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Paying Off the Mortgage Early

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By Ann Coleman (TMF AnnC)
March 7, 2001

Q. Does paying off my mortgage early make sense? I've heard it isn't a good idea, but I've also heard you can save a fortune in interest. --R.M., via email

A. You can save a fortune in interest. The question is, what does that cost you?

You've probably heard all the arguments about the value of the mortgage interest deduction and how mortgage interest rates are lower than probable investing returns, yada, yada, yada. Obviously that hasn't convinced you. It hasn't convinced a lot of folks. So let's run a real-world scenario that doesn't even consider the mortgage interest deduction, assumes a moderately high interest rate (which would motivate one to pay the mortgage off faster), and assumes a mediocre return on invested dollars. In other words, we're stacking the deck in favor of paying the mortgage off early. Let's see what happens.

We'll compare two neighbors with identical mortgages of $100,000 at 8% for 30 years. The scheduled payments are $733 per month. Fred, at 601 Motley Drive, runs some numbers and finds that by paying an additional $300 a month on his mortgage he can save over $103,000 in interest and pay the house off in 13 years. That sounds almost too good to be true. He jumps all over that plan.

Philip, at 603 Motley Drive, never ran the numbers, he just made his mortgage payments as scheduled. He also put $300 per month into a tax-efficient S&P 500 index fund that he read about on some website. He earns an average return on his index investment of 12.0% per year. (That's a smidge below the S&P 500's average return over the last 50 years and well below its average return over the last two decades.) At the end of 13 years, when Fred holds his mortgage-burning party, Phil's index fund account is worth $111,000 -- several thousand more than what Fred saved in interest.

But now Fred can start putting $1033 a month into savings, right? Putting $1033 a month into an index fund for the next 17 years, and earning an average of 12.0% per year, gives Fred an account worth $683,000 by the time Phil makes his last mortgage payment. Nice.

But... wait a minute. Phil kept socking away his paltry $300 a month. By the time his house is paid off, his investment account has grown to over $1,048,000. Both guys own their houses free and clear, both have paid out exactly the same amount every month for 30 years, but Phil comes out way ahead.

Now what? Phil's million-dollar investment account could pay for one heck of a mortgage-burning party. Wanna throw your own big bash? Do the math on your mortgage by using the online calculators in our Home Center.

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