save or pay extra mortgage?

[PRICEPLUS]

Re: save or pay extra mortgage?

I am a day late and a dollar short as usual. Sweepsplayer is correct though.
Paying off the larger loan is the way to go. The buildup in interest negates the flip effect of payments that had been going to the smaller loan.

Sweepsplayer speaks the truth and as usual is quite accurate!

[lucasrd]

Re: save or pay extra mortgage?

Right...I'd say it's worth the risk...though

[Ima saver]

Re: save or pay extra mortgage?

That is what I am thinking, there is no guarantee that you will gain that almost 10%

[Sweepsplayer]

Re: save or pay extra mortgage?

a safe index fund that earns a modest 9.5% return annually.

Ah, there's the rub. There is no guarantee that an index fund will give you a positive return, much less a return of ~10%.

I agree with you, it's usually worth the risk, but some people prefer the guaranteed return you get from paying down the mortgage.

[lucasrd]

Re: save or pay extra mortgage?

Basically I'm being an advocate for compound interest. I believe it is better to save money that compounds rather than paying off a simple-interest loan.

Let's say you have a 94,000 loan fixed at 6.75% and make $500 principal payments monthly. You'll pay off the loan in 7.5 years and have saved $30,000 in interest.

Now Let's say instead of paying $500 toward your mortgage, you invested it in a safe index fund that earns a modest 9.5% return annually. If you made the $500 deposits every month for 7.5 years, you would have $65,782 in that mutual fund where as the loan balance after 7.5 years with no prepayments would be about $58,000. So you could pay off that loan and still have $7,000 in cash...

OR

You could continue to pay on the loan for the 15 year term and keep putting away that extra $500/mo into the mutual fund. After 15 years you would have paid about 55,000 in interest. However, your mutual fund would now be worth $199,541.61. Subtract the $30,000 of interest you could have saved by making prepayments, and you're coming out about $170,000 ahead.

Now, 15 years later, loan #2 is gone and you have $199,541 in your mutual fund. Let's say you just let that simmer for a while and keep making the $500/mo investment into it (now you have that $850 extra for spending because loan #2 is paid off) Let's let it sit for 15 more years until Loan #1 is paid off. After 15 more years, your mutual fund will be worth $1,024,565.02.

What you're basically doing is sacrificing interest early to take advantage of the "time" element of compounding interest...

Hope that makes sense...

[Sweepsplayer]

Re: save or pay extra mortgage?

I have a theory on this for dedicated people...Make extra mortgage payments...yes that's good...but make them to a separate savings account that earns interest. Why pay $500 to the mortgage company when you can earn interest on that $500 while you are still paying on your mortgage...

I don't understand, can you explain?

[lucasrd]

Re: save or pay extra mortgage?

I have a theory on this for dedicated people...Make extra mortgage payments...yes that's good...but make them to a separate savings account that earns interest. Why pay $500 to the mortgage company when you can earn interest on that $500 while you are still paying on your mortgage...

Go to any mortgage calculator and compound interest calculator...punch in your numbers..you'll see by earning compound interest on your prepayments, you'll pay off your mortgage faster than if you make principal payments...

[CJsoccerchic]

Re: save or pay extra mortgage?

I agree with sweeps, if I were in your situation, I would put the $ towards small loan first (because of high interest) pay that off, then onwards to the bigger loan. You pay less interest ultimately, and that is the desired goal.

[Sweepsplayer]

Re: save or pay extra mortgage?

pinkeyy501, I stand by my calculations. You save more money by paying extra on the higher interest loan, and then putting that $850+$500 toward the lower interest loan.

[debtfreeme]

Re: save or pay extra mortgage?

That is true but in the long run the grestest savings is to put it toward the larger of the two loans.

It is true that once the second is paid off then that payment would be applied to the first, but right now the savings more than equals that.

[Sweepsplayer]

Re: save or pay extra mortgage?

mortgage 1 you would have it paid off by 2027 instead of 2036 with 500 extra per month with the total you paid being: 383, 180.XX instead of someplace like 577,XXX in interest over the life of the loan.

Mortgage 2 total interest would have been 54,000 but if you add 500 per month there it becomes 25,000.

The calculation is not that simple. Once one loan is paid off, that monthly payment is freed up and goes towards the remaining loan. Both loans get paid off faster as a result.

[debtfreeme]

Re: save or pay extra mortgage?

but i would talk to your CPA about the retirement issue. if you own your business you can put upto 40k away each year, provided you meet some small things.

check with him and start saving there asap.

[debtfreeme]

Re: save or pay extra mortgage?

i agree with yor uncle:

Playing with some figures at the bank rate website: http://www.bankrate.com/brm/mortgage-calculator.asp

It shows with:

mortgage 1 you would have it paid off by 2027 instead of 2036 with 500 extra per month with the total you paid being: 383, 180.XX instead of someplace like 577,XXX in interest over the life of the loan.


Mortgage 2 total interest would have been 54,000 but if you add 500 per month there it becomes 25,000.

Seems like you would save more money in the end by placing it with mortgage 1.

Play with the figures, this is a great calculator to know about.

[pinkeyy501]

Re: save or pay extra mortgage?

I ran some quick calculations in Excel.

If you don't put extra money toward either loan, you'll end up paying $1,217,189 on both loans ($611,848 in interest).

If you put an extra $500 toward the larger, lower interest loan for the next 90 months, you'll end up paying $1,090,487 ($485,147 in interest).

If you put an extra $500 toward the smaller, higher interest loan for the next 90 months, you'll end up paying $1,082,274 ($476,934 in interest).

Notice you save more by putting extra money toward the higher interest loan. Here's the trick that your uncle might have missed: In the last scenario, you end up paying the smaller loan off faster, so you can't forget to put that $850 a month toward the larger loan. This of course helps pay off the larger loan faster. Hope this was helpful.

That is definitely something I didn't think about. Thank you for running the numbers. That really helps me to see the difference. I think I may go that route you suggested.

[Sweepsplayer]

Re: save or pay extra mortgage?

I ran some quick calculations in Excel.

If you don't put extra money toward either loan, you'll end up paying $1,217,189 on both loans ($611,848 in interest).

If you put an extra $500 toward the larger, lower interest loan for the next 90 months, you'll end up paying $1,090,487 ($485,147 in interest).

If you put an extra $500 toward the smaller, higher interest loan for the next 90 months, you'll end up paying $1,082,274 ($476,934 in interest).

Notice you save more by putting extra money toward the higher interest loan. Here's the trick that your uncle might have missed: In the last scenario, you end up paying the smaller loan off faster, so you can't forget to put that $850 a month toward the larger loan. This of course helps pay off the larger loan faster. Hope this was helpful.