like owning your own home free and clear. That's a goal near to the heart of almost
everyone who has ever held a mortgage. Oh, the things you could do without a mortgage
Paying off a mortgage is a noble goal, and one
that can serve you well in retirement. But hang on, there's no rush. Despite the
claims that you can save a fortune in interest by paying off a mortgage early,
spreading the payments out over 30 years can be much smarter than putting your
extra dollars into additional mortgage payments.
While it is very true that a shorter mortgage incurs
far less interest than a longer one, simply paying off your existing mortgage
faster might not save you as much as you think. The key factor is that you pay
most of the interest in the early years. It takes eight years to pay down the
first 10% of the principal when you amortize a loan over 30 years. The rest of
what you've shelled out is interest. By the time you are halfway through a 30-year
mortgage, you've paid 67% of the interest. By year 20, two-thirds of the way through
the mortgage, you've paid 84% of the interest.
make accelerated payments halfway through a 30-year mortgage will save you very
little in interest. It would be better to put those extra payments into a money
market account until they are actually due. Let the bank pay you interest instead.
problem is the way some lenders handle additional payments. Not all lenders automatically
recompute the interest you owe if you reduce your principal faster than they expect.
Instead, they follow their amortization table, which divides each payment into
a set amount of interest and principal. So even though your balance is lower,
the interest you are paying doesn't change. With this type of mortgage, an early
payoff amounts to a long-term, interest-free loan to your mortgage company. Yikes!
paradox is that even if you work it right and do save tens of thousands of dollars
in interest, that decision could cost you far more in terms of lost opportunity.
The real question is: What is the best use of your money?
Imagine if you will, an anti-mortgage account. Instead of
sending a bunch of extra bucks to your mortgage lender every month, you send them
to a broad-market index fund.
Let's look at what might happen
with a $100,000 mortgage at 7%. You could pay it off in 30 years at $665 a month,
or in 15 years at $899 per month -- and you'd save about $78,000 in interest with
the 15-year option. But suppose you went for the 30-year option, sending $665
to the mortgage company and sending $234 to an index fund -- your anti-mortgage
account. That's the same amount out-of-pocket every month, right?
forward 15 years. Your mortgage has been paid down to $74,018 and you have $106,397
in your anti-mortgage account (assuming an average annual return of 11%). At that
point, you could, if you chose, convert your anti-mortgage account to cash, pay
the capital gains taxes due, and use what's left to pay off your mortgage. Assuming
a federal capital gains tax of 20% and a state capital gains rate of 5%, you'd
even have about $5,000 left over -- but don't spend it, you'll be needing new
The anti-mortgage account gives you options. You
could cash it in and pay off your mortgage early if you prefer, or you could keep
saving and building up your net worth as you pay down your mortgage. Or you could
do any of the myriad other things that cash money is good for.
continued at http://www.fool.com/Specials/2001/sp010607.htm?ref=60mortgage