Accelerated mortgage payments (and the GRS amortization calculator)

What if you've reviewed the compromises required to pay your mortgage early and the idea still appeals to you? You might pay a bank to set up a bi-weekly payment plan or a money merge account. But you can do just as well by taking mortgage acceleration into your own hands. Here are three options I've considered:

  • Rather than pay my mortgage, I could deposit my money into a high-yield savings account earning roughly 5% interest. Though this earns the lowest possible rate of return on my money, it gives me the greatest flexibility. I could withdraw the money to pay down the mortgage at any time. Or I could save for other goals.
  • On the other hand, I might make extra payments on my mortgage each month. This would effectively earn me a guaranteed rate of return equal to my mortgage interest rate (6.25%). This would also help me spend less on interest. Doing this, however, ties up my money, making it difficult to access if I decide I want it for something else.
  • My third choice is to invest the money in low-cost index funds. This would, in theory, provide the highest possible rate of return for my money, but as with any stock market investment, there's an element of risk. If my goal is to pay off my mortgage, a bear market is going to make me sweat.

Kris and I will decide what we intend to do by early next year. Initially, I thought we'd make payments directly on the loan, but after previous discussions here at Get Rich Slowly, I'm leaning toward placing the money in a high-yield savings account until we know better what our long-term financial goals are.

Meanwhile, I was curious: How long would it take to pay off my mortgage using the HELOC I already have? Would using the HELOC actually save time over applying payment directly to the mortgage itself? To play with the numbers, I developed a mortgage amortization spreadsheet. (This spreadsheet doesn't account for inflation — that's beyond my Excel acumen.)

Here are the four scenarios I examined:

  • Make no extra payments. If I simply continue to make my monthly mortgage payment, it will take me 324 months (27 years) to repay the loan. I will pay $231,938.86 in interest.
  • Make an extra payment every month. If I were to make extra payments of $1750 every single month, the mortgage would be paid off in 86 months (or just over 7 years). I would pay $52,424.73 in interest on the mortgage.
  • Implement a “do-it-yourself” money merge account. If I were to take $21,000 from my HELOC and put it toward my mortgage right now, pay the HELOC off over the course of a year, then repeat this process every September, my mortgage would be paid off in 85 months, or just over 7 years. I would pay $47,087.76 in interest on the primary mortgage, and about $7,264.39 in interest on the HELOC. That's a total of $54,352.13.
  • Make lump-sum payments every year.If I were to save $21,000 every year and then use the money to pay down the mortgage, it would be finished in 92 months (just under 8 years). I would pay $57,838.29 in interest on the mortgage, but earn about $3,070.13 on my savings, for a net cost of $54,768.16.

As you can see, there's not much difference between the three mortgage acceleration scenarios. Using the numbers I've chosen, they each take a little over seven years and $50,000 to complete.

If you'd like to play with the numbers on your home loan, download the Get Rich Slowly amortization spreadsheet.

More about...Home & Garden, Planning

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Ed
Ed
12 years ago

I decided to do the biweekly payment amount on my own. I set up an account with ING electric orange (which is paying higher interest than my credit union checking) to take 50% of my mortage payment every other week. Then on the 10th of each month, I pay 108% of my monthly mortgage payment. My acutal house payment is due on the 20th. Over the course of 12 months I have made 13 payments, earned a higher interest rate than in my CU checking and don’t have to lift a finger. If I was really AR (and I am… Read more »

J.D.
J.D.
12 years ago

I’m getting close to that, too, Ed. The magic of setting up automatic payments for fixed monthly bills is that you can just forget about them and let things work on their own! I’ve got the gas company down — four more bills to go…

Brigitte
Brigitte
12 years ago

I’m sort of curious how you got those numbers. Do you live in a state that allows loans to be paid early, through the rule of 78’s? Did you account for any penalties there may be for paying off early? It looks like most states only allow 30-60 days of interest (as if you were paying it off in 30-60 days), but some allow half the remaining interest and some allow the loan holder to charge the entirety of the interest on the loan as if paid at the regular contract date, no matter if it’s paid of early. Sometimes… Read more »

J.D.
J.D.
12 years ago

Interesting question, Brigitte. I don’t have an equally interesting answer. I simply ran the numbers through a spreadsheet making the assumptiont that there were no penalties for prepayment. You have me curious now, though. That’s not something that Kris and I would have looked for when reading the loan docs way back when. I’ll have to go dig out my mortgage and see what it actually says about prepayments. I do know that there’s a spot on my mortgage statement each month in which I can allocated extra money to principal, so this certainly leads me to believe that my… Read more »

Alan
Alan
12 years ago

I thought you were supposed to figure your after-tax effective mortgage rate based on the interest & points you can deduct (assuming you don’t take the standard deduction). So a 6.25% mortgage for someone in the 28% tax bracket would effectively be 4.5% wouldn’t it? In which case, the 5% savings is a better investment.

Jeff
Jeff
12 years ago

You know somebody has the anti-debt religion when they start talking about paying their house off over 7 years — and they haven’t even finished paying down their consumer debt yet. The phrase that immediately popped into my head was “too smart by half”. And from the post, I think J.D. is starting to realize this. Saving money will do more in the short term to reduce the risks from possible job loss or health problems than paying down the mortgage. And like Alan said, when you figure in the mortgage interest deduction, saving is very competitive numbers-wise, as well.… Read more »

PaulD
PaulD
12 years ago

” So a 6.25% mortgage for someone in the 28% tax bracket would effectively be 4.5% wouldn’t it? In which case, the 5% savings is a better investment.”

You also need to take into account the taxes on your savings account, which would reduce the return by your marginal tax bracket, unless you are saving in some type of tax advantaged account such as a 401k or IRA.

144mph
144mph
12 years ago

I think this is one of those situations where the anti-debt reflex misfires.

I think you should consider refinancing your home to get some of that 100K equity out of it and invest it elsewhere.

JD, email me if you’re curious as to why I say this, and we can discuss it further. I really don’t want to go on a rant about it, but I think pre-payments are waaaaay overrated for several reasons.

Peter
Peter
12 years ago

If I have a mortgage at 6% and people say paying it off early is like making a guaranteed 6%, is that accounting for the intrest accruals properly?

I thought that mortgage interest was calculated differently from the interest and dividends you would get from investing the money. It seems like paying it off early would actually generate a higher return than the base APR if you calculate it based on how much mortgage interet you’re not paying.

Booker
Booker
12 years ago

JD, do you already have a savings account that can cover most emergencies? Unless you are saving for an immediate goal (downpayment on a bigger house, new car, etc), the 5% savings account seems like a bad option. I would do a combination of pay down debt (effectively a 6.25% return, as you stated) and invest in an index fund. If you haven’t maxed out your Roth IRA or college savings account for your child, those would give you an additional tax benefits on top of the expected return from the stock market.

JerichoHill
JerichoHill
12 years ago

Once we’re back from our honeymoon, we’re going to be paying off the mortgage with extra automatic monthly payments. We want to pay off both positions within 10 years because that will free us up alot to raise children or work on our various entreprenurial ideas. But we wouldn’t be paying off the mortgage if we weren’t already maxing our pretax retirement savings. We also wouldn’t be doing this if we weren’t buying stocks post-tax. We’re helped in that we’re renting a room in our house and sending that money directly to the principal of our highest interest rate loan.… Read more »

Special Ed
Special Ed
12 years ago

Alan, said, “So a 6.25% mortgage for someone in the 28% tax bracket would effectively be 4.5% wouldn’t it? In which case, the 5% savings is a better investment.”

You still have to pay taxes on your 5% interest.

telly
telly
12 years ago

Special Ed said, “You still have to pay taxes on your 5% interest.” That’s the point everyone seems to be missing. Interest income is taxed like regular income so you’d likely need to earn much more to make savings in an interest bearing account better than pre-paying the mortgage (and a very low mortgage rate). I would look into what your bank / mortgage company says about skipping payments in case of emergency. Most banks (at least in Canada) will allow you to skip mortgage payments without penalty if you’ve made substantial pre-payments in the past so we stick to… Read more »

J.D.
J.D.
12 years ago

Wow. Great comments. When I started playing with the numbers yesterday and decided to post this, I didn’t realize I’d get so many useful responses. (I’m not sure why I’m surprised, though.) To answer some questions: note that this isn’t a decision I need to make until early next year. I do still have debt, but it will be gone in the next 4-8 weeks. (Believe me, you’ll read plenty about it here at GRS.) I do have an emergency fund, but I intend to pad it before making other moves. My Roth IRA is not funded yet for 2007,… Read more »

Curtis
Curtis
12 years ago

One thing I think most people forget about the “tax savings from mortgage interest” is that you really don’t get all of that. The standard deduction for married filing jointly is what, like $9,000? You save NO taxes on the first 9000 of mortgage interest. Just on anything over the standard allowable deduction.

Russell Heimlich
Russell Heimlich
12 years ago

If you can write out an algorithm I can write a handy dandy JavaScript version that anyone can use on the web. Looking at the Excel equations I get a little lost with things like D$4*(D$5/12)

Angie
Angie
12 years ago

Posts like this are why I read GRS every day. Thanks, JD.

Kurt
Kurt
12 years ago

If people don’t mind, I uploaded to GoogleDocs http://spreadsheets.google.com/ccc?key=pKtugvMWCNdQI9unxCIA3Cw&hl=en
I’ll remove immediately if asked.
Looking through it, I would have used some of the integrated payment calculators in excel, but I suppose this works as well.

Matt
Matt
12 years ago

I have a couple questions that perhaps you answer in a future post (once you process all the comments . . . ):

– how does tax-deductibility of mortgage interest effect the equation?
– how could the compounding of money saved in a on-line savings account or a low-fee index fund (or portfolio thereof) impact the equation? (i.e.: if you saved the “extra” money in some savings vehicle, while enjoying the advantage of income tax deductibility, if that’s available — and _then_ paying off the mortgage in a lump sum later?)

FinanceAndFat
FinanceAndFat
12 years ago

Thought provoking post and great comments!

I have to admit I’ve jumped on the no debt bandwagon, but I’m only getting started on getting rid of my debt so plans to pay off the house early or not are a long way off. This certainly has me thinking though. It does seem rather risky to tie up so much money in one asset before establishing several other solid sources of cash/investments.

I won’t have to decide for several years though!

Alan Corey
Alan Corey
12 years ago

J.D.,

Here’s a thought. Say your mortgage is 6.25%. Basically you are taking your savings of $21,000 a year and investing it for that amount.

But you could probably get 7-8% return in stocks/mutual fund (and a mortgage gives you some tax breaks). Plus, if you have a home repair/emergency you can sell stocks to pay it off, but you can’t take out a bigger mortgage without paying some hefty fees.

pauld
pauld
12 years ago

I think we can all agree that it does not make sense to pay off the mortgage until all other higher interest debts have first been paid. Many of us would agree that pre-payments don’t make sense until you have maxed out tax advantaged savings plan such as Roth IRA’s and 401k’s. To this list I would add the following: It doesn’t make sense to pay off the mortgage early until you have saved enough so that you can buy your next car without a loan. Otherwise, you are paying off a lower interest tax advantaged home loan when you… Read more »

Nicole
Nicole
12 years ago

JD- As much as I love Get Rich Slowly, this post raised my eyebrow quite a bit! As you know I am a financial educator and I am not so much anti – (all)debt as pro wealth building. In my opinion, you need to use leverage to your advantage. I agree with 144mph. Of course you have to go with your gut and I always teach that you have to choose between making a business decision or a what makes you comfortable. If you HATE debt, then get rid of it. But be cognizant you are losing potential long term… Read more »

Ed
Ed
12 years ago

remember that getting a tax deduction for mortgage interest is not that big of deal. You are paying $14k in yearly interest to take $10k off your taxes.

If you give me $14k, I will give you $11k, a much better deal 😉

tba02
tba02
12 years ago

Interesting post JD. I’m dealing with a similar scenario. I have 98K in savings right now. This includes my emergency fund. I have zero debt. I have yet to fund my IRA’s for the year, 401K is funded. I am going to purchase land that will cost ~125,000. The scenarios I am looking at are as follows (assuming the loan is at 7%). 20% down w/ larger monthly payments leaving more money available and greater flexibility. 20% down and paying extra payments monthly. 50% down affording some cash/investment options but lower payments. 75% down leaving minimal cash for emergency’s, much… Read more »

Todd
Todd
12 years ago

Nicole and 144mph, once that after-tax money in the market grows won’t you be thinking, “that new car looks nice” or “only a little of that would sure make a great home theater” and so on? It would only be a small portion of this savings! It’s a very slippery slope. 100% of mortgage prepayments reduce interest working AGAINST you.

pauld
pauld
12 years ago

“I’m curious what others would do.” It is hard to give generic advice regarding this question because it depends on many things. First, what is your tax bracket? If you are in the 28% marginal bracket, then the effective rate on a 7% loan is about 5% This is the number to beat. If the money is in a Roth IRA, you can do better with almost no risk and you can do much better, if you are willing to assume greater risk. So I would first fund your own Roth and your wife’s, if you have a wife. Next,… Read more »

Dave Farquhar
Dave Farquhar
12 years ago

I tend toward the zero-debt school of thought. I’ll tell you why. Yes, theoretically, I should string along my mortgage and its 5.75% rate as long as possible because I can earn a lot more than that with average stocks. Theoretically I should borrow even more money since interest rates are still significantly lower than the average historical return on stocks. But theoretically I can lose my job at the drop of a hat. In 2005, I lost two jobs due to downsizing. That’s the reality in the IT field now, and it can take 6 months to find a… Read more »

Sam
Sam
12 years ago

Good topic and one that we are think about as well. I have a couple of additional points that I don’t think have been addressed. If you pay off the mortgage, you have the option of self-insuring or reducing insurance, etc. Depending on where you live and how much insurance you have to pay for that flexibility could be significant. Here in Florida, I have 4 insurance policies for my home (primary home and separate carriage house), all required by the bank. If we paid off the mortgage we could drop the 2 insurance policies that cover the carriage house,… Read more »

Grover
Grover
12 years ago

pauld – “It is hard to give generic advice regarding this question because it depends on many things.” So true, and I guess I was just presenting the similarities of the post and the situation I am evaluating. Land loans are a bit unique as the lending scenarios are different than a conventional home loan. On average I need to have the land loan paid via balloon in 2 or 5 years (yes some 10 out there but in the majority are 2 or 5). >First, what is your tax bracket? – yes 28% If you are in the 28%… Read more »

Dylan
Dylan
12 years ago

I’ve looked at the “pre-pay mortgage” vs. “add more to savings” question dozens of times for my financial planning clients. When you take the risk of possibly missing financial goals into account, it’s a very close race. In some situations, pre-paying debt wins out and other times extra savings wins out. It is really dependant on a number of other variables. Rarely is the difference extreme and sometimes results in a fair price to pay for people to feel better about having less debt or more savings. Often times a compromise involving some amount of pre-payment is the best fit.… Read more »

lisa
lisa
12 years ago

From someone who has paid the mortgage off: It feels great. We agonized over this. Our situation is not typical. We have a lot of savings, no other debt, and a lump sum that we had to invest. Everyone told us to put it into the market and to keep the tax break that a mortgage provides. Instead we paid off the mortgage and now use the monthly payment to max out the 401K limit (with the tax break it provides.) No other investment has provided such an amazing payoff. I do not routinely smile when I think about our… Read more »

handworn
handworn
12 years ago

I’d do the lump-sum thing. That reduces your illiquidity in case a real disaster should strike, and it’s more psychologically satisfying.

I’d just point out that you might be smarter to put the money into dividend-paying stock than a savings account. Some blue chips pay as much as 5% (banks in particular) and the dividends are taxed much lower than interest.

jagg
jagg
12 years ago

I have stock options vesting over the next few years with my company. Since we’re debt free and we have an emergency fund and well funded retirement and college funds, we’ll be dumping all of the $ from the options on our mortgage as they vest. We currently have 25 years left on our 30 year mortgage, which will be paid off when we are 62 and 60 years old. By using the stock option $, we’ll have it paid for by the time we’re 52 and 50. The reason we’re doing this is because we know we’d squander a… Read more »

Mr. Witt
Mr. Witt
12 years ago

I have read with much interest, anything i come across with respect to the question of “should i pay extra towards my mortgage, or invest the $?” And i am still confused. It SEEMS straight forward – i have a fairly low interest rate 5.14%, and my investments (i’m 36, so thinking long-term) will likely do better – and have been doing MUCH better over the last 10 years. But. Noone seems to address what my major concern is. We are locked into a 5 year term. What happens if the interest rates jump significantly? Take an extreme (for sake… Read more »

Josh Baltzell
Josh Baltzell
12 years ago

Sorry, I know this post is not new, but have you considered shopping around for 15 year fixed loans and refinancing? I’m not positive what kind of rate you will get, but it might be worth looking in to.

JimmyDaGeek
JimmyDaGeek
12 years ago

The best way to pay off the mortgage (and possibly most nerve-wracking) is to invest in a diversified portfolio of index funds and use the appreciated value. This is a long-term solution, with questions about the tax rate of dividends and long-term capital gains in the future. Using an ordinary high-yield savings account is not as useful as interest rates are going down, and you are probably going to pay 25-32% in taxes, further reducing your yield. If anyone is thinking about a “do-it-yourself money merge account,” understand that: 1) The correct way to do it is to borrow just… Read more »

Jeff
Jeff
12 years ago

Only read a few comments: I added some of the feature of my schedule, such as total extra payments and total interest. Using my real life mortgage: 125,000 @ 5.375% PI=703.32 add $200 a month to principal(total 903.32} 242 monthly payments $71,462.00 total interest paid $42,660.00 xtra paid or add $2400 each Jan 1 222 monthly payments $73,272 total interest paid $43,200 xtra paid This does not take into account putting $200 a month into an interest bearing account. There is a greater difference than lead on to. First the monthly way you pay $600 LESS in interest. Pretty even… Read more »

Toni
Toni
12 years ago

Hello,

I am a divorced woman, 58 years old and bought a condo in January 2007. My loan was for $375,000 with a 30 year fix rate mortgage at 5.75%. I want to pay the condo off in ten years maximum so that I am not burdened by the mortgage payment when I retire. I would really like to retire at age 68. Please advise.

JimmyDaGeek
JimmyDaGeek
12 years ago

Hi Toni #41, According to my amortization schedule, your monthly mortgage payment, excluding your taxes, insurance and condo fee payments, is $2,188.40. Your principal will have been brought down to about 370,175, after making 12 payments. To pay this amount off in 10 years (120 payments) or less, you need to make extra principal payments of at least $1880 a month, starting with February’s payment. I hope this number doesn’t faze you. Mortgage payoff programs create an illusion that somehow more money can be gotten from your income to pay your mortgage. People get motivated to adjust their buying habits… Read more »

Pippin
Pippin
12 years ago

I love, love, love, your mortgage amortization spreadsheet. I’d been bashing around on an online calculator and coming up with really rubbish results, which were OK for me, but not making sense to my partner. Didn’t pay so much attention when I saw this in the original blog post, but having found it via a google, reminded just how important grs is!

You rule, JD!

Cyndee
Cyndee
12 years ago

I too want to pay off my mortgage early. Using a calculator on a site, I figured that mine could be paid off in 4 years, 2 months by paying an extra $1100.00 per month. My husband and I want this debt behind us so we can put aside a large nest egg outside of our retirement accounts. Not owing anyone anything is the peace of mind I want. Being debt free (and I mean owing no one) will give us options. It will be nice to have options at our age (49 & 52). Someone asked me why I… Read more »

Bob Garcia
Bob Garcia
12 years ago

Pippin,
Where can I find JD’s Spreadsheet?
Bob43

Don Kircher
Don Kircher
12 years ago

Option three misses a critical function of the idea. By putting your paycheck into the heloc you might pay that 21000 balance down to zero in six or eight months allowing a second payment in the year. Then you use your credit cards and heloc to pay all your living expenses The most advantageous feature of option three is also overlooked. In an emergency, you can pull the money back out for use as you can in the savings account scenario. Regarding option four, would you dump every last penny of savings into the mortgage leaving you nothing for an… Read more »

Mike
Mike
11 years ago

Cyndee Post 44 is right.

Paying the minimum on a mortgage solely for the ‘benefit’ of a tax deduction is idiotic.

Wouldn’t you rather have your all your money in the first place? Paying $1,000 to get a $100 refund is not the smart thing to do.

Joe Smith
Joe Smith
11 years ago

if you want to cut down on your mortgage,simply make 1 addition payment each year EQUAL TO YOUR MONTHLY AMOUNT OF your mortgage to THE PRINCIPAL< NOT AN EXTRA MORTGAGE PAYMENT! BE SURE THE PAYMENT GOES ON THE PRINCIPAL! this will cut down a 30year loan to 17years! this way,if you can’t afford it,you don’t have to do it! bi-weekly is the same type of thing,its more periods of payment,but the same monthly mortage amount as a 30 year mortgage,and it comes out to 17 years! the frequency of payments doubled,so the length of time is cut about in half!… Read more »

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