Background: Anyone who has a mortgage pays a certain amount towards principal (the loan amount) and a certain amount towards interest. Over the life of the mortgage, the interest amount can end up equalling or surpassing the principal amount. For instance, a $240,000 loan at a 30-year fixed rate of 5% means that you'd be paying $223,000 in interest on top of the $240,000 amount of the loan. Yes, $463,000, not including insurance and taxes. You can plug in your own numbers here: http://www.mortgagecalculator.org/
And banks are smart -- during the first few years of the mortgage, the payments are allocated mainly to interest and not principal. So a strategy of "hey, it's ok, I'll sell the house in a few years to avoid paying all that interest" won't work.
This is why I hate borrowing money, but it usually can't be avoided if you want to buy a house.
However, one way to grow equity in your house and at the same time reduce the amount you pay towards interest is to make occasional payments towards the principal. If you have an extra $1000 here and there, and your checking and savings accounts are adequately funded for a few months, it's a possibility. Call your lender and inquire if there's a pre-payment penalty (and make sure you don't work with anyone who imposes such penalties whenever you buy a house), and if not, look into making the payments online. My lender allows me to do this with no additional costs or fees. And each time I do it, I reduce the amount of interest I'll have to pay the lender -- which I love.
This might not always be the best advice. Unfortunately, pre-paying on your mortgage is not as cut and dry as you make it. There's a few scenarios that should be accounted for. The first being that when that money is in your house it could become very difficult to access for any reason especially an emergency. I wrote a post about it so I won't go into to much detail here: http://evolutionofwealth.com/2010/03/mortgage-acceleration-experiment-picture/
ReplyDeleteLet me know what you think.
You're absolutely right that prepaying a mortgage is not for everyone. Indeed, some folks could never do it without compromising their cash flow. The attempt to retire mortgage debt could create more debt (credit card).
ReplyDeleteI think you'll see in my last paragraph that I didn't automatically recommend this strategy for everyone. It has to be done carefully with an eye towards the balance of your liquid accounts.
I saw your post about what "debt-free" means to you. While it's fantastic to have liquidity to cover your debts, that's not "debt-free". Call it "debt-strategic", but you are in debt and must service those debts according to their terms. I personally find this to be a honkin' drag, and would rather be my own bank if at all possible.