The Decision to pay off a mortgage early might not be as easy as you thought
Are you seeing all these posts on how to pay off your mortgage faster?
There are stories floating all over the Internet about people saving $50,000 in interest by paying off their mortgages early. So homeowners are coming up with all kinds of clever ways to make that happen.
And it’s actually totally legitimate. We can all save tens of thousands of dollars paying off our mortgages early.
But you know what?
I’m not interested. I think I have a better financial strategy.
In this post, I’ll show you how anyone can save a small fortune by paying off their mortgage early. Then we’ll talk about why I refuse to play this game.
Am I the only personal finance blogger who isn't scrambling to be “debt-free”?
You should know upfront that I’m a big fan of smart debt. I believe in leveraging debt to improve net worth and quality of life. In fact, I'm currently over $800,000 in debt. And I’m fine with it. Good with it, actually.
When used carefully, debt is a useful tool. For many of us, debt is the only way we can afford college. Debt enables us to buy homes before we’re 50. It helps us take advantage of wise investment opportunities when they come along. It can even be used to launch dreams, like starting your own business.
If I can leverage debt to reach my goals sooner, you can bet I’m going to take full advantage.
But I avoid some debt like the plague.
You know what I don’t believe in? Vanity debt.
I’m not about to go into debt keeping up with the Joneses. New car? No thank you. Huge home with a sprawling lawn? Not interested. Fancy clothing, expensive cosmetics, and high-end handbags? Maybe for a special occasion, but not necessary in my everyday life.
You’ll never catch me in credit card debt. Although I confess, I use my credit card constantly. Because I earn rewards. It’s how I have an extra $1,000 for travel every year! But the card gets paid off in full every month.
And I refuse to overextend myself.
Sure I carry a lot of debt. But much of that is for assets, like rental properties, that pay for themselves and put money in my pocket. I’m not going to take on more debt than I can handle.
I’m often asked, “but what if the market changes and your investments stop generating enough income to pay for themselves?”
Such a great question!
My secret for surviving – scratch that – thriving in a down market is my recession-proof skillset. There are certain skills that are more marketable in a down economy than in a strong economy. If you have one of these skills in your back pocket, you’re effectively recession-proofed.
Think accounting, adult education, medical professions, property management, and (my skill of choice) property tax consulting. If the economy tanks, I can get back to work on property tax appeals to make more than enough income to support my debt.
And if something ever goes completely sideways on me? Well, I have assets I can sell (thanks to that debt!). And good insurance in case things get really crazy.
I say all of this to let you know that I’m comfortable with debt, but not reckless with it. You may be more risk-averse than I am. And if you’re more comfortable with the idea of being debt-free, that’s exactly what you should strive to be. I just want to present an alternative strategy for anyone interested.
So, having established that, let’s get back to talking specifically about mortgage debt.
How to save a fortune by paying off your mortgage early
Before I can explain why I refuse to pay off my mortgage early, we need to discuss how these early pay-off plans save you big money.
It all comes down to interest. Every month, a good chunk of your mortgage payment is used just to cover the interest. The interest is a percentage of the total balance on your mortgage loan. As the balance goes down, the amount you pay in interest dwindles.
So you want to pay off the principal amount as quickly as possible in order to avoid paying all the interest you would otherwise pay. Make sense?
The trick is to make sure your mortgage service provider applies any extra money you pay only to the loan principal, not to both principal and interest. Some providers will play stupid and treat the extra as a prepayment for future principal and interest. And of course that’s not what you want. You just want to focus on paying down that principal.
You’ll probably have to check in periodically to make sure your payments are consistently being processed correctly.
Quick side note
Before you even think about trying to pay off your mortgage early, check to see if your mortgage has any prepayment penalties.
That’s right; you could be penalized for paying off your mortgage early. Why? Because your lender lent you that money expecting to make a specific amount of interest over the term of the loan. If you pay the mortgage off early, your lender earns less on your loan than they projected. So they penalize you to recoup some of their lost revenue.
Assuming your mortgage doesn’t have a prepayment penalty (or you’re comfortable accepting the penalty), here are 3 super simple strategies to painlessly pay off your mortgage early.
1. Round your mortgage payment up to the next hundred
This is so easy. Instead of paying the exact amount on your mortgage statement, round up your payment to the next hundred.
You probably won’t miss that money every month, but it will add up over time.
2. Put any windfalls directly toward your mortgage principal
Did you get a tax refund? Use it to pay down your mortgage principal. A bonus at work? Pay down your principal. How about a raise? Apply that amount toward your mortgage payment every month.
You won’t feel any pinch at all with this strategy because you were already used to living without that extra money.
You can also use this strategy in conjunction with rounding your payment up to the next hundred to pay off your mortgage even faster.
3. Make bi-weekly payments instead of monthly payments on your mortgage
You probably make a mortgage payment once/month now, right? So 12 full payments per year. Instead of doing that, pay half your mortgage payment every 2 weeks. 52 weeks divided by 2 means you’ll make 26 half payments per year.
That means you’re tricking yourself into making an extra full payment every year, probably without even noticing the money you’re missing since you’re making smaller payments more often.
It’s pretty genius, really.
How I almost got tricked into paying off my mortgage early
Paying mortgages is important for people who are looking to build or maintain their credit history, but does it mean you have to pay it right away? Mortgages can be defined as a type of loan that allows you to borrow money from another individual, through banks and other lending institutions, in order to purchase a property. It is often looked at as one of the most beneficial types of loans because it is easier than most to get approved for, while also providing more benefits than conventional loans.
Of course, not all mortgage companies are the same because some offer different rates based on your current financial situation whereas other offer different benefits based on your profession. Some even offer better rates to individuals who already have existing mortgages with them. However, despite how many options there are, the standard interest rate for mortgages is currently around 4.5%.
I ran my own numbers. And let me tell you, the bi-weekly strategy is tempting!
I’m going to give you an inside peek at my mortgage numbers to show you just how much money I could save.
Principal Mortgage Balance: $347,500
Annual Interest Rate: 3.88%
Years remaining on mortgage: 27
Total remaining interest to be paid using monthly payments: $213,748
Total remaining interest to be paid using bi-weekly payments: $182,868
Total saved: $30,880
I could save $30,880 simply by paying my mortgage bi-weekly instead of monthly!
So why do I refuse to pay off my mortgage early?!
By paying bi-weekly instead of monthly, I’d be making an extra payment of $1,732.25 every year. Which only comes to $144.35 per month.
But…instead of putting that money toward my low-interest mortgage debt, what if I invested it?
Monthly investment: $144.35
Annual Rate of Return: 6.5% (using a conservative, long-term estimate for my index funds, and scaled down to account for any investment fees)
Years to invest: 27, with monthly compounding (the same number of years as the number remaining on my mortgage)
Total account balance at the end of 27 years: $127,434
Total interest earned over that period: $80,664
Are you seeing this? I can earn $80,664 in interest over the next 27 years by investing just $144.35/month.
By investing my money instead of using it to pay down my mortgage debt, I come out $49,784 ahead!
See, every penny I put toward paying down my mortgage to avoid the 3.88% interest is a penny I don't get to invest at a 6.5% rate of return.
And as I said, I don’t care about being debt-free. I care about maximizing returns.
That’s why I have no intention of paying off my mortgage early in this economy.
By the way, you can run your own bi-weekly payment numbers and investment numbers on just about any personal finance calculator.
And another thing…
Keep in mind, once you put money toward paying down a debt, that money is gone. You can’t get it back.
But if you invest the money, it’s still there for you if you need it later. Just one more reason I prefer investing to paying down mortgage debt.
Should you pay off your mortgage early or invest?
As a general rule, if the rate of return on your investments is higher than the interest rate on your mortgage, you’re better off investing.
But if the interest rate on your mortgage is higher than the rate of return on your investments, you’re probably better off paying down your mortgage.
By the way, if your interest rate on your mortgage is currently over 6%, you should strongly consider refinancing. With good credit, you can still get a rate under 5%. But interest rates are on the rise, so don’t wait to look into it.
Will I always choose investments over paying down my mortgage?
In an ever-changing economy, I can’t say I’ll never decide to pay off my mortgage early.
If the economy slows and my index funds start returning less than 3.88% (which is the interest rate on my mortgage), I’ll probably stop funneling that $144.35/month into investments and start funneling it into paying off my mortgage early.
But pay off my mortgage early in this economy? Pfft!
Michelle is the founder of Savings and Sangria and has been a saver since she was eight years old. An unabashed believer in Oxford commas, she shares her insight into saving and investing between sips of sangria.
Read the Entire Mortgage Series
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- The Financially-Dumb Answer to Pay Off the Mortgage or Invest
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.