Paying Off Your Mortgage Early Could Cost You $100,000…Or More

Both Robert and Phil have just become homeowners! They each purchased their new home for $250,000 with a 30-year 4.60% fixed rate mortgage. Although their minimum monthly payment is the same, they plan to tackle their mortgages in very different ways. Robert plans to stick to the normal payment schedule over the 30-year life of the loan, while Phil plans to pay his loan off early by contributing an extra $500 each month. Let’s see how things turn out.

Assumptions:
Mortgage = $250,000
Loan Term = 30-Years
Interest Rate = 4.60%
Minimum Monthly Payment = $1,282

Robert’s Results:
Monthly Payment = $1,282
Time To Payoff Loan = 30 years
Total Amount Paid = $461,380
Total Interest Paid = $461,380 - $250,000 = $211,380

After 30 years, Robert has paid over $200,000 in interest! His home is now paid off but it cost him nearly double the original purchase price.

Phil’s Results:
Monthly Payment = $1,282 + $500 = $1,782
Time To Payoff Loan = 16 years
Total Amount Paid = $359,480
Total Interest Paid = $359,480 - $250,000 = $109,480

Money Saved = $461,380 - $359,480 = $101,900
Time Saved = 14 years

By contributing an extra $500 each month, Phil was able to pay his mortgage off in only 16 years instead of 30. In addition, Phil saved over $100,00 in interest he would have had to pay had he only made the minimum payments!

Following this example, the correct approach seems simple: Put as much as you can afford toward your mortgage, paying it off as soon as possible, and you’ll save yourself massive amounts of both time and money. At first glance, this seems like a perfectly reasonable plan. Unfortunately, it could potentially cost you hundreds of thousands of dollars.

The key component that is missing from this analysis is, you guessed it, investing. In the example above, the extra $500 Phil applied to his mortgage each month could have just as easily been used as investment capital. I wonder how things would have turned out in that case…

First, we’ll calculate what Phil’s net worth would be after 30 years. Using the parameters from the original example, we assume he contributes an extra $500 each month to his mortgage and is finished paying off his house in 16 years. At this point, without a mortgage to pay, Phil begins making monthly contributions to his stock investment account, something he continues to do for the next 14 years (i.e. 16 years + 14 years = 30 years).

Assumptions:
Stock Investment Rate Of Return = 8.5%

Phil’s Results:
Monthly Contribution = $1,782
Years Of Investing = 14 years
Investment Account Final Value = $571,914
Net Worth After 30 Years = $571,914 + Fully Paid Off Home

After 30 years, not only does Phil fully own his home, he also has $571,914 in his investment account! Not a bad result at all, but could he have done better?

Let’s assume Robert also had an extra $500 to spend each month, but instead of applying it to his mortgage, he decided to contribute it to his stock investment account.

Robert’s Results:
Monthly Contribution = $500
Years Of Investing = 30 years
Investment Account Final Value = $825,353
Net Worth After 30 Years = $825,353 + Fully Paid Off Home

Wow. Even though Robert only contributed $500 each month to his investment account, he ended up with over $250,000 more than Phil (i.e. $825,353 - $571,914 = $253,439)! By allocating extra money to his investments instead of his mortgage, Robert was able to out-save Phil by HUNDREDS OF THOUSANDS OF DOLLARS, all while still paying off his home! How is this possible? The answer is simple: Time + Compound Growth.

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