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Defraying mortgage principal later than sooner

This has probably been discussed to death so pardon me for reviving this dead horse one more time. Back in 2004 the following post was made in this forum;

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=====================================================I learned the hard way that extra mortgage payments are the dumbest thing you can do. While they reduce your principal, they do not change the amount of interest you owe on each payment because that amortization schedule is created at the beginning of the loan. Thus, my extra payments just went into the bank's coffers. I received no economic benefit from that money. Now I set aside the extra mortgage principal payment in a savings account where it earns 2% interest and is always available to me. In six years, I will have enough aside to pay off the balance of my mortgage. I can then decide whether I want to pay off the mortgage or not. In the meantime, I have full access to this money and it is earning me interest income. I could kick myself for not realizing the stupidity of paying extra mortgage payments to the bank sooner. ===================================================== All who replied to this post seemed to miss the point the fellow was trying to make. Agreed, he was technically incorrect here;

==================================================While they reduce your principal, they do not change the amount of interest you owe on each payment because that amortization schedule is created at the beginning of the loan. ================================================== I think what he meant, as opposed to what he said, was that paying down the mortage principal doesn't reduce the minimum required monthly mortgage which is determined at the beginning of the loan. However, paying down the mortgage principal shortens the life of the loan which I think the fellow also realized.

Here is the point I think the fellow was trying to make that I tend to agree with....Up to a point (and no doubt this point in time can be calculated), it is better to invest monthly mortgage pay down amounts and pay down the principal as a large lumpsum later. Ideally, one should also refinance at that time if prevailing interest rates favor it.

If for example you are making extra payments of $300 a month to pay down the principal, wouldn't you be better off investing that $300 each month and paying down the principal with $3600 at the end of the year instead? Or, does doing it on a monthly basis shorten the loan more than doing it on a yearly basis?

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Reply to
oparr
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It totally depends on the underlying assumptions. If you can attain a net reutrn on your investment that is greater than or equal to the net interest rate on your mortgage, then you may be better off investing. Otherwise, the mortgage prepayment is essentially an investment with a guaranteed return that matches the net mortgage interest rate.

"Risk" throws a wrench in the works and tends to create a primary source of disagreement. Most investments that net a return greater than net mortgage interest rates are not "riskless". Therefore, it's not really an "apples-to-apples" comparison. It's akin to comparing treasuries to small-cap value and only considering returns while ignoring risk.

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Reply to
kastnna

If you take that $300/mo and invest it - you come out ahead if and only if that investment itself gains more than the interest you'd have had to pay on the mortgage. Ignoring liquidity benefits. So, lets's say you had a mortgage at 6%, then those 12 payments of $300/ea need to have grown to something over $3700, actually, by the end of that year. That first payment has a year to accumulate interest. That second payment has 11 months to accumulate interest. etc. etc. If you kept that money in your checking account earning nothing, then dump it all into that mortgage at the end of the year, you would definitely have done better to have prepaid that mortgage monthly - by exactly that $120 or so that those principal payments would have saved you in interest.

Every single early principal payment *does* have the economic benefit of saving you interest that you'd have otherwise paid. (You're exactly right - monthly payments don't change - but what those monthly payments are composed of does - if you prepay your mortgage, then your payments quickly become more principal and less interest than they'd been.) But they also have a similar economic opportunity cost - that money could have been used for something else. In simple financial terms, you come out ahead if you use that extra money for the most productive thing you can. But it's never quite as simple as all that, since (a) it's generally pretty hard to get a return on that cash invested otherwise which is going to beat your mortgage *risklessly*; and (b) liquidity is a bit harder to put a value on - if you've used the cash to pay down your mortgage, you no longer have easy access to it - if you accumulate that cash elsewhere and then, say, lose your job, you can use that accumulated cash to keep paying your mortgage for a while. You absolutely pay a price for that liquidity - but that price may be cheap next to the value of that liquidity.

Reply to
BreadWithSpam

Why not doing both, say $150 added to the monthly payment and $150 deposited in a MM account, withdrawn yearly to be added to the last mortgage payment of the year?

HTH

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Reply to
Augustine

It would be a method of diversifying away the uncertainty of liquidity and market risk but it also guarantees that 50% of your money is not being used most efficiently. It's like betting on two different horses to win the same race. You increase your chances of success, but only one bet can "win".

Then again, I'm a "risk manager" not a "dollar maximizer" so I personally like this suggestion.

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Reply to
kastnna

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