House Value Update Q2 2011: Mortage Loan Payoff Calculations

As part of tracking our financial status, I regularly check in to see how long it will take to pay off our home mortgage. Buying versus renting is a very personal decision, but we ended up buying our house three and a half years ago and still plan on staying in it for the foreseeable future. I see it as an inflation hedge (our mortgage payments won’t go up) and paying it off quickly as an integral part of our early retirement plan (lower expenses means smaller portfolio needed).

We obtained a 30-year, fixed rate mortgage. Our current interest rate is 4.75%, after two rate modifications, which were basically low-cost refinances through our original lender that didn’t need additional appraisals, etc. This way, we were able to advantage of dropping interest rates over the last few years.

Home Value Estimate
Good comps are still the best way to estimate your home value. Recently, a house very similar to ours was sold through a short sale by Bank of America for 92% of our original purchase price. The house is the same model with basically the same floorplan, original construction year, and is about 10 houses down from us on the same street. The main difference was that it was in worse condition in terms of interior updates and deferred maintenance. We feel this puts a pretty good floor on the current value of our house, although I like to subtract another 6% due to broker costs if we really did sell. This gives us a current value of 86% of our original purchase price. Definitely not great, but it could be worse, and we aren’t underwater.

You can also try internet valuation tools such as Zillow, Cyberhomes, Coldwell Banker, and Bank of America (old version). After using them for a year, I found them to be interesting but imprecise tools.

Remaining Mortgage Balance
On top of our normal mortgage payments, we’ve been making sporadic additional payments directly towards principal. Our current mortgage balance is 66% of the original purchase price, 77% of the value estimate above, and 82% of the original loan value (we put 20% down).

We’ve had the mortgage for 3.5 years, but we can calculate “how far” we’re actually into our mortgage by comparing the remaining balance and the remaining principal on a regular 30-year amortization. You can get this amortization table from many online mortgage calculators. Currently, we are at the same remaining balance as if we were 9 years into a normal 30-year amortization. This means if we just pay the “minimum” mortgage payment amount based on a 30-year paydown from here on out, we’ll have 21 years left until the loan is paid in full. Not bad, already cut over 5 years off the end. :)

Several months ago, we set up a regular additional principal payment of 25% of the normal 30-year payment (i.e. $500 on a $2,000 payment). This automation makes our monthly budgeting easier. According to this mortgage payoff calculator, this puts us on track to pay off the loan in only 15 years (another 6 years early). Ideally, if all goes well I would like to shave this down into the 10-year range.

Looking back, it would have saved me some interest to simply go with a 15-year mortgage initially. However, the 30-year option gave me more flexibility with lower payments back then and even now, so I don’t regret the decision all that much. I do recommend people using a 15-year mortgage to determine if you can “afford” a house to my friends now, because a 30-year mortgage just seems so long.

Comments

  1. Suzie Orman always tells people not to pay off your mortgage early, but instead put it into retirement, investments, or emergency savings. What’s your reasoning for paying it off early, other than the stated early retirement plan? Is it just that you’re already comfortable with the amount your contributing and you’ve got enough extra income available to push into your mortgage?

    Thanks for your insight! I love the blog.

  2. Jonathon, you wrote, “Several months ago, we set up a regular additional principal payment of 25% of the normal 30-year payment (i.e. $500 on a $2,000 payment).” How regular? Monthly?

    I am less inclined to pay off a low-interest mortgage (we have a 30-year, 4.875 loan on our home, no PMI). Add the tax deduction and the real rate is very low (perhaps about 2 %?) in the early-to-middle years of the loan.

    One, I can typically get a better return from investments than that. If/when inflation picks up, very safe investments will cover that.

    Two, I like the idea of having diversity and liquidity.

    A house is a home to me, not an investment. But, still, it is a significant asset. While I plan to live in it for the next ten to fifteen years, plans change.

    If I am out-of-work and need a home equity loan, will the bank even consider me to be a safe risk? If I have other investments to tap, I would not put my home in jeopardy (at least, hopefully, not for a long time if at all).

    Or am I missing something? (Serious question).

  3. @Shaun – That is a great question, I should have addressed that. I agree that if you have the ability to invest in a tax-advantaged account like IRA/401k/403b, you should do that first. Same is true for emergency fund. Both my e-funds and retirement accounts are already fully funded, so I’m redirected money towards the mortgage. If I’m going to retire early, I feel I have to do everything I can.

    @Ron – You should check out this post and its 100+ comments! It’s an ongoing debate.

    10 Reasons You Should Never Pay Off Your Mortgage

  4. Hi Jonathan, if you don’t mind would you tell where do you live ? I think you mentioned California ?

  5. Interesting about the internet valuation tools. I had just recently noticed that zillow.com and eppraisal.com were about $60k apart on their estimates for my house.

    Before today, I hadn’t tried the other sites you mentioned, but I’m not really able to get an estimate out of any of them. Not sure if it’s user error on my part or site error or what. Cyberhomes basically gave me the big range between zillow’s and eppraisal’s estimates instead of a solid number so that wasn’t helpful. Coldwell Banker looked like just a search tool for homes for sale – maybe I’m missing the link for home values? Bank of America insists that I add my last name because it thinks I’m a condominium owner (I have a single family home!) and then when I enter my last name it gets caught in a loop and asks for it again.

    So, Zillow and Eppraisal continue to be all I have to go on. I’d do as you do and look at comps, but honestly I’m too lazy. Yodlee tracks Zillow, so maybe I’ll just let that be my working number. :)

  6. Ron,

    The tax benefit would be calculated from the marginal income rate, most likely 20 or 25% of the 4.875% – would not lower the effective rate to 2%. While tax deductability is a benefit, the fact is that the mortgage owner in the 25% marginal bracket is paying the bank one dollar to save 25 cents in taxes, i.e., spend 75 cents.

  7. I can understand wanting to pay a mortgage off early. I plan on doing the same. However I’d like to know the reasoning behind paying extra each month as opposed to saving the extra premium in an account of your own, then paying off the entire mortgage when the time comes. 10 years or whenever. The extra principal payments aren’t lowering your monthly payments.

    I’d rather have the money liquid and accessible incase an emergency comes up or you lose your job.

  8. Also anyone planning on moving in the future would be better of having the money liquid.

    I bought a house 5 1/2 years ago. Knowing I most likely wouldn’t be there for more than 10 years. I paid the minimum payment each month, which was cheaper than renting.

    Earlier this year I sold my house and my fiance and I moved to a new bigger house. Having the money liquid I was able to put in a solid non contingent offer and got a great deal.

    Had I been putting extra money into my home as opposed to my bank account I wouldn’t have been able to make a non contingent offer.

  9. @JB – Let’s say that I sell my house in 5 years. My interest rate is 4.75%. That means my extra payments effectively earned 4.75% for 5 years. What other investment with similar nearly zero risk can offer that yield? Compare with current bond and CD yields. Yes, you can invest in stocks, that is an option with more risk and higher expected long-term return, but in my case I’m already maxing out 401ks/IRAs. You are giving up some liquidity, I agree, but that’s the trade-off.

  10. Let’s say two people each owe $250,000 on their loan.

    Person 1 makes extra payments at $500 per month/ $6000 per year.
    Person 2 puts the same amount of money under their mattress.

    In 5 years:
    Both loans principal amount has decreased by $35,000.
    Making up this number for demonstration purposes.
    Leaving a $215,000 prinicpal balance.
    Person 1 paid down the loan by an extra $30,000
    Person 2 has $30,000 under their mattress

    Both people sell their homes for $400,000
    Person 1 receives $215,000
    Person 2 receives $185,000 and has $30,000 under their mattress.

    Both people end up with $215,000. I don’t see how your extra payments made you 4.75% interest.

    Like I said, I am for paying a mortgage off early if you plan on staying in the house long term but I think it should be a lump sum payment.

  11. @JB – That’s not how mortgage principal prepayments work. Each regular mortgage payment goes partly to mortgage principal, and partly towards interest. If you make an extra payment, your principal owed goes down, and thus interest is lower. Any future payment will have a greater portion towards principal, reducing it faster than your Person 2 scenario.

    http://www.mymoneyblog.com/amo.....to-15.html

    http://www.mymoneyblog.com/amo.....ation.html

    If you don’t believe me, ask someone knowledgeable from your mortgage servicing company.

  12. Thanks for the links. You learn something new every day.

  13. @ JW: So the effective rate does not have the impact I thought. Still, at around 4% it is cheap money. And, a monthly cost I would have regardless (rent vs. mortgage, at least for the long term). The rate itself did not influence our decision to “buy more” … in fact, we down-sized with this move and find ourselves in what I am quite sure is the least-expensive house on the block – I am pretty confident that we also have more equity (in dollars as well as a percentage of house worth) on the block.

    So, back to the original question – put additional money toward the mortgage principal or toward investments? No easy answer.

  14. stuck in NJ says:

    Hi, great blog.

    I wish we could pay off our 30-year mortgage soon, but we overpaid for our first house and now our mortgage at 6.8% is more than our house is worth, with no equity. Trying to re-finance to a lower rate is proving fruitless as no financial institution is able to help us. I’m reading your blog with great interest and I hope to use some of your tips to help us get out of this financial dilemma we’re in.

  15. Nice plan Jonathan. I have a feeling we are similar in age and goals etc. Nice to see another way of looking at things.

    My wife and I are paying down our mortgage very agressively. Our mortgage payment is 1692.00 a month (@4.5)but we are paying an extra 7,000 or more a month. This would finish off the mortgage in about 3 more years. I know to many that sounds crazy but that would leave me mortage free at 33 and my wife at 31 with 500k in equity outside of any market appreciation. This is when we plan on having kids so for us its a lifestyle decision.

    My wife will likely still work near full time after a child and that would leave us with nearly 9k a month “free cash flow”. This is where we will start investing heavily outside of what we have now. Like you mentioned above our requirement for post retirement income will be quite low with no mortage hanging over our head.

    In this current market I am comfortable with throwing all that money into the house. If things continue to worsen or individual stocks pop up I still “reserve the right” to put the money to work in the market. Like you mentioned 4.5% return TAX FREE is not shabby in this market. I would have to be near 7% or more in return to break even after factoring in fed and state short term gain taxes.

    For those who cry out about the mortgage interest deduction benefit, try getting hit with the AMT once after deductions and then figure out how much the deduction helps you. At this point in my mind Im just throwing about money with interest payments.

    I only hold 4 months living expenses in emergency savings. I have always thought I would hold more but what kind of “emergency” will cost that much? If its that big of an emergency I havent planned correctly. Thankfully our jobs tend to be quite stable even in downturns (healthcare).

    Enjoy the updates and continue with the progress. After reading your blog I see your partial to funds. Any reason why you dont delve more into individual stocks and learn a little more? I have done well with individual stocks and that has contributed to my success.

  16. Matt, your situation sounds a bit different from most of the others here, not to take anything away from you that sounds like a very high salary. As such, I don’t think AMT will hit most people.

    I would like to clarify your investment comparison comments with some assumptions that may apply to others. The “real” return on paying off your mortgage early is 3.375% (assuming 4.5% rate and your top tax bracket is 25%). If you have to pay AMT this doesn’t apply obviously. The return you’d have to match in the markets would be 4.5% (this is assuming short-term capital gains at top income tax bracket, no state tax). If you book gains longer than a year it’s 3.825% that you’d have to match. Municipal bond funds get some tax break so their real return is slightly higher than commonly seen. There’s no one right answer for everyone so everyone should evaluate their own situation and risk tolerance.

    Regards.

  17. If I pay 6 extra payments a year on my new mortage, how fast can I pay this off? We are in our late 50′s and do not want to being paying payments in our late 80′s.
    Thanks

  18. Donna, I’ve found this calculator to be great for exploring just these kinds of questions.
    http://www.bankrate.com/calcul.....lator.aspx

    Good luck!

  19. @Matt,

    That’s a good approach. Hopefully there are a lot more people like you who would only buy houses they can afford.

    Regarding taxes: only mortgage interest paid is tax-deductible and not the extra principal payments. Higher the extra principal payments, lower will be the mortgage interest. So the break-even would be at much less than 7%.

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