Making an extra mortgage payment a year- poor choice

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amother

Sun, May 19 2024, 10:37 am

There seems to be a popular notion that making an extra mortgage payment once every year is a good financial move because it shaves several years off of a 30 year mortgage. It is actually a very poor choice for most people. Let’s take some real numbers.

A 30 year $800,000 mortgage at a rate of 3.5%, which was a pretty average mortgage rate until recently has a monthly payment of $3592. If one were to send in one extra $3592 payment every year, it would shave off close to four years off of the mortgage and save a total of around $70,000 in interest charges. Sounds pretty good, right?

However, if we were to take the same $3592 payment each year and put it in a post-tax Roth IRA, S&P 500 index fund, which has averaged over 8% returns long-term over the last 50 years, one would end up at year 26 with approximately $336,000 in one’s account, close to FIVE TIMES the amount using the extra mortgage payment strategy. (By year 30 one would have close to $475,000 in the account, but would pay a total of $172,000 in mortgage payment for years 26-29, with close to a $300,000 nest egg vs. far less with the extra mortgage payment).
At a 2.5% mortgage rate the difference is even greater.

The extra mortgage payment strategy works if one’s mortgage rate is really high, say 8 or 9%. At that point the extra payment each year can shave close to 7 years off the mortgage and save close the the amount one would make by investing the money. For the vast majority of people however, paying an extra mortgage payment annually is simply poor financial strategy.

Genius

Sun, May 19 2024, 10:40 am

Thanks for posting this. Dave Ramsey pushes paying off mortgages and I don’t get it. Not all debt is bad.

#BestBubby

Sun, May 19 2024, 11:00 am

Maybe because people are more likely to do the extra mortgage payment

And less likely to put the amount of an extra mortgage payment in an index fund.

Since people won't do the investment, better to do extra mortgage payment than waste the extra $ on frivolous purchases.

amother

Tiffanyblue

Sun, May 19 2024, 11:02 am

With the political unrest in the world, I really wish financial gurus and planners would take that into account before pushing investing.

amother

Feverfew

Sun, May 19 2024, 11:03 am

Genius wrote:

Thanks for posting this. Dave Ramsey pushes paying off mortgages and I don’t get it. Not all debt is bad.

He’s pretty extreme. Not all his points are great and he should he taken with a grain of salt.

amother

Maple

Sun, May 19 2024, 11:12 am

I was the one who posted about the extra payments. Firstly, the mortgage rate is more like 6%. So the savings are significant.

Also we are very risk adverse and pessimistic about the state of this country and the economy. So investing is something we don’t have excitement to do.

amother

Darkblue

Sun, May 19 2024, 11:16 am

amother Maple wrote:

So why is it better to invest in your house? If you have to run you would rather the money than your mortgage being paid off

amother

Tiffanyblue

Sun, May 19 2024, 11:18 am

amother Maple wrote:

I feel the same way. I do not like risk at all and have almost zero confidence in our government and economy. Right now we are in a 5% savings account but I want to do something a little better. Any ideas?

amother

Mistyrose

Sun, May 19 2024, 11:22 am

The point is to pay 1/2 your mortgage payment bi weekly instead of once monthly, and then you won’t feel the extra mortgage payment. (It works out to 26 payments = 13 annual payments instead of 12)
Most (or many) people don’t have the discipline to save up the extra mortgage payment and then invest it. They can handle it if it fits into their budget neatly.
Side point, Dave Ramsey is really for people who have zero financial literacy and bad money habits. Not for people who generally know how to manage their money. I don’t follow his advice but I believe he’s helped a tremendous amount of people get their footing. Eventually you “graduate” from his mindset and move onto more financially savvy methods.

amother

Eggshell

Sun, May 19 2024, 11:32 am

Is an 800,000 mortgage the norm?

amother

Candycane

Sun, May 19 2024, 11:46 am

I think it's good for people to be aware of how the numbers work, but the math isn't always what makes a choice good or bad.
As others have said, people may be more likely to pay extra (can't take it back) than save the money without touching it for decades.
For me, it's also the calm of not having the mortgage to pay
PLUS, if you're risk averse-some prefer a guaranteed "return" of 3% by paying extra rather than an average 8% return on their investments
I'm aware of the math and compound interest and amortization schedules, and yet I choose to pay extra principal on my mortgage.

amother

Maple

Sun, May 19 2024, 11:54 am

…

teachkids

Sun, May 19 2024, 11:56 am

Short answer: depends on what your mortgage rate is and what you would do with the money otherwise

jd1212

Sun, May 19 2024, 12:01 pm

This is not an apples to apples comparison because when you were suggesting earning 8% in the market every year, you are taking on significant investment risk versus an extra mortgage payment which involves zero. The average investor over his/her investing lifetime earns 4%, post-tax (according to a fidelity study). This 8% number is helpful if you aren’t contributing along the way buying stocks at both high and low prices, and selling at the end at an opportune time.

amother

Emerald

Sun, May 19 2024, 12:12 pm

If your house was paid off and you could get a loan for 3.5% (Hypothetically - using the rate in the OP example) would you borrow 800k against your house to invest in the market which would return a much higher rate?

amother

Pearl

Sun, May 19 2024, 12:16 pm

amother Tiffanyblue wrote:

With the political unrest in the world, I really wish financial gurus and planners would take that into account before pushing investing.

They do. It's still the safest place for long term money.

amother

Burlywood

Sun, May 19 2024, 1:19 pm

jd1212 wrote:

There is certainly risk in sinking cash in your house! Your house is an illequid asset and when you want/need to access that cash you may not be able to (bad economy, unemployment), there may be fees involved (refinance), or it may be at unattractive and possibly unaffordable interest rates (like now)!

This is a risk!

Especially now when cds are paying over 5. If your mortgage is anywhere near that put your $$$s there.

amother

Burlywood

Sun, May 19 2024, 1:21 pm

amother Emerald wrote:

Probably not the stock market, but yes to a cd.

Put in several different banks so you get fdic insurance.

amother

Plum

Sun, May 19 2024, 1:23 pm

The difference is that when you put it into your mortgage you know you’re not touching it again. When it’s in a CD or index fund it’s more accessible and since we’re human it’s a possibility that we’ll spend that money now rather than let it sit for 30 years.

amother

Sun, May 19 2024, 1:58 pm

amother Plum wrote:

By the same token at year 26 you have zero dollars and zero access to cash since every penny was given to the bank to pay down the mortgage under the extra mortgage payment plan. Taking out a new loan on your home isn’t a given if you are unemployed or can’t show steady income .

Under the investment plan you have over 350k of cash you are sitting on at year 26 should the need or opportunity arise.

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