Monday, January 21, 2008

My Philosophy on Prepaying Your Mortgage

I believe in debt freedom.  We're still many years away from that, as we finally bought our first house this year, but I believe in it.  One of the best ways to simultaneously achieve debt freedom and financial independence is to pay off your mortgage.

Imagine a day when you had nothing to pay but your monthly electric, phone and cable bills, along with some groceries.  When your expenses dropped by thousands a month.  When no matter what happened, you owned your home free and clear.

"I can get better returns in the stock market"

I maybe buy that.  Maybe.  For some people, some of the time.  I believe that paying off your mortgage is just as important is investing, for two very good reasons.

1. Security.  The less debt you have, the less at risk you are in an uncertain world.
2. Equity.   The more equity, the greater your net worth.  The greater your net worth, the more security you have.

Our approach to paying off our mortgage early is to automate biweekly payments through our mortgage company.  Because some months have 3 Fridays, each year we make an extra mortgage payment.  This costs us some money in fees, even though we could do it ourselves by just adding money to our mortgage payment every month.  Still, it's worth it, and here's why:

Over the life of the loan, fees associated with biweekly mortgage payments come to about $700.  $300 of that was a one-time setup fee, and the remainder is the debit fees.  This is a total moneymaking scheme by the mortgage companies, yes.  Still, after running the numbers, that $700 is going to save us $122k in interest payments, and shave 6 years and 9 months off our loan.  

I will contentedly spend $700.00 to save $122,000.00.  

"So why not just add money to your mortgage payment each month?"

I know me.  I know us.  Most months we would, sure.  But then there would be those 'tight months' where we decide it just doesn't work for us that month.  Or we'd really rather get a rug for the living room.  I can think of many reasons why we would choose not to add extra principal to our mortgage payment 'just this once'.  So I've taken the decision out of our hands.

"But what if you aren't in your house until it's paid off?"

We are still building equity.  Our net worth is increasing, and on some level paying off the house early is like forced savings.  And who knows what the future will bring?  This, at least, is as sure thing. 

Incidentally, David Bach advocates this approach in "The Automatic Millionaire"


EJW said...

Interesting that you invoke the Automatic Millionaire. I agree with some of your logic but not with all of it, and I can tell you that for us, automating our money has been a lifesaver.

We pay a little extra (between 100 and 150 bucks) a month on the mortgage, which will shave about 7 years and 60K off the total. It works out to just over an extra payment a year. But we don't pay any fees, as we just set up an automatic mortgage payment with a little extra principle. We really just rounded it to an even hundred dollar amount and adjust it every year when our property taxes change.

We don't pre-pay more than that because, at 5 3/8% minus the tax break, we can definitely beat that in the market. And we have automatic monthly investment in a bunch of mutual funds, so that's a no-brainer, too.

We never have an issue of "let's splurge and not do the investments or the extra mortgage payment" because we never touch it and we don't really think about it.

Lora Holmes said...

Amazing insight you got here. I think being debt free is what everybody’s striving for. Sadly, this is a bit more complicated than it looks. It’s because many of the factors that affect our mortgage payments can’t be controlled. You might have a high-paying job today and be laid off tomorrow. That’s why, it’s important to build a payment plan that is flexible enough for you to handle these unforeseen events. Thanks for sharing!