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Should I pay off my mortgage faster by adding extra principal?
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Question: I have been paying my mortgage for 5 years and now some extra income. Should I make additional principal payments? My mortgage is a 30year fixed at 6.25% interest.
And how does the taxation play a role here? I am in the 25% tax bracket.
Answer: If you prepay your mortgage or increase the monthly payment to pay of quicker, then your savings are 6.25% annually. What would you do with the money if you would NOT use it to pay down the mortgage?
You could put it in CD accounts which will yield maybe 4 to 5% interest. The benefit is that you are more flexible in case of an emergency (loss of job, health related bills).
There is zero risk in paying down the mortgage, and also zero risk in buying CD accounts, but the return of the mortgage is higher than the CD accounts.
If you buy stock, your risk is substantially higher. It is basically gambling. Your possible return is higher as well.
Investing in mutual funds on average yields 9% in the long term. However, in the short term, you may take losses. The risk is substantially lower than buying stock though.
The right decision also has to do with your age and your life, its schedule and what you expect to do in the future.
Taxation plays almost no role in the decision of whether to pay off early or invest otherwise.
Let's say you pay additional principal. That means you save interest in future payments. The interest is taxdeductible. So one could argue that the real cost of the loan is not 6.25% but 6.25% * 0.75 (since you are in the 25% tax bracket) = 4.7%
However, if your mutual fund yields 9% profit, you also pay 25% tax on that. So the effective profit is only 9% * 0.75 = 6.75%
Similarly a CD account yielding 4% effectively only returns 3% (4% * 0.75 = 3%)
The only exception is if your investment is pretax as a 401k plan or a taxexempted bond. In that case you should compare the bond's full return against the prorated mortgage interest.
In your specific case  6.25% is a pretty low rate. If you wait a little longer, you may find zerorisk investments such as savings accounts that will beat that return.
And now a completely different perspective on this topic:
If your mortgage is fully paid off, and your house gets hit by a hurricane or earthquake, then you are in more trouble than your neighbor who had only 10% equity in his place. You just lost all your house and try now to get money from the insurance. If the bank has the equity (and you have the mortgage) then the bank will deal with the insurance.
And there is also the thought that free and clear owners may more likely be subject to lawsuits if something happens to someone on your property. Not sure how relevant this is but I thought I should add it.
Comments:
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anonymous from United States



Actually, the savings is much more than you let on. Go get your amortization schedule and look at it closely. Lets say you are at the beginning of your loan. Your payment is $400 a month. Of that, $350 is interest and $50 is to principle (pay attention to that breakdown). By paying an extra $50 a month at the beginning (look at the next principle payment under the month you are paying), you in essense save $350 because it is as if you made your next month payment without the interest penalty. This is a decresing return as you move down the amortization schedule as it takes more to eliminate less interest. So at the beginning you can save thousands of dollars by 'chaining' your principle payments into an extra principle payment. Most mortages can turn a $1000 extra principle payment into a $7000+ worth of savings as it cuts out the next X number of months of interest payments. You cannot get that type of return on any other investment.


[hidden] from United States



One more thing. I would suggest sending in the extra principle payment as a separate check and writting on the memo something like 'Principle ONLY' so it gets allocated properly. You would be amazed what an extra $50 can save you on a mortgage, especially at the beginning. Call your mortgage company and ask them to send you your amortization schedule. May have to pay a fee for it but normally it is like $5.00 or just generate your own on the web. Don't take my word for it, go see for yourself. As I said above, I don't know of any investment that can more than double your money instantly and make your future money more valuable (more of your monthly payment goes to principle the further you are in repayment of your mortgage). Toward the end, you may want to stop 'extra' payments and just pay the monthly payment as toward the end your monthly payment is mostly going to principle anyway. However, you may want to continue the 'accelerated' payoff to get that $400 a month payment back in your budget for some fun or party to celebrate owning your home.


anonymous from United States



I too thought about paying down the mortgage a little early. However we have a 15 year mortgage (13 years + 4 months left), at a 5.5% rate.
The thing is, I (and anyone else) can get 5.05% interest on a savings account at EmmigrantDirect.com.
So I guess I know where the money will be going instead of toward the mortgage.


anonymous from United States



I don't get this. If I have a 30 year fixed mortgage, then regardless of how much I pay down the principle, I still pay the same monthly rate. With an ARM, the interest gets recalculated every year, so the more principle you pay down each year, the less you will pay in interest the following year. But with a fixed mortgage, the payment schedule is set from the beginning. So even if you can pay off your mortgage 5 or 6 years early, all you save are the last 5 or 6 years, where the ratio of interest to principle is much lower anyhow. So you're effectively saving at a lower rate than the percentage on your mortgage, since the total amount of interest is based on that percentage rate and not divided evenly over the life of the loan. We paid down our principle heavily when we had an ARM and we ended up beating the market, but I really don't see why it makes sense with a fixed rate mortgage.


anonymous from United States



so, this is effective ONLY if you actually pay off the loan then right?
I cant see this being of benifit (doubling up on payments of a 30 year loan) unless you see the loan all te way to the end.
Otherwise, you sell your home 10 years after you get the mortgage, and recover your money you have invested .. but the advantage of paying down will have been lost?
Or am i wrong?


anonymous from United States



Great information here. I have the same question as the poster above. How does all of this change if you plan to sell the house in say, 5 years?


anonymous from United States



I have a 30 year fixed mortgage for $375,000. The interest rate for the first 5 years is 3.4%, then it converts to adjustable. We are 2 years into the loan. Of what benefit would it be to pay double principle until we sell which may be 5 years or so away?


yb from Chapel Hill in North Carolina, United States



Great discussion, especially since i am closing soon, but not planning to stay here past 5 10 years


anonymous from United States



>> The interest rate for the first 5 years is 3.4%, then it converts to adjustable.
>> Of what benefit would it be to pay double principle until we sell
if you currently pay 3.4% interest then you should pay as little principal as possible.
You can keep the money earning 5.05% in a savings or money market account.
I have a 4.875% fixed rate and wish I could keep it forever.
Unfortunately it will be paid off in 11 years.
Peter (admin)


anonymous from United States



I have a 30year mortage at a fixed rate of 5.5%. I am in ten years into the loan with a balance of $31,000. Would I be able to pay off my mortgage sooner by making payments towards the principle? and how much should the principle payments be?


anonymous from United States



anytime you pay the principal down, you will save money. whether it is large sums in the start or small in the end. pennies make dimes, and dimes make dollars. so even the pennies count


anonymous from United States



I have a 5 year interest only loan that I am into already 2 years 9 months. I also have a line of credit I tapped for an investment property. Together my mortgage is $500,000.00 and the line is $200,000.00. Mortage is 5.25 fixed interest only, and the line is variable but usually 89%. I am paying about $100.00 extra in principle only payments. I really hate paying interest, what should I do? Should I stay where I am at or should I refinance and get a new loan with both owing amounts rolled into into them at a lower 'combined' rate?


dysonlaw@comcast.net from United States





anonymous from Omaha, United States



I hope I make sense. My biggest question is, where in the timeline of my mortgage does an extra principal payment apply? This is all hypothetical...but, say I just started a $100,000 mortgage. My payment is $1000 each month and I'm paying $100 in principal and $900 in interest. If I were to pay a $50,000 principal payment would it make my next payment ~$500 principal ~$500 interest or would it still be around $100 principal $900 interest.


[hidden] from United States



isn't it better to keep the money in savings, and then pay off one large sum? that way your money makes interest, but you still cut your loan short? so instead of paying $150 extra every month, why not just put the $150 into a savings account, and use that savings account to pay off the rest of your principal when the two are equal? this way you're making the 5% in savings + the 6.5% on cutting the years on the loan. no?

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