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Should we make extra payments on the mortgage?

by retirebyforty on February 24, 2012 · 80 comments

in real estate, saving

should we make extra mortgage payment?After the last round of refinancing, our primary residence mortgage rate is now at 4.25%. At this interest rate, I have to ask – Should we make extra payments? The original plan was to keep paying the same amount that we were paying before the refinance so the house will be paid off quicker, but perhaps this is not the best thing to do with our extra money.

Let’s make a quick pro and con comparison list to help us decide.

Extra Payment Pros:

Feels good. It feels good to pay down the mortgage every month. We don’t like owing money and it’s great to see the principle reduced visibly every month. It would be really great to own the home outright and not have to write a monthly check to the bank. This would free up our cash flow even more.

Less interest. Let’s look at an example. If you owe $200,000 @ 4.25% interest, then the monthly payment will be around $1,000. Paying an extra $200/month will save you about $50,000 in interest and the loan will be paid off almost 10 years earlier. This is very compelling to me. I don’t want to give the bank any more money than I have to.

PMI. If I had to pay private mortgage insurance, I would make extra payments until the PMI is eliminated. Fortunately, we are not paying PMI at this time.

Extra Payment Cons:

Saving and investment. The main argument against making extra payments on the mortgage is that you can invest that money better elsewhere. The 401(k), emergency fund, 529 saving plan for college, Roth IRA, and insurance are all better places to invest than the mortgage. We have a beefy $50,000 emergency fund and are already covered in these remaining items so we can eliminate this argument. Can I beat 4.25% by investing in the stock market or elsewhere? It’s possible, but not guaranteed. In the short term, you may not beat 4.25%, but I’m pretty sure in the long term, the stock market will do better than that.

Tax deduction. It’s great to have mortgage home interest to add to the tax deduction. Sure, the tax deduction alone is not a reason to buy a home, but we’ll take advantage of it while we can.

Home value. At this time, our home is worth about as much as what we owe the bank. If the home value keeps dropping, it does not make sense to pay down the mortgage. Why pay extra if the home will be underwater? Let’s say the home price continues to drop for 5 more years and we need to move. It doesn’t matter how much you prepaid if the home is underwater.  We will still have to do a short sale or a strategic default.

Inflation. Let’s continue with the $200,000 mortgage example. In 10 years, that $1,000 dollars payment will feel like $500. In 20 years, that $1,000 will be equivalent to $250 today. Isn’t it better to wait as long as you can to make these payments?

After listing all the pros and cons, it is still difficult to see what is the right thing to do. My plan is to keep paying the same amount that we were paying before the refinance while we can. These extra payments at the beginning of the loan make a big difference in the amount of interest paid. Once I leave my day job, then we probably will make fewer extra payments.

What about you? Did you refinance and will you make extra payments at this low rate? I’m sure we will see 5% CD again in the future. Wouldn’t the money be better off in an investment account?

refinanced with Quicken Loans and got 4.25% on a 30 years fixed rate mortgage. Rates are even lower today so you should check to what rate you can get. My LTV was around 100% and I didn’t have PMI. If your bank won’t work with you, check with Quicken Loans to see what they can do for you.

quicken loans refinance

photo credit: flickr – nikcname

{ 68 comments… read them below or add one }

Money Infant February 24, 2012 at 3:14 am

I think you already know the answer to this one. At such a low interest rate I’m sure that over time you can beat the 4.25% you are paying on the mortgage. You can probably even come close to beating it now with a carefully selected basket of dividend bearing stocks and municipal bonds (to lower the tax bite). If it was me I would go the investment route and just keep paying that mortgage month by month.

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retirebyforty February 24, 2012 at 2:03 pm

That’s what I’m leaning toward. In 10 years, who knows where the interest rates will be. I’m sure we’ll get 5% CD again at some point in the future.

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YourSAP February 24, 2012 at 5:14 am

We rounded our payments up instead of making separate extra payments. Whenever we refinanced, we kept the payment the same. Instead of extra payments on the mortgage, we bumped up our emergency fund until it was equal to the principle. Then we had a two payment mortgage burning party.

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retirebyforty February 24, 2012 at 2:04 pm

So you save up the e fund until it’s equal to the principle and then used it to pay off the mortgage?

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Another Reader February 24, 2012 at 5:21 am

As long as the payment is doable on the one income and you have a large stash of cash, you ought to look at another investment property. The market is turning in many if not most areas, and the current combination of very low interest rates and low prices won’t be around much longer.

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retirebyforty February 24, 2012 at 2:06 pm

That’s a great idea, but I’m already invested in 2 income properties. I want to diversify a bit.

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Another Reader February 25, 2012 at 7:46 am

Diversification is a good plan in the long run. In the short term, you have an opportunity to buy while prices and interest rates are very low. Kind of like stocking up on pantry staples when there is an outstanding sale…..

Stocks and bonds go on sale more often than real estate. Buy another property now and stock up on paper assets later.

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Michelle February 24, 2012 at 5:37 am

I’m not sure. I’ve been wondering this same exact thing. I can probably do other things with my money that will gain more.

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Matt February 24, 2012 at 5:54 am

This is a question that is both emotional and mathematical. I hate paying interest to anyone for anything and I love the security of having zero debt (pretty strong emotions there). I see perceived financial benefits of putting that extra money towards investments but my internal need for security outweighs it.

I’m 28 and have about 22 months left on my mortgage at the current rate we are paying it down.

We have a whiteboard with lists of things that we want to accomplish (more travel, starting our business, retire early) and the mortgage seems to be the biggest thing standing in our way so we supercharged our pre-payment plan several times. Literally several times. We started with rounding it up, then matching the payment (including taxes/interest), and now we putting my entire salary towards the mortgage and living off of my wife’s.

I feel that the money that would have been invested/saved over the course of this time can be backfilled in no time with no mortgage so we are full steam ahead on the pay off plan.

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retirebyforty February 24, 2012 at 2:08 pm

I love having zero debt too, but lately I’m coming around. If we are making money from the debt, then I’m ok with it. (rental properties.)
You are doing so great on your mortgage. I’m jealous. :)

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Taline February 25, 2012 at 9:42 am

I’m glad you’re coming around. So many people are afraid of having debt, but not all debt is bad….especially rental properties :)

It has helped me build my passive income stream to retire early.

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Hunter - Financially Consumed February 24, 2012 at 5:56 am

If it were my primary residence I would continue to pay extra towards the principal. This multiplies the advantage of refinancing in the first place.

We’re in the process of refinancing as we’re about to move out of our home and rent it out as an investment property. The lower payment will help to maximise our monthly profit. I don’t plan on making extra principal contributions. Instead I’ll be saving that money for maintenance, repairs, and profits.

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retirebyforty February 24, 2012 at 2:10 pm

What’s the difference if it’s rental or primary residence?
Why pay extra on the primary residence if you won’t pay extra on the rental property?
I’ve been paying extra on the primary residence too, but these questions are starting to bother me.
It’s no difference on your net worth. The answer is all physiological.

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Well Heeled Blog February 24, 2012 at 6:46 am

If you don’t have short-term needs for the cash, I’d pay down the home. That flexibility is pretty amazing. Are you planning on using the cash for another rental property?

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retirebyforty February 24, 2012 at 2:12 pm

No, I’m good with rental properties. :)
I’ll pay down while we have extra money and probably stop when we have only one paycheck.

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Aloysa February 24, 2012 at 3:57 pm

Since we are always strapped for cash, my answer is no. But as soon as we pay off debt, build savings, then my asnwer is yes. It all comes down to immediate needs and cash flow.

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MoneyCone February 24, 2012 at 6:57 am

Purely a mathematical question! Spend time to do the calculations and make a decision!

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retirebyforty February 24, 2012 at 2:12 pm

You are so cold and calculating. :)

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Peter May 8, 2012 at 5:15 am

Sure it’s purely mathematical, but it’s stochastic (fancy math word for uncertain) therefore not simple or obvious. It depends on your risk aversion. For example, you don’t know what the interest rate will be when you refinance. Assuming the “payback” on paying down your mortgage is only 4.25% is completely wrong if your interest rate becomes 10% when you refinance. Your mathematical analysis depends on an uncertain parameter (future interest rate) and the solution depends heavily on what you assume that will be.

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Squeezer February 24, 2012 at 7:24 am

I have been depating investing my money monthly or paying the house off. I would feel great to have the house paid off; however, I have a low interest rate of 3.75%. I can probably make more interest than that by investing it.

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retirebyforty February 24, 2012 at 2:13 pm

I think you can make more than 3.75% too, but it’s not guarantee.
I’m sure the rate will rise and we’ll see 5% CD in 5-10 years.

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Dollar D @ The Dollar Disciple February 24, 2012 at 7:48 am

Personally, I’d think you can do better by investing it but it comes down to psychology. Some people would rather have less debt than more investment income and I can respect that too!

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retirebyforty February 24, 2012 at 2:13 pm

I agree! It’s not all about the number crunching.

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My Own Advisor February 24, 2012 at 11:55 am

I absolutely think you should make extra payments on your mortgage. It’s a guaranteed rate of return if you do.

Should you put everything into your mortgage? No, since you could likely get a similar rate of return with dividend-paying stocks.

I think a blended approach is needed here.

BTW – why do you have a beefy emergency fund with so much debt?

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retirebyforty February 24, 2012 at 2:17 pm

Read my $50,000 post. :)
Would you put $50,000 toward your mortgage? I’d rather have the liquidity.
The debt is low interest so why not take advantage of it?

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Invest It Wisely February 24, 2012 at 12:14 pm

I’m currently paying 2.3%, and it doesn’t look like rates will be shooting up just yet. If I could lock for 15-30 years at a really cheap rate, might be doing that, but the deal right now is another 5 years for 3% – 3.5%. I’ll stay with the 2.3% until the term wraps up. Since it’s at this level, and since I did the jump, no plans to accelerate payments ATM. :)

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Epicfinances February 24, 2012 at 1:07 pm

I got offered a 2.7% 3/1 ARM by my loan officer while refinancing — I thought about it until I actually read the contract — 4% prepayment penalty!

My house is only $120k, but I am not paying a $4,800 penalty if I decide to refi into a fixed rate. That being said — I pay 4% (but I also itemize some), so maybe the 3/1 would have been smarter since I would have netted 1.3% a year. I just worried about if rates spiked and I went into refi at something like 5%+ — then I would get a double whammy of interest rate hike and penalty!

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retirebyforty February 24, 2012 at 2:21 pm

4% prepayment penalty is pretty steep.

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retirebyforty February 24, 2012 at 2:18 pm

2.3% is pretty good. I know what you mean about when you made the jump. I won’t be making extra payments anymore after I make the big move. I’d rather have extra liquidity at that point.

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krantcents February 24, 2012 at 12:43 pm

Last time I refinanced, I went with a 15 year mortgage. About 1-2 years ago, I started to pay additional principle payments to have it paid off by the time I retire. It is al about choices! If I could invest the $100/month and achieve a higher return I would.

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retirebyforty February 24, 2012 at 2:19 pm

I think soon to be retirees are in a different position. It’s probably best to pay off the mortgage so you have extra cash flow to spend on things you like to do. I’m sure you will have a lot of fun traveling.

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Epicfinances February 24, 2012 at 1:03 pm

I have written countless articles about this — Unless you get a VERY high psychological benefit from having a lower mortgage and potentially no mortgage — you are destroying a cheap vehicle of debt.

How cheap of a cheap debt vehicle? If you are itemizing, you are talking 3% or less! I think it is foolish to pay down your mortgage unless you are scared to the point of desperation when it comes to earning a decent ROR on your money.

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retirebyforty February 24, 2012 at 2:20 pm

Yeap. It’s the cheapest loan you can get. My first loan in 2000 was closer to 8%. At that rate, I would definitely pay it down.

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Don February 24, 2012 at 3:42 pm

Speaking as a guy that did pay off my mortgage early, I wouldn’t do so with such a low interest rate today!

Shoot, you can put that money in a some types of CDs and earn a higher interest rate than what the mortgage interest rate is… Money is money! So no, I personally wouldn’t pay off my house mortgage today (unless you are close to paying it off) :)

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SB @ One Cent At A Time February 24, 2012 at 3:53 pm

Come one Joe, be debt free. And divert non emergency and low return money to pay off mortgage faster. I believe in simplicity don’t want to check formulae, I know i I am earning 2% interest then I am better of diverting money to a loan which costs me more than 2% interest.

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BE @ BusyExecutiveMoneyBlog February 24, 2012 at 8:09 pm

Completely agree with the sentiment that in this historically low interest rate environment, I plan to hold onto my liquidity for greater opportunties vs. paying off my mortgage which is the only debt I have.

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retirebyforty February 26, 2012 at 1:24 pm

Yeap, rates can’t be low forever. I’m sure we can get better guarantee returns in a few years.

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Simple Rich Living February 24, 2012 at 11:40 pm

Are you planning on staying in this house forever? I don’t currently make extra payments on mortgage as I don’t plan to stay here forever. When I do move, I will either sell it or rent it out so it doesn’t make sense to pay it down. However, if I have live in the property where I plan to stay forever (retire in), then I would pay it down.

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retirebyforty February 26, 2012 at 1:24 pm

Mrs. RB40 plans to stay in this condo forever. :)
We’ll see what actually happens.

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Roshawn @ Watson Inc February 25, 2012 at 8:16 am

I think my position on this topic is obvious. It just depends on your risk tolerance and your overall strategy. I liked how you highlighted the emotional benefit. It’s good because people forget about the psychic boost :)

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retirebyforty February 26, 2012 at 1:25 pm

It would be great to be debt free, but I’m not hung up on that anymore. Some debt is fine as long as we can pay it off if needed. I mean, we can sell the place and pay off the mortgage if it comes down to that.

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MyMoneyDesign February 25, 2012 at 12:22 pm

I’m sure you already know this, but over time you should be able to pull off a better return rate than 4.25%. Even if you consider all the interest you’d save, etc, it is still a better deal to invest the money as long as you can beat the interest rate of the mortgage plus about 1%. I did a post on this with a few examples:

http://www.mymoneydesign.com/personal-finance-2/retirement/which-is-better-%e2%80%93-paying-off-your-mortgage-or-investing-the-money-%e2%80%93-part-1/

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retirebyforty February 26, 2012 at 1:26 pm

I agree that over time we’ll see better return. Once the interest rates go up, it should be easy to beat 4.25%.

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Young and Thrifty February 25, 2012 at 1:37 pm

Thats a good point you made there about the value of the home changing. You wouldn’t want to end up paying more than you have to and you can’t foresee the future so, I say make the regular payments.

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retirebyforty February 26, 2012 at 1:27 pm

Are you making any extra payments? :)
It feels good to see that debt go down.

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Jeff @ Sustainable Life Blog February 27, 2012 at 1:23 pm

Joe –
Knowing your (dream) employment situation, I would stockpile cash and not make extra payments on the mortgage, it could get your working for yourself (or retired) earlier. Even if you change your mind, you’ll still have a heap of cash to put towards the mortgage if/when you change your mind.

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retirebyforty February 27, 2012 at 4:28 pm

That’s good advice. Liquidity is king when there are changes on the horizon.

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frugalportland February 27, 2012 at 4:57 pm

I think I’d invest — but then again, I don’t have “good” debt — and so in my mind, I’m all about paying off my loans as fast as possible!

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retirebyforty February 27, 2012 at 9:12 pm

Some PF bloggers will say there are no “good debt.” Good luck with paying off your loans!

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Kurt February 28, 2012 at 1:49 pm

Can you “retire” before the mortgage is paid off? Are you aware of another investment with a guaranteed pre-tax annual return of 4.25% over the years between now and the time you pay off your mortgage? If the answers to both are “no,” I’d continue making extra mortgage payments.

On the latter question, I think it’s helpful to think of paying extra on a mortgage as an investment with a guaranteed, risk-free pre-tax annual return equal to your mortgage interest rate. If you see competing investment opportunities that you believe offer a superior risk/return profile, then it would make sense to channel at least some money to those instead of extra mortgage payments.

I’m financially conservative. In today’s environment, a guaranteed, risk-free 4.25% pre-tax annual return feels pretty appealing, especially if I judge that paying off my mortgage will have substantial intangible benefits like personal freedom, more free cash flow sooner, less vulnerability to an unexpected job loss, etc.

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retirebyforty February 29, 2012 at 9:04 am

I see your point about guarantee returns. I’m sure in the 30 years period, we’ll see interest rate rise. When that happens, CDs and bonds will pay a lot more than they are now. We should see 5% CDs sometime in the next 30 years right?

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Zack Jones March 6, 2012 at 5:14 am

Of course this could all change but right now my current plan is:

2012 – Pay off all consumer debt except mortgage ($225,000 at 4.5 % which does include PMI). We are ahead of schedule and will be out of debt in November instead of December. What a great Christmas present and no we will not be going in debt for Christmas presents :).
2013 – Fully fund emergency fund ($25,000)
2014 – Take $2,100 we were using for fund emergency fund and put on mortage until it’s paid off.
(some date in future) – Drive to Nashville, TN and scream “WE’RE DEBT FREE!!!!” on Dave Ramsey’s radio show.

I currently have 5% + 4% company match on 401(k) with current balance of $350,000 so it’s not like I don’t have a small retirement nest egg already. I am just super motivated to get the house paid off for some reason.

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retirebyforty March 6, 2012 at 3:22 pm

Good luck! Sounds like a great plan to take care of the consumer debt first.
Nice amount on the EF too.

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jim April 26, 2012 at 9:15 pm

I’m in my mid-50’s. Our daughter is “bought and paid for” – college – done, wedding – done, help with down payment on their house – done. Our son will graduate from college in a couple of weeks, debt free ’cause we paid for that. We’ve got $150,000 left on our mortgage ($400,000 house). We have just over $500,000 in retirement funds. The interest on the mortgage is at 3.37%. Do we throw all our “extra” $ into the mortgage or put 1/2 the “extra” into a savings account and the other 1/2 on the mortgage – then when the mortgage is down to $75,000 and our “mortgage only” savings account is at $75,000 make one last lump sum payment and be done with it? I’m a little afraid that if we had a lot of $ in a savings account we could easily spend that on travel, etc.

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retirebyforty April 27, 2012 at 10:14 pm

If I’m in your situation, I would invest the extra $ in the stock market. You still have 10 years left until retirement age and you probably need a bit more for your retirement. 3.37% is a great rate, why pay it off early? That’s just me though and I have a pretty high risk tolerance. Good luck!

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jim April 28, 2012 at 10:25 am

Thanks for your input. I’m still a bit gun shy of the stock market – lost over 1/2 of what we’d saved a few years back. Hmm….

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TB at BlueCollarWorkman May 15, 2012 at 12:37 pm

Honestly dude, if you’re all invested in Roth IRA and 401Ks, etc and have a humongous emergency fund, then I think there’s no reason not to pay that mortgage down early!

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jim May 15, 2012 at 3:44 pm

TB,
Thanks for the input. I’m inclined to get that mortgage paid off, but I’m wondering why not just pay “extra” on the mortgage while, at the same time, putting $ into a “mortgage only” savings account – that we could use if there is some unexpected ER. Our current ER fund is not “humongous”. And with our son looking at law school, I’m wondering how much we will be able to help him financially. The cost of law school is unbelievably expensive. Ugh – I don’t want him going into debt for school if it is at all possible to avoid it.

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Christine August 23, 2012 at 11:58 am

I am embarassed to say that I am NEW to this. We have no prepayment penalties on our mortgage. Is it better to make extra payments periodically where some of the extra amount is being applied to interest and some is being applied to principal, or should that extra amount be applied directly to the principal? Will it make a difference in the end?

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jim August 23, 2012 at 4:25 pm

Christine,
One – don’t be embarassed – everyone gets on board on their own time schedule. Two (and this should be ONE) put it ALL towards PRINCIPLE – and designate it as such!!!!! That one is a no brainer. Gotta run – steaks are on the grill. Best of luck to you and yours.

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retirebyforty August 23, 2012 at 10:32 pm

Don’t feel embarrass. We all started somewhere. Usually the extra amount will be apply toward the principle, but you should make sure by talking to your bank.

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Elli September 13, 2012 at 6:17 am

Question: I want to know how long it will take my mom to pay off her mortgage. The loan balance is about $181,000 with a 5.75% interest rate, so much goes primarily to the interest that only about $400 goes to the actual principal. Also she has been making an additional $200 each month towards principal. I for one do not want to see my mom in debt with this house forever as she will become of age to retire in the next 9 year’s.

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retirebyforty September 13, 2012 at 8:59 am

You can input the mortgage info in an online calculator and see when it will be paid off.
Try this one – http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx
It sounds like your mom’s mortgage is still early in the cycle so it will probably take a long while to pay off.

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Elli September 13, 2012 at 9:10 am

Thanks for the link. Yeah we have only lived in this house for about 12 years.

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Sue October 25, 2012 at 7:40 am

What about paying off rental properties early? Would anyone do that to access income from the rent?

I *could* invest that extra cash from a soon to be refinance in something that might yield more than 4%. Then I’d have more liquid assets than I currently do. But if I don’t pay off the rental properties, then I feel as if I am defeating the whole purpose of owning rental properties, which is to be able to live off the rent as retirement income.

Any suggestions?

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retirebyforty October 25, 2012 at 9:02 am

This is just my opinion. If I have positive cash flow, I wouldn’t pay off the rental property early. The rate is very low now and I don’t need that full income for another 15 years or so when the kid goes off to college. Right now, the small positive cash flow is good enough for us.
I think most real estate investor don’t like to pay off a rental property because they can leverage their liquidity into another property.
If you are in retirement or if you need that income soon, it might be better to pay it off so you don’t have to worry about it.

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Cat April 4, 2013 at 9:18 am

This is really a quagmire for me, and I struggle with the direction to go on this decision. I owe $61K on my home, and need to work for 9 more years. Currently, I put aside $400/Mo. in pre-tax 457 investment, and I make $400/Mo. additional principal payments. The advice I am seeking is which ratio should I use regarding the monthly disposal $800/Mo. income that I now put into both, additional principal payments and tax-free investment from my employer? Thanks a million!

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retirebyforty April 4, 2013 at 10:15 pm

It’s hard to say because I don’t know much about your situation. What you’re doing right now sounds ok.
Do you get a match for your 457 account? What’s your age? What’s the mortgage rate?

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