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Does Fast Payback Win?
We’ve moved to a small community almost an hour from the nearest mid-sized city. Homes here with 2,000 to 2,500 square feet in great shape routinely sell for $150,000 or less. Our new jobs pay well, we are very disciplined savers and we have no debt. If we buy we likely can pay off the entire mortgage in three years or so. Is that a good strategy?
Congratulations on your new jobs and the move. Your situation is surely attractive. However, repaying a new mortgage quickly may not be the best strategy.
If you buy a $150,000 home with 10 percent down there will be a $135,000 mortgage. Given the rates in early May, your interest rate is likely to be around 3.6 percent for 30-year, fixed rate financing. The cost for principal and interest will be $614 per month.
Let’s say that your situation allows you to pay off the mortgage in three years. That’s 36 months. If you pay $3,962 a month – an extra $3,348 per month – you will be able to pay off the entire debt within that time frame.
While a mortgage-free home is not a goal to be ignored, in this case you might want to try a different approach.
If you pay down the mortgage you essentially convert your cash into a low-risk savings account that generates 3.6 percent. However, if you prepay the entire debt you will lose the tax deductions you now get for the mortgage. You also will be unable to make future payments with dollars that are cheaper and cheaper due to the erosion of purchasing power by inflation.
Rather than making huge monthly prepayments, consider these alternative strategies:
• Instead of a 30-year loan get 15-year financing. The rate at this writing is about 2.88 percent, a big discount. The required monthly payment for principal and interest in this case rise to $925.
• Get the 15-year loan and make prepayments. For instance, if you want to repay the debt in 7.5 years, raise your monthly payment to $1,670. That’s a $745 monthly increase ($1,670 less $925), meaning you will have both a quicker mortgage pay-off plus you can continue to accumulate cash savings.
• Don’t make any prepayments and get a 30-year mortgage. This will allow you to accumulate large savings, hold down monthly mortgage costs and get yearly tax savings. In the future, if you want to rent the property, you will then have a very low cost basis.
The value of cash is represented by more than interest. With cash you can invest in other properties, stock or a business. Plus, if things go wrong – a job loss or other problem – you have a strong cushion to prevent a financial disaster.
While financial discipline is a great attribute, quickly paying down a mortgage in a low-rate environment may not be the best option. For a fuller discussion talk to a local fee-only financial planner.
Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to firstname.lastname@example.org.View Foreclosure Article Archives
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