# Mortgage questions

I was having a talk with a buddy of mine about paying off our houses that we both bought at the same time and around the same price. So my question is this is it better to pay 100 bucks extra every month to the mortgage or put 100 away and earn interst and when I have enough money pay the house off at once? Which way would save me the most money in the long run?

I’ve done some calculations using these numbers:

\$150,000 for the house loan
8.25% on the loan for 30 years

The straight loan cost is \$405,700 with the interst being \$255,700.

by paying 100 a month I save \$77,000 in interst and pay off the loan in 7 years.

I don’t remember how to do the math for the 100 saved every month plus interst though.

So which way would save me money in the long run. Also my buddy said that you can get 7% savings accounts but I don’t know of any so also where could I go to get the best return on my money, one can never be sure in the stock market.

I can’t answer the math part of the question–but I did recently open a CD with E-Trade that gets 7.00/7.25 (I always confuse the APY with the other rate they give you). Don’t know if they’re still running that deal but I’m sure you could find other similar things. Money market accounts often also give higher interest rates than the average savings account.

I don’t see how this would help though unless the interest rate you were getting was higher than the interest rate you had to pay.

According to this site:

http://www.webwinder.com/wwhtmbin/java_fv2.html

at 7%, \$100/month, at the end of 23 years ( I assume that you mean that you’ll save 7 years, not that you’ll pay off the loan in 7 years ) you’ll have \$69115, of which \$41415 will come from interest.

I want to point out that there are tons of other considerations you might want to consider ( getting rid of PMI, tax implications on both side of the equation, diversification, the bit where the average for the S&P500 is closer to 11%). And I wish you luck; no matter what you decide, some one will tell you you are doing it wrong.

You can outperform on your own. The fact that your loan interest is tax deductible has to be taken into account too. This makes that interest rate easier to outperform, because you are really paying less than the 8.25% or whatever it is if you are deducting the interest from your taxes.

Bruce Williams…a famous financial expert who’s expertise includes mortgages and investments always says…it is the best thing to do is to have the largest mortgage at a reasonable interest rate for the longest period of time possible. In other words…Never pay off a mortgage early. If you have the discipline to invest on your own. You will beat it ever time.

As jeel has pointed out, you should not pay off your morgage early if you can achieve a rate of return on investment greater than your morgage interest rate, adjusted down to account for tax deductions.

You have to crunch the numbers for yourself, though. If you’ve just purchased your home, the majority of your payment will be going towards paying interest, so you can get potentially huge tax breaks. If almost all of your payment is going to interest, that 8.25% morgage rate is really 40% (or whatever your tax bracket is) smaller. On the other hand, if you’re on the tail end of your morgage, most of the payment is going towards paying off the principle, which you cannot deduct on taxes.

Given that the average historic rate of return in the stock market (at least in the United States, not sure about other counties) is 9-10% or so, you can deduct the relevant tax rate from this figure to give you your expected real rate of return on investment. Compare your adjusted morgage interest rate to the adjusted rate of return. If your morgage rate is higher, pay off the morgage as quickly as possible. If your investment return is higher, pay only what is required and invest the 100/month.

Granted, I’m not a financial expert, but in my limited experiences with investing, it’s not that easy to beat even an adjusted morgage interest rate. Taking an after tax rate of return of 8% (10% - 20% for capital gains taxes), this is comparable to your non-adjusted 8.25% morgage rate. Adjusting for taxes should put your effective morgage rate below 8%. If you’re just starting to make morgage payments, this is a pretty good deal. But if you’ve been making payments for awhile, it’s not so clear. That 8.25% rate is set, but your rate of return is not; there’s risk involved. You can go for CD’s or money market accounts, but these certainly won’t net you a before-tax rate of return of 10%, and you still have to pay your taxes on these gains.

I really wasn’t concerned about income tax as that really screws things up more since you pay a good amount on investments, at least now you do.

I think that was the guy he was quoting, but I used the above caculator and at 100 bucks a month at 13% for 20 years I got \$116,000 total. after 20 years I still owe 97000 principal so it doesn’t seem to work out that well. I still don’t see the advantages really. I just looked again and if I put 100 in a month for 30 years at 11 percent I still don’t make back the interst that I paid in the house, plus there is no guarentee that I will always earn a good interst rate though one would hope that you would.

But if you use the \$100 every month to pay down principal, it will earn you somewhere about 6.5% (after taking into account income tax deduction…I did not do the math…I’m estimating) by reducing the amount of interest you owe on your house. It does not take any real complex math to figure if you can earn any more than 6.5% on your \$100 overpayments you are getting ahead…Try the calculations again.

Ok then how about something like this. I pay 100 extra each month I pay off in 23 years saving 77 thousand, that’s a load of money that I don’t have to pay.

now if I put 100 away every month at 10%, using the high average above, I get 230,000, that’s a lot of money, but I paid 255,000 in interst. That doesn’t seem to come out ahead at all.

Then I went and did this since I saved 7 years for the next 7 years I put the 1125 that would be my normal house payment and got 130,000. That’s 100,000 less but only took 7 years and that was at 8.25%

I’m not even playing with the taxes because that’s too much of a pain but just for the fun of it I’ll look at it now and apply that money to the house to pay it off even quicker and that’s the point to come out ahead right. since I don’t know what I would get back I’m gonna use 20% of the interst per year and add it to the paments.

ok, I’m guessing I did this wrong but for the first 10 years only I paid back 15,000 or around 1500 each year. that cut it down to 19 years and I own the house plus saving 120,000 in interst, almost half. Then for the next 10 years I put the 1200 away at 8.25% and got 248,000.

It seems to me that the way to go is to pay off early and THEN put the money away as I make almost 30,000 more that way, plus I don’t have to worry about the intesst and I own my house much earlier.

Over all I don’t see any advantage either way and both have pros and cons. I personally would rather own my house and not have to pay the bank the interst.

Over all I don’t see any advantage either way and both have pros and cons. I personally would rather own my house and not have to pay the bank the interst.

Well, if you could get a better return else where, then every one would pile onto that and the return would go down. That’s how economics works.

In your last sentence, you peg the important point. If you figure you’re going to die in this house, and you aren’t strapping yourself for cash (I don’t know how much a hundred bucks is to you), there is no harm in paying it off early. Could you get a better return by investing the money elsewhere? Yes. You could invest it all in an S&P 500 fund, and reasonably expect a 10% return. Jeel is probably correct when he says that you’ll get about a 6.5% return (because of the interest deduction) by prepaying your mortgage. That’s good, but not great.

A few other things to consider:

1. Inflation. If inflation goes way, way up, you are better off not paying off your house. The value of the money you owe will degrade, and you’ll be able to get a better return.

2. Liquidity. Ignore the 5 zillion “tap your home equity” mailers you are getting right now. Cash (or cds) are easier to access if you need, err, cash, than home equity is. You do not want to prepay to the point where you are not able to save in addition.

3. Liquidity. If you invest in the S&P 500, you may find yourself in a position where you cannot sell, because the market is depressed. If that occurs, you’re better having those home-equity loans I just mentioned.

4. Deflation. Sigh. Yes, I realize this hasn’t occured in forever. But it has happened, and can happen again. And it can make your home loan cost you more.

5. CD rates are probably higher than they’ll be in 6 months. You may not be able to keep up the 7/7.25% returns you are seeing now.

My advice is to fire up excel (if you’ve got it) and set up a couple of scenarios. You are looking for the future value of investments (to tell you how much to expect from saving \$100/mo), and home loans (this will let you work out how much you save by prepaying). You might also visit the motely fool website (www.fool.com). There is some good financial advice over there, even if they have lost a lot of credibility lately.

Personally, my long term savings goes 85% to the market, 15% to prepaying the house. When the market is way up, I feel bad for putting so much into prepay. Right now, I feel pretty good watching the equity numbers climb.

Equity doesn’t mean a whole lot, other than you’ve got \$X tied up in your house, where you can’t easily get to it. The best advice is to carry as large a mortgage for as long as possible (though avoiding PMI is for the better).

Look at it this way–the real estate market doesn’t care how much equity you have in your house. The value of your house will go up (hopefully) whether you’ve got 5% equity or 100% equity. If you have \$200,000 tied up in a \$200,000 house, you’re getting nothing more from your “investment” in the house than you would have from \$10,000 equity and a \$190,000 mortgage. The benefits from the mortgage include the tax deduction and the ability to invest the \$190,000 elsewhere, and since we’re obviously talking about the long-term, I’d still feel pretty good about coming out ahead after interest costs (net of the deduction).

I think that prepaying only makes sense if you plan on staying in the house for the life of the mortgage.

If you know that you’ll be selling in 5 years or so, there is no point.