Does it always make sense to pay down your mortgage? rop

[ScrimpAndSave]

I am buying a condo an putting 20% down at a 5.35% interest rate. I don't plan on staying there forever...but would like to stay for at least 10 years. Does it make sense to throw extra money at the principal of my mortgage?

[jIM_Ohio]

I am buying a condo an putting 20% down at a 5.35% interest rate. I don't plan on staying there forever...but would like to stay for at least 10 years. Does it make sense to throw extra money at the principal of my mortgage?

Depends on what other savings exists

IIRC you have a pension at work
7.5% of salary
are you allocating another 7.5% of salary to retirement?
are you allocating 5% of pay to savings?

If you do not have other savings (for both retirement, EF and general cash) then paying down mortgage should not be a priority.

In our household we put 20% to retirement (401ks and Roths) and also put another 5% to savings each month. And we pay down the mortgage with about 1% extra of net income. As other bills (like car payments) are paid off the mortgage percentage increases. It is not a priority to pay down morgage faster, but it is a priority to pay more than minimum to mortgage.

My advice when you move in:
1) round mortgage payment up to nearest hundred (meaning if your payment is $900.01 send them $1000 per month (round up to nearest hundred). We do the same now.
2) make sure you have cash on hand for those "incidentals" which come up when owning a property
3) after a year or two and you see true cost of owning house, come up with a better plan. Better to have cash on hand before making a decision one way or other.

To me length of time is not a factor if you will live there longer than 5 years. Less than 5 do not pay down, but once living there more than 5, follow above advice.

[disneysteve]

I think it depends on your situation. I would be maxing out retirement accounts first and be sure I was maintaining an adequate EF and not carrying any higher interest debt. After that, it becomes a question of asset allocation, risk tolerance, etc. Prepaying the mortgage "earns" you the equivalent of your mortgage rate after the tax deduction. In your case, that would be about 4%. That could serve as part of the fixed income part of your investment portfolio.

[ScrimpAndSave]

Thank you both!

Jim, you remembered correctly...I do have 7.5% going towards my pension. I am also maxing out my Roth which is another 5%...and then I am saving about 10% towards my Emergency Fund. I researched information about my pension and they average ALL of my years of service and then give me that average yearly as an income for the rest of my life. I started out making $37,000 and have no idea where I will end up, but according to my salary scale, I will be at $85,000 in 4 years. I have 34 more years until retirement. ::gulp::

Question about rounding up to the nearest hundred...my morgage payment with taxes, insurance and interest is $1230. So this means that I should send and extra $70 a month? But this extra $70 needs to be made toward the principal - right? Not just upping the mortgage payment to $1300?

I hope that wasn't confusing...thank you for your help!

[disneysteve]

Yes, to use Jim's method, you would add $70 as an extra principal payment. There should be a line on the payment coupon for additional principal.

[ScrimpAndSave]

Thank you!

[Alex_Adviser]

The average first time home buyer is probably very concerned about how much money will be needed to make a down payment on a home. The amount of money needed for an adequate down payment can vary greatly depending on several different factors.

The following factors may impact the down payment:
* Type of Loan: Federal Housing Administration (FHA) mortgages may require 3% or less; other types of mortgages may require a 10 - 20% down payment.
* Credit Rating of Buyer: Credit rating can impact both the type of loan a buyer qualifies for and the required down payment amount.
* Purchase Price of Home: Down payments are typically a percentage of the final purchase price. Therefore, the more expensive the home you are purchasing, the more cash you will need for your down payment.
* Availability of Down Payment Assistance Programs: First time home buyers may qualify for financial assistance.

I personally feel that 20% down payment is to much. If the lender allows then the best downpayment could be anything between 10-12%.

[zetta]

Since you are in your late 20's, single, and open to marriage someday, where your life will take you in the next five years is somewhat unpredictable. For instance, I bought a townhouse at age 27 and paid points that had a 5 year break-even. I met my future DH at age 28, married at 30, and sold the condo to buy a single family house at 31.

For this reason, after funding emergendy fund, retirement/ROTH, and mid-term savings, I would direct any extra money you'd like to invest toward a low-cost index mutual fund. While it is not a guaranteed return, over a 10 year time frame there is a good chance it will grow more than 5.35%. At some later date you can use it to pay off your mortgage early, to have a larger downpayment on your next house, or to use as a downpayment on the next house so you can turn the condo into a rental. Liquidity gives you flexiblity.

I disagree with Alex Adviser on the downpayment, and would advise 20% both to avoid PMI and to have an extra cushion against falling house prices. (People with more equity have been able to refinance where those whose loans go underwater cannot.)

[ScrimpAndSave]

Zetta and Alex,

Thank you. There is no way I am putting down less than 20%...

Zeta, I like the idea about the mutual fund. I am going to need to look into that!

[disneysteve]

I personally feel that 20% down payment is to much.

I disagree, but I'm curious to hear your reasoning.

I would direct any extra money you'd like to invest toward a low-cost index mutual fund. While it is not a guaranteed return, over a 10 year time frame there is a good chance it will grow more than 5.35%.

I agree. And remember, prepaying the mortgage doesn't "earn" you 5.35%. It earns you the after-tax deduction real interest rate. In your case, that is probably about 4%. If you can realize an average annual return of 8% in a mutual fund, even after taxes, you'd come out well ahead of prepaying the mortgage.

I also agree that prepaying the mortgage probably isn't the best move unless you are sure you will be in the house for the long-term. We didn't start making extra payments until we had been in the house for almost 15 years.

[FamilyPapi]

I agree that instead of paying extra to principal, invest in a low-cost index mutual fund. And when you do, call this account "The House Fund" - so that you call it what it is - a separate account that gives you much more flexibility and return than having it stuck in the walls of your home/condo.

[disneysteve]

I agree that instead of paying extra to principal, invest in a low-cost index mutual fund. And when you do, call this account "The House Fund" - so that you call it what it is - a separate account that gives you much more flexibility and return than having it stuck in the walls of your home/condo.

To expand on that, what some people do is invest that "extra" mortgage payment in an investment account and once the balance in that account equals the outstanding mortgage balance, they pay off the house. Until that time, though, the money isn't locked up in equity so it is available, if needed, for other purposes. Plus, it earns market returns rather than the 4% you'll earn prepaying the mortgage.

[ScrimpAndSave]

Everything makes a lot more sense now...thank you all.

[LivingAlmostLarge]

You can always save cash or bonds for a wedding fund, possible new house purchase. Yeah I recall you are single but life moves fast in your 30s. I know A LOT of couples marrying fast now that we're older.

[jIM_Ohio]

Everything makes a lot more sense now...thank you all.

Before deciding on what to do with extra. I would suggest for first 18 months keeping all extra in cash.

You need to collect some data:

1) 2008 tax return (the one you filed about 3 months ago)
2) 2009 tax return (the one you will file in about 9 months)
3) 2010 tax return (the one you will file in about 21 months)

compare these three, in particular the issues will be 2010 return is the first return with a full 12 months of mortgage interest payments.

If your mortgage is keeping your tax bracket low, and prepaying it will cost you more in taxes (always tough to "guess" or "estimate" this) than the interest it saves you.

You need to know what peace of mind means to you. I get more peace of mind giving a bank more money and the government less money- but that is me- and you might have a different answer to that question.

Meaning-
If you follow the advice above "invest the extra money in a mutual fund"- this is good advice and will probably have you pay less in taxes and more in mortgage interest to the bank over the course of time.

If you follow the advice "apply extra money as payments to principal" the opposite will happen- you will pay less in interest and more in taxes over the same time period as situation above.

If you are on the border of one tax bracket to another with deductions, prepaying mortgage will cost you more than if you are in middle of tax brackets.

Reality is most of do "all of above"- we invest some and pre-pay mortgage some with our extra funds.

In my situation I use my mortgage to get us into 15% bracket and I watch that very closely. If my pre-payments show a trend where I will not be in 15% bracket I will stop pre-payments and invest more.

The main "problem" with this plan is that it is not realistic to project tax bracket ranges more than 18-24 months in advance. I know the bracket I need to be under for 2009, but do not have confidence the 2010 number is good right now (Obama's fault LOL). The trend with the Bush brackets was the brackets went up higher than the interest deduction decreased... and the twins being added to return did help quite a bit too.

Each person's tax situation will be slightly different... know how much the house SAVED you in taxes each year and it will be easy to figure this out.