Is accelerating amortization beneficial?

Question

Not sure if this would be the exact section to put this so sorry ahead of time if it isn't.

I was hoping to discuss the idea of making an additional principal only payment on my mortgage every month. I currently have a SFR that I house hack and can easily throw in another few hundred a month extra towards the principal.

How fast would this accelerate the amortization and are there any benefits to it? Should I do something else with the money?

My idea is that since my tenants are helping build that pot of equity, I should contribute to it some also so it can build bigger faster. In the event I need to pull money out, I'll have a larger pot...if that makes sense.

Ned Carey · Answer

@Kevin Phu for the average person I think this is a great idea and will save you a ton of interest over time. A few hundred extra dollars with the reduced interest will really add up quickly.

That said for experienced investors who know how to make better returns on their money I recommend against it. If your mortgage is 4.5%, paying it off early is like earning 4.5% on your money. I can do much better investing in real estate.

So next you  have to consider your personal situation. If you have no equity in your house now it will take a long time to build up enough equity to be able to pull it out via a HELOC for example. If you already have 20%+ equity then adding to that can means you are building equity you can actually use.

Kevin Touw · Answer

BLUF: Don't make the extra payments.

I wouldn't even think about making the extra payments, especially because you're looking to invest in more real estate based on your profile.  3.625% may be the cheapest money you'll ever get and with the house hack, it seems like most, if not all, of your expenses are covered and your housing costs are pretty cheap.  Which means you should be able to save up cash for your next deal.  You really need to balance the opportunity cost of the interest you'll save with the returns you can make by investing that $400/month or however much you can scrape together.

If you want to get real nerdy, you can download a loan amortization spreadsheet, plug in the extra payments, compare the interest saved each month versus what it'd be if you keep the loan as is, and discount the NPV into today's dollars.  Or you can just trust that, given the low interest rate on your mortgage and the length of time it'd take to realize the savings (i.e. you don't save all $76k today, you accumulate the  savings over 20+ years), that $76k becomes a much smaller number in "real" dollars.  Especially when you compare that to  some FV calculations of investing that $400/month at a reasonable rate of return.

Yea, it's annoying to earn 1.5-2% in a money market account or a CD ladder as you save up for the next down payment, but it's about having the cash on hand to be able to strike when you find that next deal.

Ned Carey · Answer

@Kevin Phu a factor not mentioned yet is cash reserves. Having cash in the bank ready for emergencies is a good idea.  That is what Steve V is referring to when he says liquidity. You may want to split what you do with your extra money, at least until you have some cash saved up.

Steve Vaughan · Answer

Well, paying down a fixed rate long term 3.6% loan that doesn't bother you isn't the dumbest thing I've ever heard of, but not much of a return for no liquidity IMO.

I earn about 1.5% in my mmkt accts.  For the 2% less 'return' I'd rather have liquidity and the ability to take advantage of an opportunity, and I've paid off a bunch of mortgages as I pointed out earlier.  I'm more pro debt-free than most on here.

To each their own. Paying down debt is never dumb, there's just gotta be a higher return for your dollar out there somewhere than 3.6% I would think. For no liquidity at all?  At least if you bought a bond or something with a 4% return you could get your $ back without trouble. Good luck either way.

Steve Vaughan · Answer

Well said, Ned.  It will save you money over time for sure and paying down debt is not a dumb decision.

If all you have for debt is your primary mortgage, it may be a great use of extra dollars at least until you get below 80% LTV and get the PMI rip off removed. Hope you don't have an FHA loan?  MIP forever in that case.

If you also have credit cards and car loans you will probably be better off paying those.  Student loans are debatable as they can be forgiven in the event of death, disability or certain employment sectors.

The opportunity cost of accelerating the cheapest debt out there (your primary mortgage) can be high. What if you miss a sweet deal?  I've paid off a few mortgages, but they were higher risk commercial and seller financed loans or conventional above 7%.  I'm also not hunting much for deals anymore and still have reserves and opportunity fund. I will not spend my last dollars on debt reduction, especially in the 4% range.

What is your rate? Is it fixed?

Kevin Phu · Answer

Kevin, thank you for your insight! I took a few more days to think about it and came to the same conclusion as you and have decided to instead take the extra payments I was going to make and put it towards future investments.

Kevin Phu · Answer

Wow...I just used the early mortgage payout calculator on Bankrate.

If I make a $400 principal only payment per month, which is easy in my case, I will shorten my loan by almost 7.5 years AND save 76K in interest!

Starting these additional payments ASAP!

Kevin Phu · Answer

@Ned Carey Thanks for that insight! My interest is 3.6%. That would be 3.6% more than what my money is gaining while sitting in my bank account. I've had my house for almost 1 year (Sept) and I have just over only 1% equity into my house so I am far from having equity I can pull out. I'm in no hurry to pull money out so I think even adding to it now would help in the long run.

@Steve Vaughan The only debt I have is my mortgage and a few k in credit cards. The credit card is 0% and I am on track to have it paid off by the time the 0% goes away. Figured I keep paying it to keep my credit active since it's costing me nothing. I have a VA loan so no PMI

My rate is 3.625% 30 year/fixed.

Eric Adobo · Answer

Do it and do it often.

Is accelerating amortization beneficial?

Most Popular Reply