Is "investing" in my mortgage a good idea?

To start with, I am 27, make a comfortable living, have some money saved, some assets. I would say for a 27 year old, financially anyway, I am in the top 50 percentile of my peers.

My 2 biggest liabilities are a $20K student loan at 7%.

42k home mortgage at 4.125% with a balloon due in 2023.

Let’s say I have $100 a week, I can easily spare, and will not need it back except under the most dire circumstances.

Looking towards the future, would it be a good idea to put that $100 towards something like my mortgage or student loans. I figure if I start on my mortgage now, I can pay the entirety off by the time the balloon is due.

Or is it wiser to invest in something like stocks or CDs?

Pay down the student loan. I hate those things.

My approach in my debt-filled days was to wipe out the highest-interest debts first. It must have worked because all we have now is our mortgage, and it’s at a low enough rate that we’re not looking to blow it away yet. Maybe when the balance drops some more…

There are two schools of thought with regard to paying down debts:
[li]Pay the one with the higher interest rate first. This will ‘save’ you the most money, as you will end up paying less in interest payments.[/li][li]Pay the one with the lowest balance first. This will more quickly leave you with fewer debt obligations.[/li][/ul]

In your case, both would have you pay the student loan first.

What savings do you have? I recommend an emergency fund of at least six months worth of expenses. And what have you saved towards retirement? You might want to put some money towards that, if you’re not already doing so?

Under what circumstances is it better to have one large debt paying high interest than two small debts paying low interest?

There isn’t enough information for us to help you decide (plus some things nobody knows, like what kind of refi rate you’ll get if you need to do that on your balloon).

From a purely financial standpoint you should pay down your highest-interest debts first, but as Suburban Plankton notes, there is a school of thought that advocates eliminating balances first, it’s called the snowball method or something like that. An additional wrinkle for you is that if those are federal loans, while they have a high interest rate, they have some built-in advantages too (e.g., forbearance options, discharge for public service, etc.) that might make those the later ones to pay down.

It’s not a financial technique. It’s a psychological one. It doesn’t make sense from a financial standpoint. It’s supposed to motivate you to repay your debts by giving you the quickest victories.

For some people who have trouble paying off debt at all, this approach has been shown to be psychologically better because it shows them that it is possible to pay off a loan.

ETA: what ReticulatingSplines said.

Why pay down debt? If you can get 6% on your money through investments and both your mortgage and student loans are under 6% then you should invest for a net gain.

Stocks return 6% only over the long haul though. With a 20-year investment horizon, I agree, but he’s going to need a balloon payment in five years. I guess that’s another thing we’d need to know.

You should pay off the student loan. It is the highest interest rate, and if you find yourself in a dire financial situation, it will not go away.

For the mortgage, I would consider a refinance - you should still be able to beat that interest rate fairly easily. If you have a balloon payment due, though, I’d imagine that a refinance of the mortgage to a traditional plan would result in higher monthly payments.

It might be worth refinancing to a traditional mortgage if there’s enough equity to add 7k to the mortgage and just pay off the whole student loan.

While this is mathematically sound, I never feel like this is realistic advice for most people. Sure, if you can get an after tax return that is greater than the after tax effective rate on your loans, you should do the investment. But for most people, this type of leverage will overexpose their risk. The black swan is a loss of income and a major loss of value on the investments while the debts are still due. The expected scenario is a profit of a few hundred to a few thousand bucks a year on the 2-3% net difference on the investment.
Someone (on this board, I think) once posed this question as: “If you had a paid off house, would you mortgage it to invest in the stock market?”

Maybe it’s a cash flow thing as well as a psychological bonus. If you have a 5,000 loan at 10%, that is costing you 100 a month in payments, a 40,000 mortgage at 5% that is costing you 300 a month in payments, paying extra on the 5K loan will get rid of that faster - then you only pay a single 300 a month payment.

Change that up to a 5000 loan at 5% and a 40K mortgage at 6%, you still might be better off paying down that 5K loan first, even though it’s a lower-interest loan, because it’ll free up cash flow (ignoring the tax effect of the mortgsage of course).

To the OP: whether you prepay the mortgage with spare cash, or invest that money elsewhere, make sure you’ll be in a position to meet that balloon in 6 years. All in all, I’d personally do my best to pay down the student loan: it’s likely got a short-ish term (say, 10 years), it’s a higher rate, and getting rid of it will put you in a better position to refinance the actual mortgage.

After that I’d do a combination of putting more aside for retirement, more in a “safe” investment (CDs and so on) to support paying down the mortgage in 6 years, and some into your emergency fund.

To a 27 yo, something 5 years downtrack feels like the far future. To older folks that feels more like tomorrow.

The real value of prepaying some on a fully-amortized (non-balloon) mortgage is that a relatively small payment today “earns” the mortgage’s rate of interest for the entire remaining 25-ish year term. Which results in big gains in the payoff date and in out-year interest paid. Said another way, paying an extra payment this month doesn’t do much for 15 or 20 years. Then it pays off like a slot machine.

OTOH, if you’re going to refi in 5 years, there’s almost no upside to pre-paying. This would apply if you know you’re going to sell and move, or you have a balloon-type mortgage, or you have good reason to believe interest rates are going significantly lower than what you have now. Such as knowing that your credit rating was marginal when you got the loan but will be much better in 5 years.

So that says the OP should not pre-pay his particular kind of mortgage.
For an undisciplined saver/investor there is merit in putting extra money into the mortgage. Because they can’t withdraw it, they end up accumulating capital against their natural tendencies to blow the money. That doesn’t sound like the OP either.

A couple of observations:
[li]Pay off the higher interest rate loan first. Once it’s paid off, then apply what you were paying into it against the mortgage.[/li][li]A mortgage is buying a tangible asset. You can’t “sell” your school loan if you get into a critical bind.[/li][/ul]
Do you have a six to nine, to 12-month emergency fund? If you don’t, start one once you pay off the school loan. Better yet, if you are buying a daily Starbucks drink, go without and put the money to your emergency fund now.

That common reasoning is questionable for mortgage rate. With due respect it’s preposterous with a 7% loan. That 7% is for sure as long as you don’t pay down that debt. The return on stocks is actually unknown. It’s expected value might be around 7% (arguably higher or lower, significantly higher in the past, but stock valuations were lower in the past). It’s leaving out a major piece of puzzle to neglect that difference in risk.

Besides which the problem with that theory in this case is staring us in the face on the debt side, before even considering if the person should have debt. The student loan is 7%, the mortgage 4.125%. Obviously the person can borrow for less than 7%…they already are. And if the person borrowed against their stock portfolio, margin loan that rate would only be 2-some% from the cheapest broker albeit floating with the Fed Funds rate.

Keeping 7% debt in today’s rate and expected return environment, if you’ve got the cash flow to pay it down and a 6+ month emergency reserve already set aside as was mentioned, doesn’t make sense. Behaviorial psychology stuff saying you should pay down 4% before 7%…can’t get my head around that.

This is important to note. The mortgage can be handled through bankruptcy is things really go south for you.

Three things can’t be discharged through bankruptcy (at least in my state):

Child Support
Student Loans

Which of these things is NOT like the other?

Under circumstances where the need for wiggle room in your short-term finances outweighs the need to pay less interest in the long-term, it makes sense to pay off the smaller debts first, regardless of interest rate. In other words, when you’ve gotten yourself into trouble and need to get out.