Should I Prepay My Mortgage?

by RJ

in Real Estate

1352842996_569a3955c2To start off the year, my wife and I did a pretty in depth financial review. We took a good look at the past, present, and future. Most importantly, setting financial goals for where we would like to be in one, two, and five years.

After talking about our goals and the lifestyle we want to live, we both came to the conclusion that we should  prepay our mortgage. If we can pay off the mortgage by the time we’re 30 that will give us a lot of flexibility when we start building our family.

The ability for us to be the one raising our kids is more important to us than any other goal we have including travel, early retirement,  a new car, etc…

Also, paying our mortgage off early isn’t coming at the cost of retirement savings. We’re both maxing out our Roth IRA‘s and contributing to our 401K’s.

Last, we have an emergency fund. If something did happen, like a job loss, we can stop prepaying the mortgage and use our emergency fund.

Knowing these facts, is it a smart idea to pay off our mortgage?

First, let’s look at it from a mathematical perspective.

Essentially, paying off our mortgage, that has a 5% fixed interest rate, is the same as earning 5% in an investment account. (There are a lot of tax considerations that can make this more complex like tax brackets,  tax deductions, availability of tax deferred accounts, etc… plus inflation. Unfortunately I have not found a calculator that takes into consideration everything that needs to be considered. Therefore, I simplified this calculation as much as possible.)

This 5% return is both good and bad. Good because it’s a guaranteed rate of return. With interest rates so low today, it’s impossible to find an investment that guarantees us 5%.

Bad, because it’s only 5%. We’re losing the opportunity to earn more. Historically, investments such as a total stock market index fund have returned about 10% a year.

Therefore, since our interest rate is so low on the mortgage, mathematically it doesn’t make a lot of sense to prepay our mortgage. If we were to put the money in the stock market, history has shown that we have a really good chance of earning more than 5% if we’re long term investors.

Knowing this information, we still decided to pay off our mortgage.

Here’s why:

Flexibility is more important to us than anything. Prepaying our mortgage gives us the flexibility we desire.

Even though we have the chance to earn more money elsewhere, returns are not guaranteed. With interest rates so low and the current uncertainty of our economy, a 5% guaranteed rate of return sounds very appealing.

If we were to choose to invest in the stock market, who knows what our returns would be. There is potential that they could be a lot higher than 5%. However, there is a potential that they can really decrease over the next few years.

In short, we choose not to let the economy decide if our kids will be raised by us or be in daycare, but we made that decision.

Do you agree, should I prepay my mortgage? Are there any other options that I’m not thinking of? How weird is that picture above?  Please let me know in the comments.

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KenNo Gravatar January 19, 2010 at 8:53 am

I think it’s Ok if you don’t have any other debts. I would also recommend the Emergency Fund have at least 3 months expenses before going gung ho. Good Luck!
.-= Ken´s last blog ..Money Rules: Making More Is Not Enough =-.

RJNo Gravatar January 19, 2010 at 3:40 pm

Thanks Ken. Our emergency fund covers us for 6 months of expenses. Sorry I didn’t make that clear.

MelanieNo Gravatar January 19, 2010 at 4:56 pm

Our mortgage is tiny (our house only cost 60k), so we aren’t in a hurry to pay off the mortgage. Instead, we’re putting our energy into paying off our student loan debt, which is much more debilitating. It’s the removal of those debts that will afford us the financial stability to allow one of us to stay home with our future (hopefully not too far in the future) kids.

This is an area where it really depends on the person. If the mortgage is your biggest liability, and you can prepay *while* you prepare for retirement, emergency, house maintenance, etc., I don’t see why not.

RJNo Gravatar January 19, 2010 at 5:11 pm

Thanks Melanie for the comment. I think you hit it on the head when you said, “It really depends on the person.” Not everyone has to have the same path towards financial freedom.

Having an emergency fund and starting to invest for retirement while we’re young, has allowed us to do this.

CrystalNo Gravatar January 22, 2010 at 1:11 pm

My husband and I are in a similar boat. We have a 15 year mortgage at 5.375% that we are scheduled to pay off in 11.33 years total (I’m thinking 10 years total or less), BUT we are also interested in getting a rental property.

Purely financially, we should probably stop making overpayments on our mortgage and sock that money away for a downpayment on a rental property since that interest rate will be higher.

But we’re not. What can I say? I’m stubborn. I rather own our home outright in 7 more years or less and pay off the rental property as quickly as possible as well. After our home is paid off, I’ll snowball those payments into the second property as well. Following this plan, we should own two houses completely by 2020…we will have just turned 36.

This is only possible if we stay at our current standard of living (living on less than $40,000 a year including the mortgage and overpayments) and don’t fall below our current $78,000 combined income level before taxes.

RJNo Gravatar January 25, 2010 at 4:21 pm


I have never studied rental property to much. Out of curiosity, are you forgoing retirement contributions to save for a rental property?

CrystalNo Gravatar January 26, 2010 at 5:22 pm

No. Our most important goal is early retirement. I contribute the maximum 6% that is matched to my 401k and have fully funded a Roth IRA since 2007. My husband contributes to his pension plan. We also have a Scottrade account and multiple savings accounts that will bridge the gap between our retirement and “normal” retirement age.

My husband finishes graduate school this summer and that money is going to be redirected into another Roth IRA and an account for a future rental property. His masters will also give him a small guaranteed raise…we’ll be putting that into the rental property account as well.

So, no, we definitely are not slowing down our retirement contributions. :-)

CrystalNo Gravatar January 26, 2010 at 5:24 pm

In case it may help to know, my husband is 26 and I’m 27. We started saving for retirement since we started our first “real” jobs out of college in 2005.

CrystalNo Gravatar January 22, 2010 at 1:15 pm

Just to clarify my personal summary above, I am on the side of paying your house off early. Like you said, take advantage of a guaranteed 5% return and peace of mind.

a Gen Y maleNo Gravatar January 23, 2010 at 10:53 pm

That is the very same subject my wife & I have been thinking about it and has not made a final decision on it. In the meantime, we are doing it both: contributing to retirement accounts and making extra house payments. We definitely want to be mortgage free way before retirement (we are both Gen Y) and aim to pay our 30 yrs mortgage, a large one, within 18 years (by the time our child, a kindergartner, goes to College.)

We also DO like the feeling of being “homeowners without mortgage”. Perhaps that goal is pushing us more toward paying it off.

RJNo Gravatar January 25, 2010 at 4:24 pm

@ a Gen Y Male

Thanks for your input. Glad to see there are others who like to be debt free, including a house, long before they retire.

JoeTaxpayerNo Gravatar January 25, 2010 at 4:38 pm

To gen Y’s point, I am a late boomer (b 1962) but late to marry and have the kid as well. She’s 11, 5th grade. 7 more years of school. We’ve saved for college but would be extra comfortable knowing the mortgage is fully paid by the time she starts school. So, that’s what out plan is and we are on track for that.
While 5% return isn’t great, I’ve learned that you can’t put a price on sleeping well at night. Having no mortgage payment is freedom, not 100%, but a large payment you won’t have to think about. Freedom for one of you to stop working, or freedom to save more to retire early.
To those who would argue against the choice – sometimes a 5% fixed just makes more sense than 10% with a 14% standard deviation….
.-= JoeTaxpayer´s last blog ..A Roth Roundup =-.

Paul @ FiscalGeekNo Gravatar January 25, 2010 at 5:20 pm

I’m with Joe 100%. At this point the difference in return vs. the mobility and freedom of no payments is priceless. Personally I’ve reached a point myself where I’m ready to make a break for it, and not being saddled with a large mortgage would be such a blessing. Best of luck to you guys wish I was thinking about this stuff when I was your age.
.-= Paul @ FiscalGeek´s last blog ..Save by Dropping Your GAP Automobile Insurance =-.

PatrickNo Gravatar May 19, 2010 at 11:01 pm

A point my wife brought up in this discussion was what do you expect your house to be worth when you are done making all your payments? If your house was purchased for $60,000 and in 15 years is going to be worth $90,000 was it worth prepaying to get there?

Just a thought. Also, does anyone know an easy formal to use in excel 07 for getting a 5% growth on a house purchased for $225,000?

JoeTaxpayerNo Gravatar May 20, 2010 at 8:27 am

Patrick –
Here’s a subtle, but important point. The change in value in the house should be unrelated to this decision.
Think about it. Whether or not the house rises in value and by how much should be considered before you buy it, with cash or financed.
In the prepay discussion, whatever you decide, the choice is between the other return you might get on the cash, or the 6% return you get on prepaying the mortgage. Unless one has very little equity and ponders a ‘walk’ I don’t quire see why the 15 year price would be part of the decision. The house will grow to that value regardless. Make sense?

RJNo Gravatar May 20, 2010 at 5:04 pm

@Patrick – Great question and Joe is right on with his answer.

SarahNo Gravatar July 3, 2010 at 2:41 am

contributing to retirement accounts and making extra house payments. We definitely want to be mortgage free way before retirement and aim to pay our 30 yrs mortgage, a large one, within 18 years

JennyNo Gravatar August 26, 2010 at 7:12 pm

I want my house to be finish paying for 5 years and I don’t know if it will cost much on the interest. I applied a 20 years plan and I wanted to reduce it to 5 years. How will I do it? DO I have to make arrangement because I already started paying the 20 years plan.

RJNo Gravatar August 30, 2010 at 10:34 am


You have a few options. Without knowing all the details, it’s hard to know what is best.

In order to pay it off inside five years, you have a few options.

First, you can look to refinance it. Mortgage rates are low.

Second, you can prepay the principal. Hopefully your mortgage company has calculators to see what exactly it would take to do something like this.

Hope this helps.


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