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4 reasons why you should make extra mortgage repayments

Buying property has become part of the social norm, and along with it has come the norm of having a mortgage. A debt hanging over your head for the next 25 to 30 years of your life, an obligation to keep working in order to repay what you have borrowed. It can be all too easy to simply pay the minimum repayment each month and hope it will go away, but nothing will beat your mortgage blues quicker than some extra repayments.

Here are four reasons why extra mortgage repayments are a logical use of your hard earned cash:

You’ll save money

The most obvious reason to make extra mortgage repayments is the cost saving. Here in Australia, the average home costs around $400,000. Assuming you put down 20% plus all purchasing costs, over $300,000 of interest will accrue over the life of an average 25 year loan. 42 percent off all of the money you pay to the bank will go in their pocket as opposed to paying off your home. Paying even $10 a week extra off of the loan will save you over $13,000 and result in you owning your home outright a whole year earlier.

The debt isn’t going anywhere

Unlike investing your money in the stock market, every extra dollar invested into extra mortgage repayments is guaranteed to reduce the amount of your loan. The value of your home might fluctuate over time, but your loan amount won’t vary accordingly – the only way to reduce your debt is to repay it. Even if your property halves in value the bank won’t agree to halve your loan amount just because they are nice people. Why would you risk investing in something which could go down in value when you’ve got a safe investment in your own home?

You aren’t taxed on extra repayments

By making extra mortgage repayments you aren’t earning income, you’re reducing your expenses. The beauty of this is that you are taxed on what you earn, not what your expenses are. Even if you cold earn 8% in a risk free investment, after paying tax on your earnings it might work out to be less than what you could have saved investing that money into your mortgage at 6%. If you decide to sell your family home in the future and it has gone up in value, many countries will offer capital gains tax exemptions or reductions – try saying that about other forms of investment!

The tax deduction is illogical

While not available for homes in my part of the world, American friends are quick to point out that they shouldn’t pay off their mortgage early because the interest is tax deductible. The glaring hole in this logic is that in order to claim the deduction, you need to pay the interest – and the interest will always outweigh the return from the deduction. You’re paying the bank a dollar for the privilege of not paying the government 40 cents. Yes, paying off non-deductible debt such as a car loan first may be a better option (assuming the same interest rates) but at the end of the day debt is debt – regardless of deductions.

So next time you receive a windfall such as a tax return or you have a few extra dollars burning a hole in your pocket, contribute them to your mortgage as extra repayments and enjoy the knowledge that you’ve made the smart decision.

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9 Comments

  1. August 15, 2013

    And when you’ve invested all that extra money into your home and its finally paid off it then sits there getting you 0% return for the rest of your life. That’s a good financial decision? I respectfully disagree. I just feel like this is not good cookie cutter advice and I can’t understand why so many seemingly smart individuals recommend mortgage prepayment – honestly!

    Reply
    • Financial Independence
      August 15, 2013

      Thanks for your thoughts on this Beingcentsible – the benefit to paying out the mortgage doesn’t lie in generating income, but in reducing expenses. At the end of the day if the mortgage is fully paid off, you aren’t having to pay a monthly interest payment (or having to pay rent which would be the expected alternative if you don’t own a home). It would be a fair assumption that comparable rent would increase over time, as would the assumption that the average home loan interest rate is greater than the risk free rate of return available elsewhere.

      The alternative you propose (to keep the mortgage debt) presumably means you would be investing elsewhere. Keeping in mind that you are likely to incur tax on investment earnings I believe it would be difficult to find a risk free investment providing a similar return. One also needs to consider that mortgage debt is only tax deductible in a handful of countries around the world.

      I would look forward to gaining further insight as to why you feel this is bad advice?

      Reply
  2. August 15, 2013

    Thanks, I think it’s generally safe advice you are providing however I just think most people can, and should do better. Here are a few reasons to support my case
    - It’s not as risk free proposition…many people are forced to sell their home for less than what they paid.
    -The money in your mortgage is very illiquid. You can’t go to an ATM and access any of its equity.
    -You forfeit the benefits of compound interest in other savings vehicles.
    -Other expenses remain
    -Prepayment penalties that may be present.
    -it’s currently a poor rate of return for a younger person. For reference, compare to major index funds from Vanguard.
    -There are other tax advantaged vehicles/buckets that should be filled first.
    Typed on my lunch break on my phone please forgive potential typos :). Hope this helps.

    Reply
    • Financial Independence
      August 15, 2013

      Thanks for your further input, you have definitely raised some logical and valid points which support your standing. Some people may definitely be able to gain better returns on their money elsewhere and if they are in a position to do so then I agree it can be a better strategy.

      Just on the point of repaying a mortgage not being risk free as you may have to sell your home at a loss, I still believe the repayment is risk free as you have already committed to the lender to repay an agreed value:

      - If you buy a house for $100k and repay nothing, then sell it for 80k you have made a loss of 20k
      - If you buy a house for $100k, repay $50k and sell it for 80k you have still only made a loss of 20k however you have incurred less interest over the holding period.

      As for illiquidity and prepayment penalties, these are definitely both factors which could come into play and effect the most suitable strategy. The same goes for comparing the rate of return to Vanguard Index funds – here in Australia the standard variable rate on a mortgage is nearly double the rate of return on the Vanguard International Shares Index (over 8 years, the longest time period listed on their site) and slightly higher than the Domestic Index, but due to different mortgage rates in different countries this may not always be the case.

      Once again, thanks for taking the time to explain your position. I believe it is important for readers to consider both sides of the coin and you have definitely provided some food for thought. I think this has also highlighted the importance of readers not blindly following advice and instead questioning if what they read is suitable for them.

      Reply
  3. August 15, 2013

    I prefer to invest elsewhere as well, my mortgage is at 2.29% so between inflation and a 30 year span I do get a much better return from my money elsewhere. My residence is paid for and I like but be it a rental or your own house there is not much financial logic today to repay early.

    Reply
    • Financial Independence
      August 16, 2013

      Hi Pauline,
      I recently came across your post regarding your Weighted Average Interest and the reasons you have chosen to invest rather than reduce mortgage debt. I can definitely see the appeal of investing over reducing debt when your rates are so low – to be honest I hadn’t considered international mortgage rates when writing this post. Thanks for your input.

      Reply
  4. Tracy
    August 20, 2013

    I have maxed out my retirement savings and my goal is to have my house paid for within the next 12 years at which time I’d like to retire early so I am on board with paying off the mortgage early. I will save a lot in interest payments and have no debt at that time. I would ultimately like to live in England for a couple of years so I will likely rent my house during that time and have some income from doing so.

    Reply
    • Evan
      August 21, 2013

      Renting out your primary home while overseas is something I have seen done in the past – it’s good to keep in mind that your home is an asset regardless of if you live in it or rent it out. Some countries even provide CGT concessions if you convert your primary home to an investment and then back to primary home again.

      I believe real estate in England is quite expensive, so it’s probably easier to pay off your existing home and use the rental income to pay rent in England rather than purchase over there!

      Reply
  5. September 20, 2013

    I have a 15-year mortgage, max out my 401K, and take the rest of our money and directly invest it. To me, I can get better long term returns (7%-8%) vs. 3% on the debt early repayment.

    I’d suggest that most people that are saving for the long term invest vs. repay their mortgage early unless they have a VERY low tolerance for risk.

    Reply

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