This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Thursday, August 14, 2008

Shrinking the mortgage

Posted by Matt

When my wife and I first bought our house, I posted some thoughts about whether we should make any additional payments to the mortgage principal. We deferred, electing instead to focus our savings efforts on retirement and our son's education savings account.

Those efforts have been going along just fine; we've been making regular, automatic contributions to the 529 and I'm maximally funding my 401k, but still we had a little extra and felt like our emergency savings accounts were adequate for now.

So, that brought us back to the question: "Should we use the extra cash to reduce our mortgage?"

The arguments against:

  1. The additional capital that we convert to home equity becomes inaccessible (well, OK, less accessible anyway; we could take out a HELOC, but that brings us right back to paying interest again.)

  2. The extra money could effectively earn a greater return invested elsewhere.

These are both valid arguments that Paul and I have explored the pros and cons of previously. Now that we have "adequate" (debatable; the term is relative and you could make the case that more is ALWAYS better) cash on hand for emergencies, I wasn't too worried about the first argument, but I had a hard time getting past the second. What finally sold me is that the payoff scenarios I sketched out revealed that we could pay off the mortgage in a much shorter period than I had originally guessed.

I still have some confidence that the stock market will outperform my other investments over the long term, but over the short term, I'm much less optimistic. In the short term, I decided to go for the guaranteed return of reducing our total interest expense on the mortgage. So toward that end, we transferred our first extra principal payment (a very easy online option since our mortgage and checking accounts are held by the same bank) this month. Because we just bought this house last year, we're still in that frustrating stage of mortgage repayment where most of the payment gets applied toward interest (read this if you're not familiar with how amortization works). Now I'll be watching much more intently for our principal balance to drop off more and more steeply.

Another part of the plan that I like is that we've got an easy out. I didn't automate the extra payments (which is unusual for me), but this allows us to be flexible in how much extra we pay. I'll target a set amount each month, but there will certainly be months where we need to adjust it up or down, e.g. during the holidays or months when we have travel expenses.

In case that isn't enough for you, here's another bonus I thought of: we'll be able to reduce our life insurance coverage eventually. When I was evaluating life insurance, I decided to pay for adequate coverage to pay off our mortgage if I die. As our principal drops, I can periodically reduce my insurance payments until I get to the point where the basic coverage that my employer provides will cover the remainder. Okay, this one is less significant than the other benefits, providing maybe 4-digit savings as opposed to 6-digit savings achieved through reduction of interest payments, but every little bit helps!

Let me end by acknowledging that this strategy isn't going to apply for everyone. My wife and I are grateful that we are fortunate enough to be in a position to even have to consider where to put our "extra" money each month. But I hope that everyone who reads this, whether they have a little extra money each month or a lot, will at least appreciate the benefits of prioritizing spending. As I mentioned above, this strategy only achieved priority after we'd eliminated car and student loan debt, carefully filled up our emergency funds and ensured that we are saving adequately for retirement and our son's education.


Paul said...

With our first baby coming I can't seem to stop adding every spare dollar to are gradually growing "emergency fund".

I think once the shock of parenthood has worn off a bit that I might try to make paying off the mortgage a higher priority as well.

Anonymous said...

Nice summary of priorities! It's helpful to stand back and take in the big picture periodically.