Prepaying a mortgage is prepaying the principal, which immediately lowers the interest portion of future payments (and giving you an immediate 6% return for the rest of the life of the loan).

The reason I bring this up is that people have this idea that if they have a 6% mortgage (fully amortized), that they are saving 6% by paying it off early. But you are not. You are saving more like 3-4%, as you are essentially applying the extra money to the final payments.

Keep this in mind when doing calculations for paying the loan off early and how much interest is really being saved percentage wise.

“Now, if your mortgage is at 5% and CDs are at 2%, it makes sense to prepay. But if in a few years the interest rates change, you can put money in a CD instead. This is what you get with 30-year mortgage: more flexibility.”

Actually I am prepaying quite a bit on my mortgage — almost double payments a month, since CD yields are nowhere near my mortgage interest. I have a fairly large cash reserve as well, which I recommend everyone to have before any investing or prepaying. My specific goal is to have the house paid off before my first child enters college — and that is driving my decisions at this point. The equity I’m building in my house is never lost, since I can always take out a no-cost HELOC if I needed the money again. Some would argue that you should “invest” for kids college, but instead, I’m freeing up future cashflow to pay for college on the spot… It’s a conservative / low-risk move on my part.

FYI, I do invest 6% into a matching Roth-401k for retirement.

If CD’s yields rise above my mortgage interest rate, then instead of prepaying, I’ll buy the CDs instead (that’s a no-brainer) — but not until that happens. I doubt CD rates will go above my mortgage rate in the next 4 years anyhow.

Once my house if paid off, I’m going to get quite aggressive in my investing, since I still will have a 25-year time horizon until retirement. I feel that I can get aggressive at this time because I’ll have $0 debt. Plus having no debt will give me the _freedom_ to pursue other lines of work (ie; start a business), as an alternate investment than just the stock market.

That’s my plan anyhow…

However, with a 30 year loan, you can choose to pay it off in 15 years and pay the higher payment, but have the lower payment to come back to if there is a sudden loss in income. This isn’t possible with the 15 year loan, where you are locked into the rate.

So if I was 25 and had a home, I would get the 30 year and invest the rest of the money, as my timeline would be longer and I would not have so much at risk in the market when I am close to retirement.

Finally, you can lose 100% of your house. If you have a disaster that isn’t covered by your insurance, then you lose everything on your paid-for house. Even if you are insured, there is still the need to rent and cover deductables until your new house is built, which is much easier to do when you have the extra cash you have been putting away. In other words, the safest place to be would not necessarily having the house paid, but having enough liquid assets (cash, stocks, bonds) to cover the rest of the cost of the house.

My short observation would be that with an 8% difference in net worth at the end of 30 years, with assumed 8% investment growth, it’s pretty much a wash.

My second observation would be that it depends very much what real-world buyers would be doing outside of the play model (6% mortgage and 8% investment income). The lower payments with the 30 year mortgage give greater opportunity to invest … wisely or badly. Of course, Mr 15 Years might have priced his housing to still allow parallel investment … wisely or badly.

I overpaid my adjustable rate 30 yr loan, essentially making it into a 15. In retrospect I could have kept it at a 30 year pace and bought SP500 starting in the mid-eighties. I’d be ahead no doubt, but of course I didn’t know then what I know now.

No, what I am saying is that it is less risky to have smaller payments and more money in the bank than larger payments and less or no money in the bank. You are not debt-free for the first 15 years with either mortgage, but with one you have higher premiums, hence more risk. This is also the time when you are more vulnerable – you are still young, didn’t have much time to save money and are earning less.

The remaining 15 years are riskier with 30 year mortgage, but my point was that if you have saved money during the first 15 years and if you got a normal growth of income; you have enough of a cushion to survive an emergency. I.e. the extra risk with 15 year mortgage in the first 15 years is higher than the extra risk in the second 15 years. Why is it so difficult to understand? Do you get raises every year (or every other year)? Are you hoping for the promotions? Do you really think you’ll have less money and less income 15 years from now?

‘“…This is really an investment decision…”

I’d never treat my house as an investment. You can lose 50% of your stock investments, but you can’t lose 50% of your house — you lose all of it.’

You misunderstood. I don’t consider my home as an investment either. But I am not saying buying or not buying a home is an investment decision, I am talking about taking a loan or not taking a loan or talking a shorter term loan or longer term loan. Saying that choosing the type of mortgage is an investment decision has nothing to do with whether or not your home is an investment. It is an investment decision because you are choosing of what to do with the money to get higher return: invest more of your money into your house by paying it off quicker or invest less money into your house and put the rest elsewhere.

In terms of taking money from the house and investing it in the market. It is an investment decision even if a stupid one. Any investment decision can be good or bad, less risky or more risky. Buying stocks on margin is also an investment decision though for most people it is likely to be a stupid one. Now, what is stupid or “risk that paid off” is often better visible in hindsight, but it is certainly an extremely risky decision. Putting all of your money into GM bonds would’ve been an extremely stupid decision, but it is still an investment decision. But taking a 30-year vs 15-year mortgage and putting money in, for example, AAA municipal bonds may not be a bad decision. Or buying a rental. Taking a 30-year fixed in, for example, 1970 and just keeping money in a bank waiting for higher interest rates turned out to be a better investment decision that taking a 15-year fixed. In 1980, those who took 15-year mortgages in 1970 still had higher payments and less cash whereas those who took 30-year mortgages and saved extra money in CDs, could simply take the money they saved and buy 13% CDs while paying 9% to the bank (I didn’t check the exact interest rates, so my exact years may be a bit off). If you are taking a 15 year fixed right now and we end up getting 80-style inflation 5 years from now and double digit interest rates on CDs, would you rather have cash or all your money in a house equity?

Now, if your mortgage is at 5% and CDs are at 2%, it makes sense to prepay. But if in a few years the interest rates change, you can put money in a CD instead. This is what you get with 30-year mortgage: more flexibility. You can pay extra while you have money and interest rates are low – all the way keeping a nice cash cushion to cover payments if something happens. Then if you have some family emergency, at least you have lower payments. But if interest rates change, you have flexibility of putting extra money into a CD instead. Or municipal bonds. BTW – just a few months ago I bought AA and AAA individual munis with yield-to-maturity of 5.5% (tax-free rate of 5% and 5.25% on two different issues; 5.5 YTM is because I bought at a discount).

The answer to your investing point is this: my husband and I do a combo re: investing. For the past 18 months we have consciously chosen to have a lot in laddered cds (rates had been around 3-4%, now rolled over into 1.9- 2%), our ING savings acct, some EE and I savings bonds, cash value of our NWM life insurance, our retirement 401ks and IRAs, some P&G stock, and a mutual fund. Since we’ve been working 20+ years and my husband has had nice e’er matches, of course the majority of our investments would be in stocks, but I’d say 70% stocks vs 30% cash/CDs/US bonds.

We’ve been carrying 3 mortgages for the last 2 years: 1st mortg and equity line (used as downpmt on our current house and for its renovations) on our 1st house and our 1st mortgage on our “dream” house. Yup, we thought we’d be able to sell our house right away…23 months later it finally happened this week. If it weren’t for my 2.75% equity rate and 3% ING ARM on the 1st home it could have been much worse carrying the debt load. Looking back, if I hadn’t been so intent on paying off the 1st home’s mortgage w/extra prin pmts and had instead saved more, we might not have had to take the equity line. So…it all depends on what you think is coming down the road. I never thought we’d move from our 1st house so I pursued the paydown w/vigor. And that was ok as we did save a lot on interest in the early years when it was 6%+. Did I beat the market while I had such low debt rates in the last couple years? Well my cds were at a higher rate than my 1st home’s debt rates, but that was just dumb luck. I got the debt at the right time and I got the cds at the right time. Meanwhile the stocks took a beating but have, of course, come back. But the time value is lost…

Now I’m a little wiser and will still pay a little extra on our 4.75% mortgage, but I like the cash cushion, being able to save for college (yes, all equities) and continue fully funding hubby’s 401k. And I’m starting to sleep better…

If you and kitty both think that the earlier years of owning a home are the riskiest time-periods, then shouldn’t you be more conservative with excess cash instead of putting it into a non-guaranteed & risky stock investment?

If we want to approach the subject specifically from an “investment” POV:

We are comparing two investments:

1) risk-free (and tax-free) return of 6.3%, for mortgage prepayment

2) non-guaranteed, hence risky, and taxable (unless in a Roth) return of 8.0% for stock investing

In my mind, the 1.7% return you are trying to capture with the 30-year scenario just simply is not enough for the risk you are taking (my opinion). If the spread were 5%, then you’d get my attention…

But it is all about the risk. My mortgage is at 5%, and if CDs were yielding 5.5%, then I’d buy them instead of prepaying the mortgage — but in this case, both investments would be “risk-free” and the yields are comparable, though I’d need to do the math for the tax consequences on the CDs.

Stocks can be more risky than a home–just look at the darkest days of GM’s swandive, etc.

Kitty’s point is a good one…either financing path you choose, the 1st 15 year’s risk level affects either term (whether 15- or 30-yr) and certainly has more impact in the earlier years when your earning power is less and you have fewer resources.

We’re the perfect example: 15 years ago my husband was 31 and we were just about to have our first child. Salary was way less than half of what it is now and we had no significant E-fund (early years of our mortgage.)Fast forward 15 years later: Now we could get thru a year if God forbid, something catastrophic happened that he couldn’t provide (and in the event of disability, we’d have his disability income.)

So yes, there is less risk in the latter years of a loan for most people as they should have some resources at their disposal.

And yes, Kitty did not mispeak when stating it was an investing decision. You either invest the money and go long-term on the loan or you choose another path for the funds (pay down debt, further your education, etc.) Whether you’re paying rent or a mortgage, the use of the discretionary funds is indeed an investing decision.

Finally, if inflation gets to 5%+ percent and one’s mortgage is fixed at 4.75%, then it was less risky to maintain some level of debt b/c you can be earning a better return on your funds than your mortgage rate. You may not sleep better, but the spread is there. Arbitrage.