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Effect of early mortgage payments
Old 06-13-2013, 02:36 PM   #1
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Effect of early mortgage payments

Another payoff the mortgage debacle thread, but this time to model it to death, to be informed on a higher level.

The reason I'm beating the dead horse, is that I'm really having second thoughts/buyer's remorse about getting a larger mortgage compared to our first one. Tough to sleep at night being cash poor and house rich, and not knowing the effect of extra payments (and to get the wife off my back - not providing justification to her for sending extra to the mortgage). Glad to be rid of the old money pit.

I was wondering what savings any early payments have; whether I should pile money in now, or what effect waiting until kids are out of daycare in a year, or after a vehicle is paid off, etc. I couldn't figure out the equation after forgetting too much algebra and tinkering with a spreadsheet for awhile, so I Googled... turns out it's pretty straight forward (to me).

[(1 + R/12)^M]-1 where R is your mortgage interest rate, and M is the number of months left in your mortgage.

So, let's say, at the beginning of year 5 (or after 48 payments), you have 26 * 12, or 312 monthly loan payments left. If the interest rate is 4 percent. Calculate (1 + 0.04/12)^312 which is just over 2.82. Every extra dollar you pay now will save you $1.82 (2.82 – 1) over the lifetime of the mortgage.

Plugging in personal numbers, my factor is almost 2 and goes to under 1.5 after 5 years. Initial interest rate has a big effect on the slope of your curve! All fairly obvious perhaps, but, I wanted to actually calculate the effect. So, I'll plow it in now, and after a few years let inflation take its toll.

I thought this might be of use to others assuming you've already forecast inflation rates, mortgage rates, stock market returns and absorbed other run of the mill general personal finance and economic knowledge. Ahhh, boredom.

-CC
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Old 06-13-2013, 02:50 PM   #2
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I understand the cash flow crunch when you have kids in daycare. We put in smaller "extra" payments till the kids were both in elementary school. (After school programs are dirt cheap compared to preschool/daycare in our area.)

Once we had more wiggle room, we amped up the extra payments a bit. Then we were getting some payments from a judgement - and put those towards the extra principal... and kept it up when the deadbeat loser other party stopped paying.

Early extra payments save you more interest, but the late extra payments make HUGE differences on the amount still owed (because it's mostly principal.).
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Old 06-13-2013, 02:54 PM   #3
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Maybe I'm not understanding, but if you are 'cash poor and house rich', then plugging more money into the mortgage and locking it up there intensifies that situation.

If that's the case, I'm not sure how to weigh that against other concerns and $.

-ERD50
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Old 06-13-2013, 03:03 PM   #4
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It is probably more complex because of the tax effects, and that depends on your tax rate, and whether you have reached the standard deduction with other items, etc.

Back in the day I started doing lots of calculations and eventually gave up. I was just happy to put some extra cash I had in a "safe" investment, of sorts. (At least in my mind.)

In the end, the biggest benefit we obtained was psychological. Paying that sucker off changed our perspective on everything. After that, we really started saving.

I know this has been discussed to death. But I just wanted to say you may want to factor in some tax effects into your math...
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Old 06-13-2013, 03:23 PM   #5
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Originally Posted by ERD50 View Post
Maybe I'm not understanding, but if you are 'cash poor and house rich', then plugging more money into the mortgage and locking it up there intensifies that situation.

If that's the case, I'm not sure how to weigh that against other concerns and $.

-ERD50
Yeah, not really, in the grand scheme of things. House payment is now 17% of net/take home pay (including escrow). But, compared to the old 10%, it just seems dauntingly more since it's nearly double.

Just navel gazing, I guess.

-CC
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Old 06-13-2013, 03:35 PM   #6
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Quote:
Originally Posted by CCdaCE View Post
Another payoff the mortgage debacle thread, but this time to model it to death, to be informed on a higher level.

The reason I'm beating the dead horse, is that I'm really having second thoughts/buyer's remorse about getting a larger mortgage compared to our first one. Tough to sleep at night being cash poor and house rich, and not knowing the effect of extra payments (and to get the wife off my back - not providing justification to her for sending extra to the mortgage). Glad to be rid of the old money pit.

I was wondering what savings any early payments have; whether I should pile money in now, or what effect waiting until kids are out of daycare in a year, or after a vehicle is paid off, etc. I couldn't figure out the equation after forgetting too much algebra and tinkering with a spreadsheet for awhile, so I Googled... turns out it's pretty straight forward (to me).

[(1 + R/12)^M]-1 where R is your mortgage interest rate, and M is the number of months left in your mortgage.

So, let's say, at the beginning of year 5 (or after 48 payments), you have 26 * 12, or 312 monthly loan payments left. If the interest rate is 4 percent. Calculate (1 + 0.04/12)^312 which is just over 2.82. Every extra dollar you pay now will save you $1.82 (2.82 1) over the lifetime of the mortgage.

Plugging in personal numbers, my factor is almost 2 and goes to under 1.5 after 5 years. Initial interest rate has a big effect on the slope of your curve! All fairly obvious perhaps, but, I wanted to actually calculate the effect. So, I'll plow it in now, and after a few years let inflation take its toll.

I thought this might be of use to others assuming you've already forecast inflation rates, mortgage rates, stock market returns and absorbed other run of the mill general personal finance and economic knowledge. Ahhh, boredom.

-CC
You really need to also consider the impact of investment earnings on the dollars you'd invest by not paying the mortgage ahead. With today's low mortgage rates, it could turn out that investments a few years from now will be returning far more than 3% - 4% mortgage rates. But, of course, we don't know that.
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Old 06-19-2013, 11:22 AM   #7
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Originally Posted by youbet View Post
You really need to also consider the impact of investment earnings on the dollars you'd invest by not paying the mortgage ahead. With today's low mortgage rates, it could turn out that investments a few years from now will be returning far more than 3% - 4% mortgage rates. But, of course, we don't know that.
This. Especially if it's a first home or not the home you see yourself staying in forever. There's much more value in paying down a mortgage if your retirement horizon is closer than if it's further away, IMO. A locked in 4% return when you're retired is more valuable than a locked in 4% return when you're 30, at least in my opinion.

Despite the temptation, I don't make early mortgage payments on my current house for a couple of reasons:

1) I am able to save aggressively even while making my payments.
2) Over the course of the next 15 years (my desired retirement timeline), I believe I can do better than locking in the 4% ROI implicit in making early payments.
3) The tax deduction for interest paid over that period is not to be discounted, and indirectly reduces that locked in ROI.
4) This is not the house I am going to retire in.
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