Would you overpay your mortgage?

In My Humble Opinion
1

Which is a better investment:

  1. Overpaying your mortgage. There are no early payment penalties or additional fees. Current rate is 4.5% variable. There is 30+ years left on the mortgage.

  2. Investing in a tax efficient passive global developed markets equity fund. Assume there is no capital gains tax.

They way I see it, interest rate risk is a little 1 sided right now. There is more room for rates to go up than go down. Overpaying the mortgage is like investing in a floating rate bond. You would be pretty much getting a guaranteed 4% return, probably more if rates go up in the future.
On the other hand, you would be diversifying your portfolio by investing in Equities. I have no idea what the expected return on the Equity is (and I don’t think anyone else does either).

What else is there to consider?

2

How long do you plan on living in this house?

3

No plans to sell the house in the next 50 years.

4

I would (and did) pay down the mortgage as fast as possible. This was not based on any kind of financial planning beyond not wanting to be in debt though.

5

At 4.5% I’d overpay the mortgage. At 3.5% I’d probably put half the overpayment into equities. But if I had a 4.5% thirty plus year loan, I’d probably refinance for a shorter term lower interest. That wasn’t one of the options offered, but it’s what I would do.

6

Investigate remortgage to a 15-year and then pay that puppy off. I paid off my 15-year in 11 years.

There’s nothing quite like the feeling of living in a house you own 100%.

7

There’s a lot to be said for the feeling “No matter what happens, I’ve got a roof over my head”.

8

[QUOTE=Campp]
Investigate remortgage to a 15-year and then pay that puppy off. I paid off my 15-year in 11 years.

There’s nothing quite like the feeling of living in a house you own 100%.
[/QUOTE]

Unfortunately remortgaging is not an option as part of my debt is an interest free loan from the house builder that will need to be repaid in full if I remortgage.
Besides, I am out of the initial 2 year fixed rate period so I can overpay as much as I like. Effectively my mortgage is not really at 30 year, it is an “at most 30 year” since I can pay it off whenever I want/can. Also, going onto another fixed “low” rate deal does not accomplish anything as the “processing fees” make the overall cost equivalent to my current variable rate with the added restriction that I can no longer overpay during the fixed rate period.

So I guess my options are overpay the mortgage or invest in equities. I am wondering if there is some sort of theoretical framework to evaluate these options. Perhaps this thread is more suited to GQ.

9

Pay off the mortgage.

From a lawyer with 30 plus years of helping people buy and sell their homes.

You can in theory invest in passive international funds and that might work out, but the horizon is far off.

By contrast the one number which is certain is what you owe to the bank, so get rid of it. Every one of us needs a roof over our heads.

10

good point.

11

Are you happy with where your home is, workwise, neighbourhood etc? Can you see yourself staying there in the long term? Is the property likely to retain its value? If so, then pay down your mortgage as much as you can - you are building equity by doing that anyway if circumstances change. If not, then you might like a bit more flexibility, with more liquid assets. Home ownership isn’t, or at least shouldn’t be, like other investment choices

12

I did.
I paid of a 15 year mortgage in around 10 years. I didn’t care whether is was the financially “best” use of my money - all the other investments had unknown risks. Doing this had a quantifiable payoff. Now I now my house outright, and have no debt.

13

It depends on how disciplined you are when it comes to investing and saving.

If you can invest the money you intended to add to your payments, without pissing it away at some later date, I would recommend that you invest the money.

If money has a tendency to slip through your fingers, or you don’t feel comfortable playing the various markets, pay down you rmortgage. The extra money you add comes off the principle.

14

When I still had a mortgage, I inquired about the the “overpaying my mortgage” thing. My mortgage co. said that if I just started sending in more than the normal payments, they would just return the money. I would have to arrange some kind of accelerated repayment scheme with them and it would cost me to do it.

Maybe it was just that mortgage co. that was this way.

15

If I invest in Equity, it will be for the long term. What gets invested, stays invested unless something really bad happens, in which case the liquidity of the equity will be useful.

Also, I would never play any markets (I assume you mean by stock picking) as I believe the majority of active fund managers are unable to reliably out-perform comparable passive funds and I lack the resources and inclination to identify the few that can.

After reading all these responses, I am slightly inclined to overpay the mortgage but I need to think about it a bit more.

16

Actually… the expected return on a market equity portfolio is usually quoted as a premium to the risk-free rate “rf” (10-20 year US treasuries) and depending on the finance professor you talk to ranges to rf+5 to rf+7%, based on their interpretation of historic stock returns.

Saying you prefer to invest in the mortgage is like saying you would prefer to borrow at 6-12% (the opportunity cost of the equity market investment) and invest in a 4% instrument, which obviously makes the equity investment superior from a purely mathematical perspective before considering more practical aspects and risk tolerances for short-term losses.

Of course there are plenty of times when the bonds have paid off better, but the whole basis of modern financial theory is risk adjusting long-term expected returns, so riskier instruments like equities should outperform at some point.

I present these thoughts not as an individual contributor, but as a conduit for my numerous finance professors from my finance undergrad and subsequent MBA at a top 10-15 b-school. (Not intending to brag, just listing sources) I can also say that having worked in corporate finance for several large companies, the underlying financial theory and formulas are applied fairly consistently in practice (betas, rf, etc). I’m sure other finance-oriented dopers can refine the broad generalities I have presented better, but it’s a good conversation starter.

17

First, and I assume you already do this, max out your 401K contribution that get matched. Best investment you can make.

You don’t say how much you overpay. We overpay $100 a month (about 11% of our payment) because we can afford it. We also invest a lot more than that. You also didn’t say how much equity you have. If it is little enough that there is a chance that your home may be underwater in a new downturn, overpaying could be useless.
So the right answer might be to do both, and divide the money in a way that makes sense for you in terms of risk. You can change either amount at any time, after all.

18

Another voice here in favor of investing rather than paying down the mortgage, or at least a "50/50 split.

Paying the mortgage down faster does not improve your financial flexibility until you get the mortgage practically entirely paid off, because for the foreseeable future you will still have the same monthly payment that you will have to make month after month, no matter how fast you pay down the mortgage.

Just for illustration, let’s look at a somewhat extreme example. Say you have a $300,000 mortgage. If it was 30yrs fixed at 4.5%, your payment would be $1520.06. (I know you have a variable rate mortgage, but for simplicity let’s ignore that.) Lets also say you have an extra $800 or so every month, and so you decide to pay 2294.98 every month in order to pay off the mortgage in exactly 15 years.

In seven years, though, you lose your job.

Because you paid down your mortgage faster, your outstanding balance on the original $300,000 loan is only $184,732.87 instead of $261,078.37. However, you have little in savings and now have no income. No lender will extend you new credit on the equity in your home to cover your living expenses while you find a new job, and you may soon be faced with the possibility of being forced to sell the house if you can’t make your payments.

Suppose, though, that you had paid down the mortgage at the 30 year pace, and instead stuffed the extra money (774.96 every month) in your mattress (at 0% interest). You will still have a balance of $261,078.37 left on your mortgage, but you will also have a cash cushion (mattress!) worth a little over $65,000, which means you won’t need to worry about paying living expenses for quite a few months while you look for a new job.

If you lose your job in seven years, which position would you prefer to be in?

Yes, on a net worth basis, you will be $12K ahead in the rapid pay down scenario versus the standard paydown scenario, but in the second scenario you have much more financial flexibilty to weather the storm.

Also, in this example, we are ignoring the fact that the standard paydown scenario will result in you having a bit more of a tax deduction each year, so the actual difference will be a little less pronounced than 12K. Also, if you invest the money in an equity fund, you will inevitably have more or less than 65K, depending on the actual returns, but in either case you will have an emergency cushion. If you think you can be confident of earning positive returns over 7 years, the 12K difference will be even smaller.

Finally, if you do chose the standard paydown/invest option, at some point down the road you can always revisit your situation and decide whether or not to make a lump sum payment towards your mortgage balance. The advantage in this case is you will be able to look at your then current employment situation, current rates, etc. before deciding whether to tie up your capital in the house or not.

19

I have fourteen more payments on my house…

20

Yes and no - refinancing comes with its own costs, and that would have to be weighed against the interest rate savings.

Also while refinancing to a lower rate and 15 year term would save a lot of money in the long run, the monthly payment would be a bit higher and that might pose short-term cash-flow concerns.

Say your payment is 1,000 at 4.5% for a 30 year loan, and it would be 1,200 at 3.5% for a 15 year loan.

You could instead overpay the 200 on the current loan each month you can afford to do so. It might not save you as much as if you refinanced, but then if there’s a month where you don’t have 200 to spare, you can just pay the 1,000 instead.

I just plugged in the numbers for our mortgage - and the rate we have now, versus the rate if we refinanced to a 20 year loan, would cost us about 360 extra a month.

That said: prepaying a mortgage always seems like a good idea to me - no immediate cash flow benefit, but if it’s money you don’t need access to, a significant savings in the long run.