Prepaying Your Mortgage
The Best Guaranteed-Return Investment There Is!
Did you know that when you buy a home with a 30-year mortgage, you will pay for that loan almost three times? It’s true. Just multiply whatever your monthly payment is by 360 (months) and you’ll discover that the total amount you’re paying the bank is nearly three times the amount you borrowed from them. Unbelievable, isn’t it?
And what’s so amazing is that everyone acts as if this is the way it should be. Your parents undoubtedly did it this way, and your friends and relatives likely do too. Even the banker (or mortgage broker) and real estate agent act as though borrowing this money and paying back nearly three times the amount is completely normal!
Inside the Numbers
If you buy a $300,000 home, with a $250,000, 7 percent mortgage, you’ll end up paying $598,769 in total payments over the life of the loan (not even including taxes and PMI). That’s nearly $600,000 to pay back a $250,000 loan! And almost $350,000 of that is interest!
It’s likely that nobody has ever told you that if you would just cut back on a few things and pay the mortgage company an extra $350/month that you would pay your mortgage off in 19 years instead of 30. It’s true.
This technique is referred to as accelerating payments or prepaying your mortgage. And the amount of money you can save from this strategy is incredible.
Objections You Will Likely Hear
Most people don’t understand the power of prepaying their mortgage—and if you tell those close to you about it, you’ll find that many will argue with you out of ignorance. Almost inevitably, it’s the same two objections. Let’s address them, shall we?
1. “If you pay off your mortgage sooner, you will loose your tax deduction.”
Technically this is true, but it’s a ridiculous statement. Let’s assume you’re in the 28 percent tax bracket. Each dollar of interest you pay the mortgage company is deductible. This will save you 28 cents you would have otherwise paid to the IRS on that dollar as income tax. But think about that. You’re giving up a dollar to save just 28 cents of federal income tax. On the other hand… if you pay off your mortgage, you will certainly have to pay 28 cents on each dollar not going to mortgage interest… but you’re getting to keep the other 72 cents!
So while this objection is technically correct, they are, in essence, saying, “Keep on paying a dollar of interest to the bank in order to save 28 cents in taxes.” Does that sound like good advice to you?
Oh, and don’t forget: You still get the full mortgage interest tax deduction while you’re paying off your loan… it only ends when your mortgage is paid off.
2. “If you invest that money instead, you’ll be able to come out ahead.”
Inevitably, someone will ask you why you don’t just make the minimum payments on your mortgage and invest that extra money instead. After all, if you’ve got a 6.25 percent mortgage, and can earn 8 percent in the stock market, isn’t this a wise trade-off?
No! On a typical monthly mortgage payment, 95 percent or more of the payment is interest each month. While the mortgage company made you feel as if you were getting a 6 or 7 percent mortgage, you’re actually paying 92 to 98 percent of your money toward interest each month. (It would only be 6 or 7 percent if you paid the entire balance off the first year.) Look at any amortization schedule. You’ll see that the loan is front-loaded with interest so that the bank can turn a profit quickly.
The other reason paying off your mortgage is a good idea is that paying off debt gives you a guaranteed return on investment equal to the debt’s interest rate, so you must only compare paying off your mortgage loan with investments that would also guarantee their return.
Stocks, bonds, mutual funds, real estate, precious metals, and almost all types of securities DO NOT guarantee rates of return. So let’s look at what type of investments DO guarantee their returns. The safest investments that guarantee their returns are U.S. Treasury bonds, and the bond market will always pay less than current mortgage interest rates cost.
Second, whatever you invest in, you will have to pay capital gains tax on. So depending on mortgage interest rates, you better earn at least 12 to 13 percent to even think about this strategy.
The fact is that prepaying any mortgages on your personal residence—along with your investment properties—will always give you a higher return than any comparable, guaranteed-return investment!
