Save LOTS of Money in the Long Run

[Ima saver]

Well, I am certainly no expert, but I paid off my mortgage at age 32. It was nice having no house payments for 30 years and it helped me to save. My mortgage rate was 9% back then.
when we moved to the mountains 23 years ago, we were able to live on our savings for an entire year and build our house for cash.
Of course, when I was younger, I knew nothing about investing and just saved our money in a regular savings account. Getting rid of tha 9% mortgage freed up a lot of cash to start investing into mutual funds.

[Aleta]

Ima: Know what you mean about the 9% mortgage. My sister had one for over 10% and it was extremely hard for them to make their payments back then in the 80's I think. Yes, paying off your house early gives you more money to save toward your future not to mention the interest that you save by paying it off earlier.

[bjl584]

I've gone round and round in my head concerning this issue. In the end I decided to do a little bit of both. An extra $100 a month toward my principal works out to two extra payments per year. That will cut down the term on my loan quite considerably. On top of that, I invest and save each month. I decided that this is the best approach for me at this point in my life. My nest egg will grow AND I will get piece of mind that my house is mine free and clear.

[Scanner]

I don't know. . .maybe the "moving" wild card isn't what I think it is.

On one hand, like I said, for the average person who probably moves 2-3 times over 30 years of their "productive" years, it means more interest on the amortization tables as you continually need to "remortgage" like I said.

There's also closing costs, not to mention the real estate agents fees (which you would have whether the house was paid off or not)

For people like DisneySteve, who I imagine since he's a family physician and in a densely populated part of the country, it's a no-brainor. He could and probably will remain in demand at his job for years. If he does have to change jobs, I'm sure there are some within 30 miles of where he lives.

On the other hand, there's a flip side of the coin.

If my house was paid off and I owned 100% of my wealth in my home, that probably makes me less able to move because you don't even want to take a 5% loss on the home.

That's kind of where our psychology is. If let's say I was offered a job moving distance away, I can see me saying,

"Well, I have to sell my house." Since we have a lot our wealth contained within it, we aren't going to want to take a huge loss, maybe only a little one. Actually, it's not even a matter of a loss, since we have 60% equity or more, it's just a matter of feeling like you are getting what it's worth.

There's something to be said for having a certain percentage of your wealth "liquid and portable."

I wonder if employers will offer to "buy out" employees houses to help them with moving. I would do that in a second - get 2 apprasials, split the difference and not have the hassle of a real estate agent. Then the employer could turn around and sell it in 3-4 years after the market changes.

[Aleta]

bjl584: That is a good approach if you're not sure. We started doing the same thing in the beginning. If you have an amoritization breakdown (and you should have one), you will see for yourself how much you are saving yourself.

[disneysteve]

Here is my thought on why you should pay the principal off early. Once it is paid off you still have the mortgage payment for investing now. If you were to lose your job that emergency fund you have will be able to last longer as your monthly expenses are at a much lower level, and if needed you can get a loan against the equity in your home.

But what if you lose or change jobs BEFORE your mortgage is prepaid. You find yourself house poor. All your money is locked up in your home equity. Much better to have a nice investment portfolio to draw from to cover expenses while you are out of work.

Sure. . .I see DisneySteve, LivingLarge, JimOhio et als point about investing for the long term yadda, yadda, yadda, $250/month @ 7% beats prepaying mortgage.

What I think they forget is that often people move/change jobs.

I don't forget that at all. That's exactly why you shouldn't prepay the mortgage. Prepaying your mortgage doesn't help you at all until the day that you finish repaying the loan. Let's say that takes 21 years instead of 30. That means that for those first 21 years, you are pouring money into a relatively non-liquid asset. Should some emergency come along, you need to borrow against the home to raise funds. That's a pain, takes time and, if you find yourself out of work suddenly, you may have trouble getting approved for a HEL/HELOC.

Plus the money I invest I can fall back on in an emergency fund. I don't see how a lot of cash in my house helps me.

Bingo. My point exactly.

Here is a real life example. I went into practice in July 1993. We bought our home in April 1994. I quit my job in February 2000 and was unemployed for 3 months, and then underemployed for about a year after that (big pay cut, part-time hours). We were able to maintain our standard of living and pay all our bills just fine because we had substantial savings. Having a bunch of home equity would have done us no good at all, unless we took out a loan. And when money is tight, the last thing you really want to do is take on more debt.

Most people move every few years. So what's the point of prepaying a loan that you are going to retire many years early anyway? Better to keep the money in savings and when you decide to move, you can use some of that money toward the new house purchase if you wish, meaning you'll have to borrow less.

[disneysteve]

I've gone round and round in my head concerning this issue. In the end I decided to do a little bit of both.

I think this is a perfect solution. I actually do the same thing. I don't send any extra to our primary mortgage, but I do send in extra principal on our home equity loan, which is at a bit higher rate than the first mortgage. I consider it part of the fixed income portion of our portfolio since it "earns" a guaranteed return.

[avengerki]

I think I should of added that even while making the extra payment to the principal that you keep on building your emergency fund, keep paying into your 401k and ira. its just take that extra little bit from your general investing and place torwards the principal.

I hate having all my eggs in one basket, but I also hate having one large bill to take care of each month.

[cptacek]

Well, I am certainly no expert, but I paid off my mortgage at age 32. It was nice having no house payments for 30 years and it helped me to save. My mortgage rate was 9% back then.

If I had a mortgate of 9-10%, I would send A LOT of money to it to save on interest. But lots of people now have mortgages between 4% and 7%, and I wouldn't pre-pay the mortgage in this case. I think it depends on what your interest rate on the mortgage is vs. the long term investment return on whatever you would be investing in instead.

[bjl584]

Strickly speaking in terms of pure finances and mathematics it is better to NOT pay off your mortgage early if you have the ability to earn a higher return elsewhere. Problem is, once you add human wants, needs, and behavior into your equations, things get a little fuzzy. There is no one size fits all answer to this question. It depends on peoples' age, income, goals, etc, etc. You need to sit down and figure out your personal situation and then decide how to approach this situation. For me, as stated earlier, I am saving to build up my EF and my other retirement investments AND paying extra toward my mortgage. That formula works best for me.

[disneysteve]

Money magazine addressed this issue - prepay or invest - this month:


Prepay your mortgage OR invest
The feel-good choice isn't necessarily the smart choice.

When some extra cash comes your way, it's tempting to put it toward your mortgage. You'll save on interest and pay off your house earlier. Buying stocks, on the other hand, feels like a risky leap into the unknown, especially now.

Strictly by the numbers Paying off your mortgage or any loan is an investment, and your return is essentially the interest rate on the loan. If you have 25 years left on a 30-year mortgage with a fixed rate of 6.2 percent and you deduct your interest payments on your taxes, you'll earn 4.5 percent by prepaying the loan (assuming you're in the 28 percent tax bracket).

Now let's say you invest your spare cash in stocks instead. You'll pay a 15 percent tax rate on your long-term capital gains and dividends. So to beat the 4.5 percent return you'd get from prepaying your mortgage, you'd have to earn just 5.3 percent a year on your stocks before taxes.

The odds of your doing that over the 25-year remaining term of your mortgage are excellent: Historically, a portfolio of 80 percent stocks and 20 percent bonds has returned 7.5 percent a year after taxes.


• But wait Paying down the mortgage earns you a risk-free 4.5 percent. That's as good as you'll do with Treasury bonds. True, and if you are investing for a near-term goal and don't want to take any risk, you can make a stronger case for prepaying your mortgage. But if you are investing for a goal that's more than a decade away, you can and should take more risk for a chance at a higher return.


• You do the math To run the numbers on how much money you could end up with by investing, use the savings calculator at CNNMoney.com. To see how much interest you'd save by prepaying your mortgage, use the payoff calculator at Dinkytown.net.


• Beyond the math Of course, all that mortgage debt may be keeping you awake at night, especially if you are worried about losing your job or you're approaching retirement and hope to live on less. You'd be grateful to be rid of that major monthly bill sooner. In that case, prepaying your mortgage starts looking better.


Remember, though, that by prepaying your mortgage, you are reducing your liquid assets. If you suddenly need money, it's easier to sell a mutual fund than it is to pull cash from your home, and you can always pay off your mortgage later with the money you invest now.


• The bottom line Investing wins.

[Ima saver]

I worked for a small building and loan association back in the late 1970's. All of our mortgages back then were for 9% and above. Of course, we did not owe nearly as much on our homes back then.
It also helps that my husband is a builder. He has built us two new homes in the past 23 years and of course, his labor is free. (He built our house at nights and on weekends)

[disneysteve]

I worked for a small building and loan association back in the late 1970's. All of our mortgages back then were for 9% and above. Of course, we did not owe nearly as much on our homes back then

You raise a couple of interesting points. Mortgage rates were much higher, but also keep in mind that savings rates were higher, as well. That was a time of high inflation and I remember going with my dad to buy CDs that were paying 12 and 13% interest, so you need to look at that 9% mortgage in the proper historic context.

As for owing less on a home, that was probably true for a few reasons. Homes were generally smaller and more basic. It was standard to put down 20% or more. And it was standard, pretty much required in fact, that your payments couldn't exceed 28% of your income and the total home price was 2-3 times income. Now, all of those guidelines have gone out the window. Folks are buying homes costing 6 or more times income with little to nothing down and taking on housing expenses that approach or even exceed 50% of income. It really is insane.

[scfr]

Glad this discussion has come up again, because IMHO it's one that everyone should think seriously about, listen to the so-called experts but then just as importantly factor in their own personal situation, and then decide for themselves what is the best thing to do.

Is there an area of personal finance where one size does NOT fit all more than the "pay off the mortgage early vs. invest" debate?

Back when we were salaried employees, DH & I contributed to our employer-sponsored plans and followed a pretty "plain-vanilla" investment strategy (heavy on index stock funds) and occasionally made some extra payment toward our mortgage. But after DH started his own business, it made more sense to start paying off the mortgage early because we taking plenty of risk in our business and wanted to take a more cautious approach in our personal finances.

I guess you could say that as our "stock in ourselves" (our own businesses) rose, our need to have stock in publicly traded companies declined. I think this is a common way of thinking for entrepreneurs.

It's all about balance and doing what is right in your own situation.

[Scanner]

Back when we were salaried employees, DH & I contributed to our employer-sponsored plans and followed a pretty "plain-vanilla" investment strategy (heavy on index stock funds) and occasionally made some extra payment toward our mortgage. But after DH started his own business, it made more sense to start paying off the mortgage early because we taking plenty of risk in our business and wanted to take a more cautious approach in our personal finances.

Bingo!!!! Bingo!!!

We have a winner.

One of my mentors in my field - the only thing he invested in were tax-free, insured municipal bonds and pay off debts/live debt-free. Many here would have laughed at his investment strategy as the Microsofts and Dells rose to power in the 90's and late 80's and people were making some huge bull runs.

But his philosophy was,

"I take tremendous risk in business - upstarting one, making it work, having bad years, having good years. So, when I bring money home, it's my duty to not take [sic: principal] risk with it."

I was hard-pressed to argue with that logic and still think about the strategy until this day.

He built a portfolio of 1-2 million in municipal bonds, all paying him tax-free money in interest every month at the age of 50. When he became disabled (bad back) he had a nice parachute. He was able to get at some of his money and help pay for some disability and medical expenses (his wife died of cervical cancer at age 52).

Ironically, he didn't even think about Roths, IRA's, SEP's, etc.