I purchased a new home about a year ago. A few times last year, when I had some extra money, I made a few extra payments towards the mortgage. My goal (originally) was to pay off the mortgage much sooner than the original 30-year term.
I realized I shouldn’t be doing that… I think.
Here’s why: My Company Savings Account earns 6% interest each year. (Note: It’s not a 401 K… it’s just a regular savings account that I can make deposits or withdrawls to at any time.)
The amount in the account earns interest on the balance every two weeks. At the end of our fiscal year all interest we earned is then deposited into our account, which, of course, helps to earn more interest the next year.)
According to my calculations, instead of making extra payments towards my 4.625% mortgage loan, INSTEAD I should just take that extra money and deposit it into my 6% savings account.
The math:
Assume my monthly mortgage payment is $1,185 and I have an extra $300.00 each and every month to either 1) save it or 2) help pay the loan.
Scenario 1: Save the $300
NOT make an extra $300 mortgage payment
Deposit this money in my savings account instead.
$300 a month = $3600 a year = $138.50 every two weeks
Saving $138.50 every two weeks for 30 years = $298,000 (with the above method and rate for my company savings account.)
So in 30 years the loan will be paid off and I’ll have about $300,000 in this account.
vs
Scenario Two: Pay the loan off early
MAKE an extra $300 mortgage payment every month.
By doing so my loan will be paid off in approximately 20 years.
At the end of this time I’ll have no money (all of the extra $300 I have went to pay off the loan) But I’ll then have and extra $1485 (1185 + 300) each month to put into the account and save for 10 years. According to my excel spreadsheet, that will only earn about $249,000.
So, am I missing anything? SAVING the money, at 6%, seems the much better way to go.
Thanks bluebell. It’s a fixed rate… at worst, it won’t change. At best, I can refinance at an even LOWER rate.
For the moment, your math shows the better option. But keep an eye on interest rates. If they rise, the picture changes, and it might then be a better choice to pay off the mortgage.
One slight advantage comes into play with home insurance costs.
Once you pay off a mortgate you can slash more than 1/2 off your home insurance.
You can even go with a 10K deductible to pay only a couple of hundred per year.
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For the moment, your math shows the better option. But keep an eye on interest rates. If they rise, the picture changes, and it might then be a better choice to pay off the mortgage.
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A company savings account or sometimes a cash balance may be a tax deferred retirement account. If you can’t access the funds you may be better off saving them. It sounds like it’s some sort of annuity type product that offers you a higher rate of interest than the current rate. These rates usually are not fixed and you typically can’t access the funds until you retire.
Depending on your pay schedule you may be able to sign up for bi-weekly payments (pay every 2 weeks instead of once a month) with your mortgage company. If you get paid weekly or every two weeks this method will help you cut about 6 and a half years off your mortgage.
Mortgages are installment debt meaning that no matter how much you put towards your principal the payment will remain the same every month.
Pocketing that additional principal will help you just in case you should ever lose your job or have some sort of financial emergency. Hopefully one day you’ll have enough to pay off the mortgage in full. Then you won’t have to worry about that payment every month.
You may also consider a tax deferred IRA, 401k or other deductible deferred retirement plan and invest in some mutual funds. They can grow tax deferred so you lower your taxable income (bigger return = more savings) and the long term growth should be well over 6%. Consult your tax adviser on your ability to invest into an IRA if you’re employer doesn’t offer some sort of retirement plan.
The last thing you want is to have that big beautiful house paid off and only have social security to live off of.
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