Save LOTS of Money in the Long Run

[Aleta]

Steve: I totally agree with you that a retirement fund should be a retirement fund but I thought it was an interesting strategy and one that I hadn't heard of. I also thought that once you start taking your Roth that you had to set up sums that are pretty much equal and once you start taking it that you have to continue.

[St. Theresa]

Sorry if this has already been mentioned, but you can also knock down your mortgage interest by paying it in two monthly installments. But if your lender is anything like mine, that might be impossible to do. I have WaMu and they will accept nothing other than a full-payment. If you send them half the mortgage, they WILL apply it to your principal, but you will still owe them the full monthly payment on its due date.

How I wish I could pay ahead. I can barely keep up with the $1400. And by refinancing with cash out, I have not only made my payment higher, but I've made the mortgage pay-off date much later.

Also, I own the house with my ex-husband and if I pay ahead, he reaps the benefits, even though I'm the one making the payments, so I've really got no incentive to do so.

But I would do the same thing. It's the biggest, most important and scariest expense. To own a home free and clear must bring peace of mind I can hardly imagine. I'm going on 42, and I don't see myself living rent or mortgage free EVER - unless I hit the lottery or find my niche in the business world and make a really good income.

[safari]

Sorry if this has already been mentioned, but you can also knock down your mortgage interest by paying it in two monthly installments. But if your lender is anything like mine, that might be impossible to do. I have WaMu and they will accept nothing other than a full-payment. If you send them half the mortgage, they WILL apply it to your principal, but you will still owe them the full monthly payment on its due date.

You must be talking about the bi-weekly payment plan, which you got confused with paying twice a month. If you pay twice a month, it's not going to make much difference because you're still going to make 24 payments a year, which equal to 12 full payments, same as paying once a month. With bi-weekly plan, you will be making 26 payments a year (since a year consists of 52 weeks), which is equivalent to making 13 full payments. In other words, it would result in an extra payment a year, which will help you pay off the mortgage faster. However, you can achieve exact same thing buy paying extra 1/12 of your monthly bill and applying it to the principal. Banks usually charge a fee to enroll you in their bi-weekly payment plan, but it's a rip-off. Just pay a little extra every month, and the end result will be the same.

[St. Theresa]

I was under the impression that the bi-weekly payments (which is what I meant by two installments per month) knocks down interest because the first payment is early, reducing your principal 2 weeks ahead of time, saving that much interest (whatever it works out to be.) Of course, I could be wrong. It happens sometimes.

[Coleroo]

Yes, you could buy a very nice house in the late 70's for about $40,000. At that point, I was working for $89 a week as a bookkeeper and my husband made $4 an hour designing house plans.

shoot...i remember when i was little dad bought the home they still live in for i think $30,000. that was 1985. silly me grew up unaware of rising house costs - i didnt become fully aware of the high dollar housing market until i was around 22!! i lived as a teen thinking that all regular houses cost less than 50k. LOL!


as for everything else...whew..this is a deeeep thread!

[disneysteve]

I also thought that once you start taking your Roth that you had to set up sums that are pretty much equal and once you start taking it that you have to continue.

You can withdraw money you've contributed (not interest or earnings) at any time, in any amount, for any reason. That is different than taking qualified distributions from the account, which is what you are thinking of.

[MonkeyMama]

Oh, I understand what she says. I watch Suze and think she generally gives good advice. I just don't happen to agree with planning to use Roth money for anything but retirement. The reality is that most Americans aren't saving nearly enough for retirement, whether it is in a 401K or Roth or whatever, and folks are likely going to need every penny in their Roth to support themselves in retirement. While it is true that contributions to a Roth can be withdrawn at any time for any reason without penalty, I think that is an option that should be reserved for a major emergency only.

Yeah but there is no way I would contribute 25% of my income to retirement if I couldn't use some of it down the road or in case of emergency. It's a tax shelter. A lot of people way over-contribute because of the tax shelter. But it is nice to know the money is accessible. (Our ROTHS are not a large part of our overall retirement so we can withdraw much without a problem).

I agree most people probably shouldn't plan to touch their retirement funds. But it gives financially savvy people a lot of flexibility. I am quite conservative and so it gives me extra peace of mind. I keep a smaller cash emergency fund (taxable) and keep a little extra cash in my ROTH to pad my emergency fund. It's a great tax shelter & I am not exactly worried about saving enough for retirement. Even if we have to dig in at some point.

Of course, tread carefully, but this is a great financial planning tool. I envision the odds we would ever touch our ROTH cash as slim to none. But the extra peace of mind is priceless.

[MonkeyMama]

Large IRA's not fully protected from bankruptcy or lawsuit seizure?

Whoops. . .after reading this article - all IRA's seem to offer some protection courtesy of President Bush.

Retirement as a whole is more protected than houses. That is actually another reason I am not keen to pay off our house too fast.

It depends on the state. They all have different rules. & employer plans seem immune to anything. (From what I have seen you can steal six figures from your employer but they still have to give you your retirement - the portion they funded. True story). I think IRAs have less protection. (Yes, the article pointed this out - IRAs have less protection than employer plans).

Bankruptcy laws are also state by state.

[disneysteve]

I agree most people probably shouldn't plan to touch their retirement funds. But it gives financially savvy people a lot of flexibility.

I agree. If you've got a huge 401K account and other assets besides, a Roth could be a nice tax shelter bonus. I wish I was in that situation but, unfortunately, I'm not. I'll need every penny of that Roth money for retirement.

[MonkeyMama]

Um yeah, I wasn't sure about Cali homes being safe from bankruptcy/lawsuit. Looks something like only $75k equity is protected. That is not much since I am sure the average homeowner has much more equity. (More along my memory - I was just doing a quick web search. Depends on your age and marital status, etc.).

Be careful paying off your house because you think it is more protected than your retirement. Check your state rules; check with an attorney.

[karen110]

"Why would you stay in debt to save money? Wouldn't you want to pay off the mortgage and then save? I guess I would pay off my mortgage ASAP, then take that payment and save it."


Puck36 made a very valid point. And I think it was missed. So let's break it down into numbers.

If you saved $250 a month for 29 years (I'm assuming they've been in the house one year). At a 9% rate of return your investment would grow to: $415,575.

If you pre-paid your mortgage. By $250 a month. You would save in interest: $50,000. Along with that, because you are out of Debt 16 years sooner ("cutting our 30 year mortgage down to 14 years" per your first email), you now can save your entire house note payment plus the $250, for the remaining 15 years when you would have been still making house note payments using the other method (again, I'm assuming you've been in the house one year). If your principal and interest payment is $700 (I assumed $120,000 mortgage at 6%) that account would be worth at a 9% rate of return: $405,089.
$50,000 interest savings + $405,089 investment returns = $455,089 total savings.
One thing, not mentioned is money is as much a psychological game as it is a numbers game. Having your house paid off free and clear is a huge psychological boost. Knowing that you own your house outright could give you the freedom of mind to be a little more aggressive with at least some of your investments. Possibly earning a 11% or 12% average return. After all, if I'm not mistaken, the market since 1991 averaged an annual rate of 11.9%.
Obviously, I don't know the numbers for your mortgage so I had to make some assumptions. Still the bottom line is, I do not see how you can go wrong prepaying your mortgage.

[lgslgs]

"Why would you stay in debt to save money? Wouldn't you want to pay off the mortgage and then save? I guess I would pay off my mortgage ASAP, then take that payment and save it."


Puck36 made a very valid point. And I think it was missed. So let's break it down into numbers.

If you saved $250 a month for 29 years (I'm assuming they've been in the house one year). At a 9% rate of return your investment would grow to: $415,575.

If you pre-paid your mortgage. By $250 a month. You would save in interest: $50,000. Along with that, because you are out of Debt 16 years sooner ("cutting our 30 year mortgage down to 14 years" per your first email), you now can save your entire house note payment plus the $250, for the remaining 15 years when you would have been still making house note payments using the other method (again, I'm assuming you've been in the house one year). If your principal and interest payment is $700 (I assumed $120,000 mortgage at 6%) that account would be worth at a 9% rate of return: $405,089.
$50,000 interest savings + $405,089 investment returns = $455,089 total savings.
One thing, not mentioned is money is as much a psychological game as it is a numbers game. Having your house paid off free and clear is a huge psychological boost. Knowing that you own your house outright could give you the freedom of mind to be a little more aggressive with at least some of your investments. Possibly earning a 11% or 12% average return. After all, if I'm not mistaken, the market since 1991 averaged an annual rate of 11.9%.
Obviously, I don't know the numbers for your mortgage so I had to make some assumptions. Still the bottom line is, I do not see how you can go wrong prepaying your mortgage.

Your numbers are wrong.

Using your assumptions:

12 payments per year
120,000 loan
Interest rate on mortgage 7%
Interest rate on investments 9%


First of all, a 120,000 loan at 6% with monthly payments of $700 isn't a 30 year loan. It is a 390 month loan (32.5 years).

So let's stick with your numbers, and look at the $$ over a 32.5 year period.



Paying off the mortgage early with an extra $250 per month will pay off your loan in 16.667 years. Then you put $950 per month into investments at 9% and keep doing so for the remaining 15.823 years. At the end of 32.5 years you own one house free and clear, and have an investment account with $360,548.09 in it.



2nd case. You don't pay off your mortgage early. Every month for 32.5 yeas you write your mortgage check for $700 and you send a $250 check to your investment company. Same 9% rate of return. At the end of 32.5 years you own one house free and clear, and have an investment account with $558,233.75 in it.


If your rate of return on your investments is higher than your mortgage interest rate, paying off your mortgage early is only a $$$$ winner if you do your math wrong. It may be an emotional winner, but there is a $$$ cost to your long term financial plan if you do so.



Incidently, in the example above you "save" $82,913.81 in interest if you pay off your mortgage early. (You pay $70,193.8 in mortgage interest if you pay the extra $250 per month, and $153,107.61 if you pay $700 as scheduled for the life of the loan.) So what! That money out of your pocket is offset by interest earned on your investments where paying off your mortgage slowly earns you $462,233.75 in interest vs. only $189.548.09 with the rapid loan pay off.


The bottom line $$ in your pocket is the important thing to evaluate, and that's $360,547.10 more if you send the $250 to your investment company instead of to your mortgage broker.



This guy has a great set of financial calculators Hugh's Mortgage and Financial Calculators They are worth getting familiar with, because gut feeling or calculations with innacurate assumptions and incorrect numbers will take money out of your pocket in your lifetime.


Lynda

[Aleta]

It' not totally a $700 payment because that might include your escrow for taxes and insurance. Many people find out that their principal and interest is just a portion of the payment when the house is paid off. You'll still have to pay your taxes and insurance once the house is paid off.

[disneysteve]

Your numbers are wrong.

Thanks, Lynda. I knew those numbers couldn't be right because there is no way prepaying the mortgage can come out ahead but I didn't have time to run the numbers. As you showed, investing beats prepaying by about $200,000 over the life of the loan.

[jIM_Ohio]

when I did this calculation, I needed many spreadsheets.

I downloaded an ammortization schedule from microsoft and entered numbers for our first mortgage.

I did the same for the second mortgage.

The result is a 360 payment, 30 year breakdown. You can then sum the interest columns, the payment columns. These are very important pieces to the puzzle.

I then copied both spreadhseets to the right. In the copied cells there is a column for extra payments. I could then see the impact of extra payments compared to normal schedule. This was important in my case because I would not pay down the 5.75% first before the 7.4% second, so I needed to know when one was paid off before applying extra payments to other.

I then created another spreadsheet which allowed me to to enter amount invested, yearly average return, and see total invested amount. It's import to see the sum of all investments made on this sheet.

The first comparison is to make sure you compare the amount of extra payments to total amount of money invested. They should be the same.

The second comparision should be between interest paid vs total amount at end of investment period.

The third comparison (this is important)- is to then look at investing the mortgage payment once it's paid off.

In my case, I found out I should pay off the 7.4% 2nd mortgage. Because the amount I could afford would pay this off in 15 years. Investing the EXTRA, plus the morgtage payment, for the last 15 years, suggesting paying off early comes out way ahead. Because 15 years compounding a $400 payment at 10% return invested is better than paying same $400 to mortgage company for 30 years. I can send about $1200 or $1800 per year to the mortgage. The $1800 invested for 30 years at 10% ($54,000 to invest) did not beat $5600 invested for 15 years compounding at 10% ($84,000). So investing the freed up cash flow makes the most sense in this situation.

But the 5.75% mortgage was not easy to pay off (principal amount is way higher), so it made sense to pay off second early, then invest the difference and keep 1st for 30 years.

I did not factor the tax deduction into this calculation.

Obviously if I can set aside the $1800 into an account an earn 10%, then when this account earns enough to pay off the 2nd, that is the most efficient way to do this.