Different Ways to Pay a 30-Year Mortgage
The last post looked at the advantage of a 30-year mortgage over a 15-year one, provided you invested the difference into a low-cost index fund. For more, see Benefits of a 30-Year Mortgage. We say that a 15-year mortgage would cost you approximately $1.5 million is a lost opportunity. But what if you cannot afford to save that extra money? What are your options to save money on a traditional 30-year mortgage if you either do not or cannot pay the difference into a brokerage account? Two simple options can save you monthly payments and, thereby, interest on a 30-year mortgage. Here is how.
First, we rule out the 15-year mortgage due to financial constraints as you cannot afford the extra $500 a month in payments. So, you have two options, and they are as follows. One is to make a split payment where you pay half your mortgage with one payment on the first and the other on the fifteenth. Or there is option two, where you pay an extra $46 in principle monthly. The figures we will examine are the same as the previous post, where we borrow $249,181 at 3.75% annual interest. So which way to pay your mortgage saves you the most? Let’s find out now.
In the split monthly payment, your first payment will be $1,731, the base payment of $1,154, and the first half-month payment of $577. Then you will make 708 payments, two per month, and then a final single payment of $172.07. I know that 710 payments seem like a lot, but it saves you ten months, resulting in a savings of $3,865.25 in interest. That is not too bad, as all the extra money you paid out was in the initial payment that contained the extra $577. Then you paid the same $1,154 a month until the final payment. But wait, you cannot afford the extra $577 for the initial payment, so let’s look at the other simplified option of paying an extra $46 a month for an even $1,200.
Okay, we ruled out the 15-year mortgage and the 30-year split into bi-monthly payments due to hardships on our finances. So, what if you paid an extra $46 per month that went towards your principle? The answer may surprise you as we will explore that option now. It is rather simple; you pay your regular $1,154 and add an extra $46 to round it up to an even $1,200. Not a huge sacrifice but a doable one, I hope. Well, the simple addition of an extra $46 will cut two full years off your payments and save you $12,872.99 in interest payments. If you can send more a month towards your principle, you will shave off more payments and increase your interest savings.
Paying Extra vs. Saving
If you can afford to pay an extra $146 for around $1,300 payment, it shaves your mortgage to 24 years and five months for total savings in interest payments of $34,716.72. But if you elected to skip the extra $146 and invest that money as you did in the 15 and 30-year mortgage comparison, you can accumulate $213,213.32.
This means you are still ahead by saving in a brokerage account that invests in a low-cost indexed fund with an approximate market return of 10.9%. I hope you now see that under no scenario we have examined, are you better off paying off your mortgage early than investing. Yes, paying off the mortgage early will save you some in interest payments, but you come out far ahead investing over paying off the mortgage early. Even just saving the extra $46 per month over the 28 years of the mortgage, you will have accumulated $101,530.42 in investments or only seen a savings of the cost of interest payments of $12,872.99.
No matter how you look at it, you are always better off saving extra payments and not paying off “cheap” money early. If you cannot make the extra payments into a brokerage account, select to either pay the 30-years as intended or make a bi-monthly split payment.
If you have any questions concerning paying off a mortgage early rather than investing those funds, feel free to reach out to me directly if you are in the Metro Nashville area. And for those not located in Tennessee, you may still reach out to me or find a qualified fee-only Registered Financial Consultant today.