When to consider making extra principal payments on mortgage?

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Ed_Sandwich
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When to consider making extra principal payments on mortgage?

Post by Ed_Sandwich » Fri Dec 07, 2018 9:52 am

We bought our home 3 years ago and put 20% down. It has appreciated at 3% per year since based on comps, so essentially we have made a return of ~20% when you factor in the leverage. I expect the 3% number to stay the same or increase in coming years.

We currently max our tax deferred investments (401k's and HSA), and occaisionally we have a little bit leftover to put somewhere. We have been putting it in our kids' 529s, but I am wondering if it might be better invested as extra mortgage payments. Obviously that is a pretty illiquid place to put it but the rate of return has me considering it. What do you think?

onourway
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Re: When to consider making extra principal payments on mortgage?

Post by onourway » Fri Dec 07, 2018 10:02 am

What is the interest rate on the mortgage?

You're right, it's an illiquid place to put it. Hard to use your mortgage equity to pay for college, or a cash need, or to use as a down payment on a new home, simplifying the process by not having your down payment tied up in equity.

If you have any chance of qualifying for need-based financial aid it may be better to have the money tied up in the home rather than in the 529.

daheld
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Re: When to consider making extra principal payments on mortgage?

Post by daheld » Fri Dec 07, 2018 10:04 am

Ed_Sandwich wrote:
Fri Dec 07, 2018 9:52 am
We bought our home 3 years ago and put 20% down. It has appreciated at 3% per year since based on comps, so essentially we have made a return of ~20% when you factor in the leverage. I expect the 3% number to stay the same or increase in coming years.

We currently max our tax deferred investments (401k's and HSA), and occaisionally we have a little bit leftover to put somewhere. We have been putting it in our kids' 529s, but I am wondering if it might be better invested as extra mortgage payments. Obviously that is a pretty illiquid place to put it but the rate of return has me considering it. What do you think?
This will quite obviously depend on the mortgage interest rate and term. Without that information, I don't believe anyone is going to be willing to offer a strong opinion. At the end of the day, nobody can really answer this except for you. There will be logical reasons for and against paying ahead, and these may or may not be outweighed by the psychological comfort of paying down debt, regardless of it that early payment makes financial sense.

Ed_Sandwich
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Re: When to consider making extra principal payments on mortgage?

Post by Ed_Sandwich » Fri Dec 07, 2018 10:20 am

onourway wrote:
Fri Dec 07, 2018 10:02 am
What is the interest rate on the mortgage?
Sorry, I forgot to mention this very important part. Interest rate is sub-4%. So not much of a guaranteed return.

Grt2bOutdoors
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Re: When to consider making extra principal payments on mortgage?

Post by Grt2bOutdoors » Fri Dec 07, 2018 10:22 am

529 plan is where i would put it, especially if you have 10+ years to go before withdrawals.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

onourway
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Re: When to consider making extra principal payments on mortgage?

Post by onourway » Fri Dec 07, 2018 10:28 am

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:20 am
onourway wrote:
Fri Dec 07, 2018 10:02 am
What is the interest rate on the mortgage?
Sorry, I forgot to mention this very important part. Interest rate is sub-4%. So not much of a guaranteed return.
So it's really a personal decision. Some people feel the weight of a mortgage as a burden and can't wait to get out from under it. That's fine. In our similar situation, our mortgage rate is low, our payment is very low relative to our earnings, so I prefer to pay it off only as scheduled. I prefer the liquidity of saving excess funds elsewhere, including in our 529's.

HoosierJim
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Re: When to consider making extra principal payments on mortgage?

Post by HoosierJim » Fri Dec 07, 2018 10:39 am

If you have a 4% mortgage on $100,000 balance - an extra payment of $144 - the current principle paydown will remove 1 payment at the end. The only reason to do this if helps you sleep better.


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Ed_Sandwich
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Re: When to consider making extra principal payments on mortgage?

Post by Ed_Sandwich » Fri Dec 07, 2018 10:56 am

(OP here)

I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.

daheld
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Re: When to consider making extra principal payments on mortgage?

Post by daheld » Fri Dec 07, 2018 11:16 am

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:56 am
(OP here)

I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.
If your goal does not involve early payoff, and you plan to sell in the next handful of years, I would not pay extra.

Ed_Sandwich
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Re: When to consider making extra principal payments on mortgage?

Post by Ed_Sandwich » Fri Dec 07, 2018 11:26 am

HoosierJim wrote:
Fri Dec 07, 2018 10:39 am
If you have a 4% mortgage on $100,000 balance - an extra payment of $144 - the current principle paydown will remove 1 payment at the end. The only reason to do this if helps you sleep better.
Thanks for the spreadsheet visual. I have been looking for a spreadsheet/calculator that gets my ROI on the mortgage payments. I just did back of the napkin math for the ~20% I cited.

onourway
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Re: When to consider making extra principal payments on mortgage?

Post by onourway » Fri Dec 07, 2018 11:31 am

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:56 am
(OP here)

I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.
You get the 20% return regardless of whether you pay extra or not. The fact that you won’t be able to buy another house without selling this one for the down payment is a strong reason to consider saving outside of the mortgage. Your options are much more open when you can pay cash up front for the next down payment.

pdavi21
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Re: When to consider making extra principal payments on mortgage?

Post by pdavi21 » Fri Dec 07, 2018 11:42 am

When your interest rate on mortgage corrected for tax reduction (if taken) is lower than the aftertax return on your safest asset class.

btenny
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Re: When to consider making extra principal payments on mortgage?

Post by btenny » Fri Dec 07, 2018 11:56 am

Back when I was in my big house and working I refinanced my home with a 30 year mortgage. But I wanted to pay it off in 15 years. So I set up a payment plan to prepay some principal each month. The amount I selected would pay off the mortgage in 14ish years when I was nearing retirement. But during that time I was also putting several $K in my taxable account and my 401K and my wifes IRA. So in your case I suggest you put the small left over $$ in your taxable investment account for now. Maybe in the future you can use the next raise to also start to prepay the mortgage.

Good Luck.

guitarguy
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Re: When to consider making extra principal payments on mortgage?

Post by guitarguy » Fri Dec 07, 2018 1:36 pm

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:56 am
(OP here)

I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.
In a very similar situation to yours (low rate, looking to move in a few years, have a little extra left over each month, may keep current home as a rental, not enough for next down payment in cash yet).

We're keeping the extra money liquid. Without question.

HoosierJim
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Re: When to consider making extra principal payments on mortgage?

Post by HoosierJim » Fri Dec 07, 2018 4:24 pm

Consider yourself lucky if you have a modern interest rate and can contemplate alternative investments.

Had you been one of the "blessed" few that actually took out a mortgage in November, 1981 - at a bargain interest rate of 18.4%, your first payment on $100,000 would have been $1,540 with $1,533 of those dollars going towards interest and $7 going towards the principle. So if you ponied up $7 more dollars in your first payment envelope, you would knock 1 month off the 360 payments. You probably could have refinanced 10 times between 1981 and 2011, although the average interest rate for about 10 years was at least 12%. Since not many homes were selling then you may have gotten a bargain price too.

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ralph124cf
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Re: When to consider making extra principal payments on mortgage?

Post by ralph124cf » Fri Dec 07, 2018 4:36 pm

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:20 am
onourway wrote:
Fri Dec 07, 2018 10:02 am
What is the interest rate on the mortgage?
Sorry, I forgot to mention this very important part. Interest rate is sub-4%. So not much of a guaranteed return.
Considering the 2018 tax law, are you still able to deduct the interest against your Federal income taxes? Due to the many new limits on deductions, especially the $10,000 limit on state and local taxes, many people find that the increased standard deduction is more advantageous than the interest deduction. This would argue slightly in favor of paying extra on the mortgage.

Ralph

Ben Mathew
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Re: When to consider making extra principal payments on mortgage?

Post by Ben Mathew » Fri Dec 07, 2018 4:50 pm

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:56 am
I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.
Paying off the mortgage early will get you a rate of return equal to the 4% interest rate on the mortgage (minus mortgage tax deductions, if any). It is not connected to the 20% rate of return you got on your house over the last three years after leverage. You will get that return again only if you borrow and buy another house, and the house price continues to increase at the same rate. That's not something you should count on. It might happen. But prices could also fall and you could lose big. There is simply no way to get a 20% rate or return on any investment without taking a risk (possibly hidden) that can go very badly.

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grabiner
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Re: When to consider making extra principal payments on mortgage?

Post by grabiner » Fri Dec 07, 2018 10:41 pm

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:20 am
onourway wrote:
Fri Dec 07, 2018 10:02 am
What is the interest rate on the mortgage?
Sorry, I forgot to mention this very important part. Interest rate is sub-4%. So not much of a guaranteed return.
That's still a decent guaranteed return if you don't itemize deductions. Paying down a 4% mortgage gives you a risk-free return of 4%. If you expect to sell the home in six years, then it is a six-year return, as you'll get the money back when you sell.

If you are maxing out your retirement accounts, that's better than the 3% you can get on a long-term investment with a six-year duration (Admiral shares of Vanguard Long-Term Tax-Exempt yield 3.22% with a 7-year duration, and Admiral shares of Vanguard Intermediate-Term Tax-Exempt yield 2.75% with a 5-year duration). Thus, if you don't need the liquidity, it's a good deal.

If you are deducting the interest at 24%, the after-tax return is only 3.04%, and it probably isn't worth making extra payments.
Wiki David Grabiner

KlangFool
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Re: When to consider making extra principal payments on mortgage?

Post by KlangFool » Fri Dec 07, 2018 10:49 pm

OP,

Why are you not contributing to your Roth IRAs?

KlangFool

cashheavy18
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Re: When to consider making extra principal payments on mortgage?

Post by cashheavy18 » Fri Dec 07, 2018 11:10 pm

I found this to be a good resource - appropriately titled investment order

https://forum.mrmoneymustache.com/inves ... msg1333153

AtlBoglehead
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Re: When to consider making extra principal payments on mortgage?

Post by AtlBoglehead » Fri Dec 07, 2018 11:14 pm

With that low interest rate, I would NOT prepay but instead put the extra money in savings toward my new home. By the time I got ready to buy and move, I'd have saved a dwnpmt without having to sell this house. Then I'd get me a new home while keeping the present one with its low owner-occupied rate as a good rental investment.

Olemiss540
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Re: When to consider making extra principal payments on mortgage?

Post by Olemiss540 » Sat Dec 08, 2018 8:39 am

Build a taxable account buffer invested in equities before prepaying mortgage IMO. This assumes you have the ability to keep your hands off of it unless it is an emergency. If you are like us and struggle with spending, prepaying the house may very well be preferred to a 529 in my opinion.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

stan1
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Re: When to consider making extra principal payments on mortgage?

Post by stan1 » Sat Dec 08, 2018 8:52 am

Ed_Sandwich wrote:
Fri Dec 07, 2018 10:56 am
(OP here)

I don't have any specific goal to pay it off early. It is a starter home (2BR) for our family of 4. Ideally we will upgrade in the next 6 years or so. I would love to keep it and rent it out, but the only way we can make a down payment on another house is to sell this one. This is the main reason I am considering extra payments. To get a 20% return on our savings for our next down payment.
I would not put more money into paying down the mortgage since you plan to sell it in a few years. If you think you may need to spend money to add to the down payment, fix up the old house before you sell it, or fix up the new house I'd save in cash. Cash gives you liquidity and is more flexible than home equity and right now with rising interest rates and yield on Prime Money Market fund is 2.3% before tax.

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Watty
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Re: When to consider making extra principal payments on mortgage?

Post by Watty » Sat Dec 08, 2018 9:05 am

There is a wiki on this choice if you have not seen it.

https://www.bogleheads.org/wiki/Paying_ ... _investing

I wanted to have my house paid off by the time I retired so occasionally paying extra made sense for me. If you could get the house paid off by the time your kids start college that might allow you to pay many of the college costs out of your cash flow.

It has been a while since I have looked at it but as I recall the college financial aid calculations do not include home equity or retirement accounts so in some situations not having a lot of money in taxable accounts could get you more financial aid.

In some states home equity is also protected if you are sued which can be important for people like doctors that are more likely to be sued. For most people that have an umbrella policy that is unlikely to make a difference.

One other option to consider would be to save up a significant amount of money and then call your lender to see if they will "recast your mortgage"(Google this) of you make a large prepayment like 20% of the loan balance, or whatever makes sense. They are not required to do this but they usually will for a couple of hundred dollar processing fee. The way this works is that your required mortage payment would be reduced by the same percentage but the interest rate and length of the mortage would stay the same. This could be important if something happens like a layoff or interest rates get really high.

I would also consider how the payments would affect your overall net worth asset allocation, which is different than your investment asset allocation. There are not any magic "right" numbers but if 50% of my net worth is already in home equity I would not feel comfortable with putting more into home equity. If the home equity was less than 25% of my net worth I would have feel pretty good about paying additional. But that is just me.

Grogs
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Re: When to consider making extra principal payments on mortgage?

Post by Grogs » Sat Dec 08, 2018 10:21 am

Like others have said, the appreciation of the home is irrelevant for the decision on paying extra. You'll see that money when you sell/refinance either way. The variables that matter most are the outstanding principal on your loan and the effective interest rate. Since you say you'll probably sell your house and buy another is six years, I would probably lean towards not paying extra and trying to save enough for the down payment on the new place. If you're able to buy the new place (and qualify for the loan) as a separate transaction, that makes life a lot easier than having to either do a contingency sale on the old house or living with friends/relatives, in a short-term rental, etc.

I was on the other end of an unofficial contingency sale when I bought my condo, and they pushed the closing date back three times because their new home wasn't ready. If I had been less interested, I might have pulled out. Even when they finally had a closing date, they asked if they could rent from me for a week until they could get everything moved. I told them to pound sand on that last request, and I think they had to put everything in a U Haul truck and stay in a hotel for a few nights until the new place was ready to move in.

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