$Retirement Nerd

Our House and Mortgage Debt

Our House and Mortgage Debt

We bought our house in March of 2002, just after we got married. We have generally followed tradition, so we went with a 30 year fixed mortgage. At that time, people said that if you get a 30 year mortgage rate under 7%, that’s great! Another piece of advice we followed was to put down 20% to avoid the extra cost of Private Mortgage Insurance (PMI). If felt like that would be throwing money away, so we were fortunate to use our savings from living at home for a year in addition to wedding gifts to reach the 20% threshold.

One of the lessons from my mother during my teenage years was the benefit of paying down a mortgage sooner to save money on the interest. Later, I would play around on mortgage calculators to review the amortization schedule and show the crazy amount of interest we pay on a typical 30 year mortgage, and the amount we can save by paying it down faster.

For example, if we bought a $300K house, putting down 20% ($60K) would leave a mortgage of $240K. Our mortgage rate was for 30 years fixed @ 6.875%.

The total amount of INTEREST on this loan according to the amortization schedule? $328,108.79!!

Yes, this means that we were going to pay more in interest than the original cost of the house! Yikes! The grand total would be $568,108.79.

One idea on paying down the mortgage faster was to make one extra payment a year. My wife and I both get paid every 2 weeks, so we actually receive 26 paychecks per year. If we break the year up based on a cycle of 2 paychecks rather than months, we could make one extra payment a year (26/2 = 13).

What is the impact of making one extra payment/year?

It would reduce the total interest paid to $235,350.14!!

Yes, you could almost save $100K over the life of the loan, by just making 13 payments/year. Additionally, this would payoff the loan sooner, by 7 years and 3 months!! The grand total would be $475,346.04, savings of $92,762.75.

Let that sink in for a bit. Seems like a no-brainer, right? Like the power of time and compound interest on your nest egg, it seems like everyone should try to do this. Of course, like saving for retirement, it is easier said than done for many people. We need to consider pre-paying the mortgage as part of the overall plan, and other actions are probably a higher priority, like building an emergency fund or maximizing 401k contributions (to get the company match or full contribution for the year).

Another thing my mother taught me was that paying down your mortgage is a forced saving plan. Whenever you pay down the principal on your mortgage (or other debts), it is increasing your net worth because it reduces the liabilities side of the equation. Investing can be complex and a little scary with some element of risk. Paying down your mortgage and other debts can be a direct way to improve your bottom line and help eliminate a recurring debt sooner, to make our monthly budget more manageable and help us achieve financial independence sooner. However, we need to weigh the cost of allocating resources to pay down the debts vs investing it. Of course there are online calculators like this one at millionin10.com to help us run the numbers, but we need to make the decisions based on our own situation. We can also use a hybrid approach, which is the path we took.

Growing up, I was told that mortgage debt was “good” debt because you need a primary residence anyway and the interest was also tax deductible, along with the real estate taxes. It seemed true, and this was a major deduction for us in the early years of our mortgage and we would get a decent tax refund checks of a couple thousand dollars.

Several things have changed since then. For the past couple of years, we have taken the standard deduction with the new tax code, so we’re not getting tax deductions from our primary mortgage or real estate taxes anymore. I also realized that getting a tax refund is just returning my own money to me. I could have kept the money and invested it to make more, although there can be merit to getting a refund if you would have spent the money on something else…

We’ve been owing taxes the last few years, which isn’t great either, but I’m not sure how “good” mortgage debt was anyway. Generally, your mortgage debt will be at a lower interest rate than credit card debt or student loans, so it may make sense to prioritize those. If you’re seeking FIRE, it’s better to have as little debt as possible so your nest egg and passive income can cover your expenses, and maybe allow for more discretionary spending (fun money!).

Over the past decade +, there has been a huge change in interest rates, which have plummeted since the Great Recession, so it changes the calculus somewhat.

Current rates are very low and as reported in this article in the nytimes.com, the Fed is committing to keep them unchanged through 2023 to help the economy recover from impacts of the global COVID-19 pandemic. Look at the chart of 30 year fixed mortgage rates from macrotrends.net. Note, low interest rates also means low yields from treasuries and other fixed income, so we may need to make adjustments to our investment strategies.

Source: macrotrends.net

If we rerun our tests above with the rate at 3.0% in our mortgage example ($240K @ 3.0% for 30 years), the total interest paid is “only” $124,265.89. If we make an extra payment annually (13/year), the interest goes down to $107,425.39, so a savings of about $17K, which is ok, definitely not as drastic as when the rate was 6.875%.

We have adjusted tactics and our last refinance was in 2013 @ 3.25% for 15 years. A shorter term obviously pays off the loan sooner, with a higher payment, but it also saves significant interest. We pay a little extra principal per payment, by rounding up a few hundred dollars to the next thousand, but we’re not sending the equivalent of one extra payment a year. Still we will save a lot on interest over the life of the loan compared to an equivalent 30 year term.

To illustrate, if we change our example loan to a 15 year term ($240K @ 2.5% for 15 years), the total interest paid goes down to $48,052.94. Wow, that’s better! Note in this example we changed the interest rate for 15 years to 2.5%.

The tables summarize the results for our examples:

Test Case 1

This is similar to our first mortgage we got in 2002.

  • Original Principal: $240K
  • Origination Date: 3/4/2021
  • Term: 30 Years
  • Rate: 6.875%
  • Test Case: Make one extra payment annually in March
MetricBaselineTest CaseComments
* Est. Monthy Pmt$2,089$2,089Make 13 payments/year
Payoff Date3/4/20511/4/20447 years and 3 months sooner!
Total Interest$328,108.79$235,350.14Savings of $92,758.65!
* from bankrate.com mortgage calculator (includes estimate for Homeowners and property tax)

Test Case 2

This is a repeat of test case 1, but at a rate of 3.0%, which is close to the current rates for a 30 year fixed mortgage in March 2021. There are savings in both time and money, but not as much as when rates are higher.

  • Original Principal: $240K
  • Origination Date: 3/4/2021
  • Term: 30 Years
  • Rate: 3.0%
  • Test Case: Make one extra payment annually in March
MetricBaselineTest CaseComments
* Est. Monthy Pmt$1,011.85$1,011.85Make 13 payments/year
Payoff Date3/4/20518/4/20473 years and 7 months sooner!
Total Interest$124,265.89$107,425.39Savings of $16,840.50!
* from bankrate.com mortgage calculator (includes estimate for Homeowners and property tax)

Test Case 3

For the last test, we change to a 15 year term, which has a more pronounced savings effect in this low rate environment. This is our current approach and we have about 7 years left, but hopefully we can eliminate this debt sooner as part of our overall plan. We send a couple hundred extra per payment, but it does not have a significant impact on the interest savings.

  • Original Principal: $240K
  • Origination Date: 3/4/2051
  • Term: 30 Years
  • Rate: 3.0%
  • Test Case: Compare to a 15 year term at 2.5% ($240K @ 2.5% for 15 years)
MetricBaselineTest CaseComments
* Est. Monthy Pmt$1,011.85$1,600.2915 year term, so higher pmt
Payoff Date3/4/20513/4/203615 years sooner (duh)!
Total Interest$124,265.89$48,052.94Savings of $76,212.95
* from bankrate.com mortgage calculator (includes estimate for Homeowners and property tax)

So, priorities, guidelines, and approach can change based on how the economy evolves (this is a recurring theme!). Making extra payments to principal, such as by paying more each month or making 13 payments/year, will reduce the total interest and shorten the duration of the loan. Particularly with the current low rate environment, we can probably save more by going to a shorter term, rather than trying to pay a longer term mortgage off sooner. You can run scenarios in Excel or more easily in an online mortgage calculator (such as the one at bankrate.com) and review the amortization schedule to validate. These online tools are helpful to nerds like us πŸ€“, we can look at other tools to help create a budget, calculate net worth, and predict readiness for retirement in other articles.

Saving money is important, but paying off the mortgage sooner will also be a benefit if you’re trying to achieve Financial Independence, because you can eliminate a big-ticket monthly expense. Part of the timing for our (early) retirement will be based on when we can pay off our mortgage and hopefully get one of our two kids through college so we don’t have the dreaded tuition bill too. Finally, we need to weigh the opportunity cost of paying down the mortgage versus using these funds to invest in our nest egg. We may be able to come out ahead if we just invest the money instead, but you have to consider the risk and diversification factors to see what makes the most sense.

Subscribe to get email updates when we post new content and please discuss further in the comments below or let me know if you have any questions or other feedback.

~$Retirement NerdπŸ€“

Disclaimer: I am not a financial planner and content on this site is meant to provide food for thought, not professional advice. I share my experiences to show what worked so far and what didn’t, YMMV. Please consult your financial advisor or tax professional as needed.

By $Retirement Nerd

$Retirement Nerd is in his late 40s and looking to retire in the next few years.

2 comments

  1. Excellent article. I am older than you….and did as you talk about in your article above. It was soooo cool to get the house paid off much faster, with much less interest paid. It really works! Good job! and Good Article!

  2. Thank you so much for commenting! Yes, seeing the theory pay off is rewarding and reaffirms our commitment to saving diligently and reducing our debt. I’m glad I listened to my mother’s advice and stuck with it over the years, hoping others will see results like yours and mine to be inspired too. Seeing articles with the “average retirement” balance by age is pretty scary and disappointing.

Leave a Reply

Your email address will not be published. Required fields are marked *

error

Enjoy the $Retirement Nerd Blog? Connect or Share