.

@lightheir ...this isn't a question of being short on my mortgage to buy stocks,.. i dunno though my whole thought process could be wrong on this
You should be investing in the IRA anyway. We are comparing investing in stocks/bonds in a Taxable account v/s paying down debt.

It really comes down to your risk tolerance and when it comes to paying down debt its not all about making/losing money. A lot of it is about no longer having debt and having the ability to invest your monthly surplus while sleeping comfortably at night knowing all you have to do to stay in your house is pay your taxes.


When it comes to paying off your mortgage early, its a personal choice for most.

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Post by Watty » Thu Oct 13, 2011 5:14 pm

If I remember correctly through the end of the month you can still get iBonds that are yielding 4.6% with tax advantages and after the end of the month I would think they might still be in the mid 3% range which could be competitive to your effective mortgage interest rate if you are able to deduct it. There are some pros and cons to iBonds so that you would need to look into first.


One advantage of saving up a lump sum is that you may be able to have your lender "recast" your mortgage after a large pre-payment. this would have the advantages of reducing your required monthly payment and keeping your loan term the same which would be desirable if (when) inflation and interest rates get higher than 4.5%.


There have been a number of threads on these that you should be able to search for.


One advantage of paying additional each month is that it would actually happen if you set it up to be don automatically. Saving up for a year or more to have a lump sum might sound like a good choice, but there is a huge risk that something would come up and it would never happen.


Either choice is probably not the best use of your money if you are not making all the maximum tax preferred contributions for all your retirement accounts (IRA, Roth, 401k, etc) for both you and any spouse as well as some of the college savings plans for any kids.. The tax advantages would likely outweigh the mortgage interest savings.

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Post by mas » Thu Oct 13, 2011 9:57 pm

Watty wrote:If I remember correctly through the end of the month you can still get iBonds that are yielding 4.6% with tax advantages and after the end of the month I would think they might still be in the mid 3% range which could be competitive to your effective mortgage interest rate if you are able to deduct it. There are some pros and cons to iBonds so that you would need to look into first.
Both you and blocky97 are confusing whether it is worthwhile to pay off the mortgage, or invest in something else. That isn't the question that was asked.

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Post by camiboxer » Fri Oct 14, 2011 1:16 pm

This was my actual question.
Is it better to make additional principal payments monthly or to do a larger lump sum payment once a year?
I assumed paying an additional amount monthly was the way to go however had read instances where people had saved yearly and then paid a lump sum. I never saw a reason as to why it was done that way and wanted clarification as to if this method offered a different benefit I wasn't seeing.

I have always paid extra monthly and will continue to do so. Might even do a larger lump sum yearly (or whenever if funds are available after other investment opportunities are met).

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Post by grabiner » Fri Oct 14, 2011 10:30 pm

lightheir wrote:I'm a big believer in market efficiency in areas where there are a lot of buyers and sellers and lots of liquidity. Which means that if it was indeed true that you could snap up a no-risk security (like a CD or gov't bond) that would give you yields higher than a typical mortgage, the mortgage brokers would promptly change their rates so this would no longer be the case. No free lunches out there - when you actually start shopping for a mortgage in earnest, you quickly see this at play, and these ideas quickly no longer even are considered.
However, the IRS can create a free lunch. If you aren't maxing out your IRA or 401(k), it can often happen that the after-tax rate on your mortgage is more than the tax-free rate on a Treasury bond. The bank would rather lend the money to you than to the Treasury, because it has to pay tax on the interest either way, but if you can deduct the mortgage interest and not pay tax on the Treasury interest, you may come out ahead.
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Re: Best way to shorten the life of a mortgage

Post by wander » Sat Oct 15, 2011 8:07 am

camiboxer wrote:Is it better to make additional principal payments monthly or to do a larger lump sum payment once a year?
Additional principal payments is better. For example, if you want to pay $2,000 extra each year, then divide it by 12 and add to your payments.

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Post by snyder66 » Sat Oct 15, 2011 8:15 am

I would just keep attacking your principal, if that's your goal.

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Post by Alex Frakt » Sat Oct 15, 2011 9:51 am

blocky97 wrote:hmmm i dunno...based upon @texas_archer link for yahoo finance calculator...still seems a better deal to go and invest in stock returning 5% dividend. YES its more risky, ....but I don't see it as being that much more risky then anything else...(granted i'm a noob and haven't really been burned yet)
I think what you are missing is that while the dividend (x pennies per share) is set by the company, the rate (%) is set by the market through its determination of the share price. Generally speaking, market participants only drive a stock's price low enough to produce a dividend rate higher than mortgage rates when they believe there is a significant chance of something bad happening to the company such as bankruptcy or a dividend cut.

To take an extreme example from the bond world, right now you can get a 65% yield on Greek bonds. Obviously no one expects to receive that entire 65% until maturity and then receive their principal back, the rate is currently only available because of of the virtual certainty of some amount of principal loss and/or payment default. But if you extend your argument that you can ignore risk when comparing yields, this is where you should be investing all of your extra principal payments. I hope you can see that this would not be a good idea.

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Post by LadyGeek » Sat Oct 15, 2011 10:17 am

To the OP, the best way to minimize the total interest paid over the life of your mortgage is to reduce the term. I'm refinancing from a 30 year fixed to 15 year fixed, which will save a ton of interest. It will cost me only $120 more per month, but will save $$$ thousands in interest. If I lose my job, that $120 / month isn't a deciding factor to pay the mortgage or not.

So, you really want to pay down the principal as soon as possible.

If you decide to put the money into alternative investments, you still have to pay the mortgage. You have no idea what will happen in 5 months, let alone 5 years.

If anything bad happens, you can always stop paying additional principal and use those extra funds to deal with the problem. If you had used the money on something else, it may not be liquid (available for quick withdrawal), or you'll take a huge hit in expenses or penalties.

(Update: Clarified for relative month vs. year time frame.)
Last edited by LadyGeek on Sat Oct 15, 2011 1:15 pm, edited 1 time in total.
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Post by happymob » Sat Oct 15, 2011 11:02 am

blocky97 wrote:
You're mixing apples and oranges. Paying down a mortgage is a near-riskless investment. Proper comparisons are CDs and short-to-intermediate Treasury bills. Stocks bring much higher risk of loss of principal.
@archbish99 ... true it is mixing apples and oranges ...in a sense...but if you invest in something secure(ish) ... then i don't see the advantage...Maybe an example will help in how i'm thinking....

lets say I invest in a stock that has a dividend... Lets say the history of the stock for the dividend is pretty consistent...and its returning 5% a year right now.... to simplify it lets say its in a non taxable account. Then you are up .5% overall....unless my thinking is way off.

@camiboxer you could be right, i didn't do the math to check (would have to figure it out) just used 5% because I figured it would be at least a break even point...
GE had a "Secure" dividend - before they cut it. Many utilities (say, Ameren) has "secure" deividends - before they cut them. Bank of America, Citigroup, etc has "Secure" dividends - before they cut them. Point is, equity investing has risks, regardless of how safe a company was before.

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Post by legio XX » Sun Oct 16, 2011 6:59 am

I recently came across an idea that will help me kill my student loans a bit faster. I am old enough that paying off the entire loan was worrisome because "something (a bad text result?) might happen and I'll need the money." Then the income from investments sank, and the cheap loans of decades past became expensive loans so I started looking at calcs to figure out what adding a bit more (been sending a few bucks extra all along) to the payment would do.

Found a compromise that works for me: I have to take the RMD from a small inherited IRA which just goes into my MM, at nearly 0%. If I consider this a "windfall" and send it to the loan instead, the results are gratifying. If things do go wrong and I need that money for living expenses instead of making another windfall payment, the principal/interest going forward will still have been reduced.

Don't know if you have a handy windfall, but another possibility.

Vic

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