Saving a very large amount of interest paid makes sense, but the numbers don’t support this being the best use of extra money.
If you have high interest credit cards, these are probably well above the 4 to 5% you are paying on your mortgage and have the benefit of having a reduced payment as the balance drops. Most planners or investors would tell you to focus on these getting paid down or off first.
If you do not have high interest debt, the primary alternative to paying your mortgage loan off early is to invest the extra money.
Numbers:
We will ignore numbers like homeowners insurance, property taxes, etc for these examples.
Mortgage:
I buy a home at $275,000 and get a 30 year mortgage loan for $260,000 at 4.5%.
Principle and Interest Payment: $1317.38
Interest over the 30 years: $214,257.45
Pay an extra $200 per month will change my mortgage to:
P&I + Additional: $1517.38
Interest Paid: $165,308.77
Time Saved by paying off early: 6 years and 4 months
Interest Saved during that time: $48,948.68
Investment:
Current Investment Balance: $0
Monthly Contribution: $200
Years to Save: 23 (using about the same time as if you paid your mortgage off early)
Rate of return: 7% (below market average)
Contributions: $55,200
Growth: $82,023
Investment Balance: $137,223
Difference:
Mortgage interest saved: $48,948.68
Investment Interest: $82,023
Difference of: $33,074.32 in favor of investing.
There are still Pros and Cons that go beyond the numbers. Here are some examples and we will let you decide whether it is a Pro or Con and for which decision.
- Peace of mind of no longer having a mortgage payment and the
- Flexibility that gives a budget and also that
- Investing is not a guaranteed return and can lose money as well.
- Don’t forget mortgage interest is tax deductible.
- The extra money can’t be spent on other items.
This article is for consideration of your options, but like all financial decisions, we recommend you talk to your retirement planner for your specific needs and goals.