Thinking of Accelerating Your Mortgage Payments? Consider These Factors First
Q A recent article discussed the importance of debt retirement, especially credit card debt. But mortgage debt may also be worth retiring early, especially on an adjustable-rate loan, because principal pay-down will usually reduce the monthly payment and give you more money for investing or even more mortgage debt retirement.
But I’m wondering how wise it is to pay down a fixed-rate loan given the fact that early principal pay-down won’t reduce monthly payments but only cut the length of time the mortgage is in effect. How much would the length of a 30-year, $250,000 loan at 8.5% be reduced by paying off an additional $100, $300 or $500 each month on the principal? Is is worth the effort?
S.J.Q.
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A First let’s give you the numbers, then the analysis. Given the information you’ve supplied, Earl Peattie of Mortgage News Co. in Morro Bay, Calif., made the following calculations: Your monthly principal and interest payments are $1,922.29, and you will pay a total of $442,013.87 in interest over the 30-year life of the loan. The following figures assume that you start accelerated principal payments in the first month of your mortgage. If you pay an additional $100 in principal each month, you will cut the life of the loan to 24 years and seven months and save $94,721. If you pay an additional $300 per month, you’ll trim the loan to 18 years and 10 months, saving $190,208; if you pay an additional $500 per month, you reduce the loan life to 15 years and seven months, saving $241,329 in interest.
Clearly you would have far more immediate rewards by making additional principal payments on an adjustable-rate mortgage because the note is reset at regular intervals and your monthly payments quickly reflect the outstanding principal amount. But one beauty of a fixed-rate mortgage is that it does offer a stable monthly payment, thus protecting the borrower against interest rate fluctuations. You can’t have it both ways.
Only you can decide if it’s worth the effort to reduce your mortgage debt ahead of schedule. But here are some questions to consider:
First, what alternative uses do you have for the money you would use to reduce the mortgage debt? Could you invest that $100, $300 or $500 each month and see a return of at least 8.5%, the amount you’re paying to borrow that money? Will you have any emergency need for that money? After all, short of a refinancing, you won’t have access to that money until you sell the house. Mortgage repayment is a highly illiquid activity.
How long do you expect to own the house? If you’ll just be there a few years, you’ll be pulling your money out of the house relatively soon and thus reaping the benefits of the accelerated payment schedule. However, your savings won’t be great. If you plan to remain in your home until the mortgage is entirely repaid, you’ll be waiting that long for your just rewards, which, as noted above, could be quite substantial depending on how much you accelerate the loan repayment.
In addition, inflation should be considered. If it soars, you’re always better off borrowing as much as possible when the loan carries a fixed interest rate because you’re repaying the debt with devalued dollars.
Further, if you expend your capital paying down the principal, you’ll have less to invest during a prolonged period of high inflation. But if you think inflation is under control for at least the period of time you’ll own the house, then you can look at the debt repayment as just one investment alternative and judge it against what else you can do with that same amount of money.
By the way, if you do decide to accelerate your principal payment, be sure to clearly note that fact each month when you make your mortgage payment. Some lenders or mortgage service companies include a separate notation on the payment coupon. If yours doesn’t, you should write a separate check for the additional principal payment to ensure that your loan is properly credited.
