Question: I was interested in a column you did recently on accelerating mortgage payments on your home and saving a bundle in interest. Like the person who wrote you, I've been getting all sorts of static from my friends about how dumb it is (because I could be investing those over-payments), but I'm not convinced either.
I figure this would be a good resolution to make starting in '86, but I'd like a little reinforcement and also need some advice on a practical way of going about this acceleration so that there's some system to it. I don't want to just guess about how much I should be paying extra every month. On one point, at least, I guess my friends are right: You sharply reduce how much you can deduct for taxes by doing this, don't you?--T.R.
Answer: Sure you do, but it's a matter of priorities. Even if by accelerating your mortgage payments you cut your payoff time down from 30 to 15 years, you're still going to have an appreciable deductibility for most of those 15 years.
The old "why prepay when you can invest this difference instead" argument can't be entirely discounted, of course, even though it doesn't nearly make the sense that it did a few short years ago when, instead of accelerating the payment on an 11% mortgage, you could invest those funds in a money-market fund yielding 14%. Today, of course, the yield on a money-market fund (7%-8%) is comparable to the return you can get on a conventional bank time deposit, and fixed-rate mortgages remain stubbornly high in the 12%-13% range.
But to give the devil his due, let's take an example of what your friends are talking about: You've just taken on a $100,000, 30-year mortgage (fixed rate) at 13%. This makes your payments roughly $1,107 a month. At the end of 30 years, then, you will have paid your lender $398,520, of which a full $298,520 is interest only.
Other Side of the Coin
Accelerating your payments to pay off the same indebtedness, $100,000, in 15 years instead of 30, would mean increasing the monthly payments 14% (or $159) to $1,266. At the end of 15 years you will have paid your lender $227,880, $127,880 of it in interest only, for a net savings in interest of $170,640.
But here's the other side of that coin: Instead of accelerating your monthly payments, you stick with your 30-year amortization schedule, pay $1,107 a month and invest that extra $159 in something productive. For instance: a tax-exempt municipal bond fund yielding 8%. At the end of 15 years--I suspect that your friends are telling you--you could then cash in this fund and pay off the remaining balance.
But it doesn't quite work that way.
At the end of 15 years, your $159-a-month investment (compounded quarterly) would have grown to $55,126, a nice nest egg, but still not enough to pay off the mortgage. Meanwhile, during those 15 years, you've already paid your lender $199,260, or, at the halfway point, almost twice the amount you originally borrowed.
Admittedly, during those 15 years, you will have been able to deduct considerably more from your taxes for interest expense than you did by accelerating your monthly payments, which will distort the net cost.
The other side of this coin, however, is the proposed changes in the Tax Code now being pondered by Congress, and if the anticipated lower rates for individuals come into play, you'll have still another distortion built in--one that will reduce the desirability of those interest-rate deductions in which your friends put such faith.
But all of this is pretty academic as soon as someone like you begins thinking in terms of how unproductive it is--as long as he can afford it--to pay a lender over 30 years a fat $298,520 for the privilege of using his $100,000 during that time.
Now for the other aspect of your question: How do you go about it?
There are two popular approaches, but the easier, by far, is simply to go to your local stationery shop and buy a paperback mortgage-payment guide, which gives a tabular rundown of the monthly payments (principal and interest) required to amortize various mortgages (by dollar amount) at different interest rates, year by year, from one year to 35 or 40 years.
Let's say that you're winding up your third year paying on a 30-year, 13% mortgage for $100,000. What you'll want to do, first, is to go back to the last year-end statement from your lender detailing how much in principal and interest you paid during the previous year and what the outstanding balance was at the beginning of the current year.
Don't be surprised to discover that after three years of paying your lender $1,107 a month--$13,284 a year--you still owe slightly more than $99,000 of the original $100,000 (you'll be about 25 or 26 years along on the standard 30-year mortgage before your monthly payments begin going 50 50 toward principal and interest.)