Does Early Mortgage Repayment Still Make Sense? by Stephen L. Nelson, CPA
Early mortgage repayment looks on paper at least like a wonderful deal. If you have a typical mortgage and you are near the beginning of the mortgage term and make an extra $25 a month in principal payments, you could potentially save $25,000 in interest over the life of the loan.
Note: The exact amount of early repayment savings depends on the loan, but, in general, the apparent savings are astounding.
In spite of the superficial profit that seems to come from early mortgage repayment, it’s often not a good decision. The tragedy here is if you would have used that $25 a month to boost your individual retirement account, or IRA contribution, you would end up with $50,000 in your IRA account. If you would have used the $25 a month to make extra contributions to your employer’s 401(k) plan, you might have easily ended up with $75,000 in a 401(k) account.
The reason for these discrepancies is simple. In effect, when you calculate the interest you save by early mortgage repayment, or the interest you make by investing in an IRA or a 401(k), you are making a compound interest calculation. Any time you compound interest over long periods of time, the numbers eventually grow large. But the most important factor driving the interest rate compounding calculation is the interest rate. The larger the interest rate, the faster the compounding and ultimately the larger the final value.
If you can prepay a mortgage that charges 6% but invest in an individual retirement account or 401(k) account that will pay 8%, mortgage repayment is actually a terrible idea. And, unfortunately, very small differences in interest rates ultimately produce very large differences in the final compounded values.
Although early mortgage repayment is a technique that many financial writers who don’t know better recommend, you are typically better off using the money you would have used for early mortgage repayment for additional individual retirement account or 401(k) contributions. The one scenario in which you could save money through early mortgage repayment is when you have already taken maximum advantage of these other investment choices and are still looking for some other place to "save" additional money.
About The Author
Stephen L. Nelson, CPA
Redmond WA accountant Stephen L. Nelson, CPA, MBA is the author of Quicken for Dummies, QuickBooks for Dummies and more than 100 other books as well. He can be reached at http://www.stephenlnelson.com
Reprinted from ArticleCity.com
“If you can prepay a mortgage that charges 6% but invest in an individual retirement account or 401(k) account that will pay 8%, mortgage repayment is actually a terrible idea.”
Not so. The 6% interest rate on a mortgage only applies to the 360th payment on a 30 year mortgage. It makes sense to paydown a mortgage early due to the front-end interst load on a mortgage amortization schedule.
Remember, also — a home is not an asset until such time as it has been paid off “free and clear”; until then a home is a liability.
The biggest obstacle most folks have to abtaining wealth is their mortgage — that’s why it makes sense to use home equity acceleration:
More and more folks are using a Home Equity Line of Credit (HELOC) or a business-line-of-credit (BLOC) or personal-line-of-credit (PLOC) as an interest cancellation account to accelerate their home equity and payoff their home *years* sooner than listed on their mortgage amortization schedule.
Unfortunately, today’s Real Estate market means that folks can no longer count on appreciation to build home equity. Those who realize that they need to pay down their current mortgage debt are looking for alternate ways to aggressively (yet safely) build equity.
And they’ve discovered a perfect online system to do that; they can focus on their wealth accumulation goals while accelerating their equity simply by using an Advanced Line of Credit (ALOC) to ‘power’ the Money Merge Accountâ„¢ financial solutions program.
A typical 30 year loan (of whatever type) can be paid down in 1/3 to 1/2 the time  it’s a great way to save *huge* amounts of income by eliminating a mortgage amortization front-end interest load. (On a million-plus dollar home, I’ve personally seen where the Money Merge Accountâ„¢ program will save the homeowner $750,000 in interest charges!)
And the best thing – homeowners don’t have to refinance their existing mortgage or, in most cases, make any adjustments to their lifestyle.
It is unfortunate that most of us were never taught to follow three essential principles: (1) Avoid paying interest, whenever possible, (2) Use other people’s money, whenever possible and (3) Find and use a financial system that will guide you, especially if you have the tendency to go off-track. The Money Merge Accountâ„¢ software and the program’s counselors use these principles to keep each homeowner focused on their wealth accumulation goals.
I’d be happy to provide further details…
Comment by Lee Matthews — Financial Concepts West — February 25, 2008 @ 1:30 pm
Interesting and informative post, thanks for share!
Comment by banque et credit — September 18, 2009 @ 7:28 am
Stephen I really enjoyed this article. Working for a Law Firm I see so much of this on a weekly basis that its nice to see others that share the concerns of the rest of us out here.
Comment by Broward Foreclosure Defense — October 13, 2009 @ 11:11 am
I’d appreciate more information on this subject. I want to make biweekly payments on my mortgage. The bank charges a fee to set this up. I want to do it myself and just set up a recurring payment twice a month. Please advise.
Comment by Erman Harris — May 11, 2010 @ 8:18 pm
Mortgage Rates Fall To .01 Points Above All Time Historic Low June 13, 2010
The 30 year rate fell from 4.79 to 4.72 this week. This is the lowest point this year. The previous low was 4.78 reached two weeks ago. What is more interesting is that the all time low is 4.71 so just .01 points lower than current rates.
Looking at other rates the 15 year dropped from 4.20 to 4.17. The 5 and 1 year arms dropped from 3.94 to 3.92 (5 year arm) and 3.95 to 3.91 (1 year arm). These are all time lows since we have good tracking data for these mortgage products. So would it make sense to look at some of these other mortgage products since they are at all time lows? Personally I would still avoid the 5 and 1 year arm. Since mortgage rates in general are so low it makes sense to lock in for as long as possible. Below are rates from the weeks from May 13, 2010 to Jun 10, 2010.
Jun 10, 2010
30-fixed 4.72 15-fixed 4.17 5 ARM 3.92 1 ARM 3.91
Jun 03, 2010
30-fixed 4.79 15-fixed 4.20 5 ARM 3.94 1 ARM 3.95
May 27, 2010
30-fixed 4.78 15-fixed 4.21 5 ARM 3.97 1 ARM 3.95
May 20, 2010
30-fixed 4.84 15-fixed 4.24 5 ARM 3.91 1 ARM 4.00
May 13, 2010
30-fixed 4.93 15-fixed 4.30 5 ARM 3.95 1 ARM 4.02
Nov 26, 2009
30-fixed 4.78 15-fixed 4.29 5 ARM 4.18 1 ARM 4.35
So rates are one thing but it’s also informative to calculate mortgage payments. We took today’s rates and calculated a mortgage payment on a 200k house. We also did the same thing with rates from May, 13 2010 and rates from November,
26 2009.
Jun 10
30-year $1039.68
15-year $1496.47
5-year ARM $945.62
1-year ARM $944.48
May 13
30-year $1065.1
15-year $1509.62
5-year ARM $949.07
1-year ARM $957.13
Nov 26
30-year $1046.91
15-year $1508.6
5-year ARM $975.7
1-year ARM $995.62
So compared to a month ago a mortgage payment is $25.42 less a month for a drop of 2.45 percent. While that is not a huge drop it is considering rates from last week were already pretty low.
So what is going to happen moving forward? As always it’s hard to tell. If the economy continues to have a rocky recovery I would expect that rates will stay at current levels and possibly break down to new all time lows in the next few months. If the economy starts to rebound we should see mortgage rates move higher perhaps much higher. Over the next 6 months while it’s hard to know which way mortgage rates will move if they move up they could move up substantially while if they drop they do not have much room to fall.
Comment by Austin Movers — June 17, 2010 @ 2:48 pm