Sunday, December 25, 2011

More on the Mortgage

As previously posted, we are working on both our 2012 Annual Spending Plan and our 2012 Savings Plan.

One of our goals for 2011, which we completed, was to prepay $5,000 on our primary home mortgage.  I expect that we will repeat or increase this goal for 2012.  But, I'm somewhat conflicted because I know that our primary home mortgage is fixed rate, at 4.6%, for 25 years.  I also know that our mortgage interest is tax deductible so the effective interest rate of the mortgage is even lower.  Most likely, we could get a better return on our money if we invested it in the market.  However, in Florida, especially South Florida, we could save quite a bit of money in insurance if our home was mortgage free.  We could reduce our coverage, reduce or drop wind-storm insurance for our carriage house, we could self insure, etc.

Liz Pullam Weston opines that we should basically do anything else with with our money besides paying down a mortgage.  Although she doesn't suggest spending it on frivolities.  

First, Ms. Weston suggests investing in one's 401k to get a guaranteed 50% return rather than paying down the mortgage.  As an aside, I get so annoyed that every financial writer out there assumes that an employer provides a match or a match of up to 50% of one's contribution.  I've been contributing to a 401k for 10 years now and during that time (with three different employers) I've never received a match from my employer.  Even, Mr. Sam who gets a great match does not receive a 50% match, rather he receives a 30% match and it is all in company stock.  Putting all that aside, I agree that it doesn't make sense to forego contributing to a 401k or an IRA in order to prepay one's mortgage.  For us, this advice is not applicable because we are already maxing out our retirement accounts.

Second, she advises that paying down other debt before prepaying mortgage debt is probably the way to go because other debt likely has a higher interest rate.  Again, while I agree with this point, for us this advice is not applicable because we don't have other debt.

Ms. Weston's last two points, however, are interesting and I think more applicable for our situation.  Specifically, she suggests that we might be better off putting money we would use to prepay our mortgage into our emergency fund because we would have more flexibility.  I've got to agree with that, the $5000 we prepaid on our mortgage in 2011 is $5000 we cannot currently access.  We do, already, have an emergency fund, but we could continue to add to it rather than prepay the mortgage.  After a few years, if we found ourselves with an overly large emergency fund we could make a lump sum prepayment.  The only problem with this plan is that we are more likely to spend money that is available to us (even money that is in our emergency fund).  If we prepay our mortgage that is forced savings since we can't then turn around and spend that money.

The other point that Ms. Weston makes, and it is one I have already identified as something we need to look at in 2012, is that we should make sure we have adequate insurance coverage and if we do not we should be using our extra dollars for same.  Her point, if we don't have proper life or disability coverage, we could lose the house (and all the prepayment monies) if one of us became disabled or died.

So, are we going to prepay our mortgage principal in 2012?  I think we will still put a sum of money towards the mortgage principal, but we are still discussing the issue and this article has raised at least one point, the insurance issue, we have not really properly considered.


Anonymous said...

I struggle a lot with the question of paying down mortgage debt. I do not separate out the mortgage on rentals as different from my house because it is all debt in my name and regardless of which property its on you can write off the interest. Like you I have no consumer debt and max out my retirement accounts. Look at this NY Times article and the link in it to the questions. Its another planner with another view on extra mortgage payments vs investing. I am still hedging with my 50/50 approach but revisit the question more than I should.

Frugal Coconut said...

I'm planning to make extra principal payments toward the mortgage on my primary residence again this year because I am finally within striking distance of paying it off completely which is the ultimate reward (to permanently free up some cash flow in addition to eradicating the debt). It's harder to do that when the outstanding balance still feels so overwhelming, but seeing the finish line just up ahead definitely gives me motivation.

Sam said...

Thanks for sharing your thoughts and for sharing the Bucks post.

There are some, of course, great comments on the Bucks post. Interesting to see, Mr. Anonymous, that at least another person out there, takes the money left over at the end of the month and splits it between extra investing and paying down the mortgage.

Also a good comment on the issue of tying up extra money. Some suggest putting that extra money into a liquid fund and then paying off the mortgage all at once. But, of course, that assumes that you don't ever spend that money on anything else and knowing us I think that would be difficult.

Darius Degross said...

You should listen to Liz. Her suggestions can help, especially the one about splitting the payment for a month. That is a very good option, and you wouldn't have a hard a time paying it as well. Everything she said makes sense.