Pay off mortgage early in tough economy?
August 20, 2010 11:14 AM   Subscribe

If we have 30K in savings, and owe 200000 on a new house with 5% interest, do we want to put 10K of that into our 30 year mortgage as an early payment? Complicated by my feelings about the economy...

Soooooo...from what I've assessed, the economic outlook for the U.S. looks mighty grim. We have 30K in savings right now, plus a small retirement fund (we are in our 30's). We are really not sure where to put the money right now. I get the sense, from reading everything out there, that the economy is going to get uglier. Seriously ugly. Like 1930's and 40's ugly.

Do we want to keep all of our savings (and any additional we receive) liquid for the next few years (and I'm guessing, decades)? One of our goals was to pay down our mortgage early. Now I'm not so sure.

If we do put 10K into our mortgage, we'd have enough left as "an emergency fund" to last us 5-6 months.

Is paying off the mortgage early a good idea in what one believes is a tanking economy? Or not? I feel like the former layperson's knowledge I have about things like this do not necessarily hold true in a (possible) pending economic crash.
posted by The ____ of Justice to Work & Money (30 answers total)
I wouldn't do it. As a homeowner, you want your emergency fund to be able to cover home repair emergencies and maintenance urgencies. And those can easily eat thousands.
posted by Zed at 11:25 AM on August 20, 2010

I think it's worth making the mortgage payment to reduce the interest that you are paying. That money doesn't disappear; you still have it (in effect) in the form of home equity, and if you need it for something else, you can take out a second mortgage based on that equity.

But if you are really worried about a coming economic crash, I guess the best investment is gold. And guns, with which to protect your gold.
posted by grizzled at 11:25 AM on August 20, 2010 [1 favorite]

Lately, it takes way longer to get a job than 5-6 months. I would leave it alone.

We just had our injector sewer pump blow. It was $600. We also needed our deck stained before it rotted $200 for supplies/stain.

Things happen with homes and it sucks. Plus if you lose your job, there's that little thing called healthcare/med bills.

$30k in savings is probably an awesome emergency fund. Leave it.
posted by stormpooper at 11:31 AM on August 20, 2010

How much interest are you getting from the savings? Do mortgage companies in the US allow an offset deal? That is to say, but having the savings with the same company that provides the mortgage, you don't pay interest on the amount of your mortgage that equals the amount of your savings.
posted by Biru at 11:31 AM on August 20, 2010 [1 favorite]

How are your jobs currently? What are warning signs in the future in your fields? You're not planning on having kids (per prior question), but are there any potential major large fiscal demands (need to support elderly relatives, etc)? Where do you live, in terms of community stability? Examples: I'm figuring that much of coastal California, Oregon and Washington will remain desirable, as will other diverse big cities, but some towns are shrinking, or people are moving to cheaper communities in the general area.

Your money won't make much of anything in savings, and you could refinance your house to get money back out if you put money in now, but I don't know how well that works, especially in different financial times.

And Gold isn't always a safe bet. In the end, it's a commodity like anything else, and subject to price bubbles and bursts.
posted by filthy light thief at 11:32 AM on August 20, 2010

Response by poster: Thanks for the answers so far, everyone. Grizzled--I personally feel we're past the point of opportunity with gold, given its current highs. It would have been a great investment BEFORE our present day--at this point it seems a little too late. Also, I'm not crazy about the idea of having to protect something that valuable; there are many secondary costs associated with protecting it, as well as trying to sell it or transport it. We would be ill-equipped to deal with those. But thanks for your response nonetheless.

Filthy light thief--our jobs are okay right now, but you never know, right? Our jobs, like many jobs, are dependent on whether other people have money to spend. We don't have any major potential expenses currently.

Biru--we are currently getting a tiny amount from our savings, as most of it is in a checking account. (I know, we're lame.) As far as I know, US mortgage companies don't offset these things. (Anybody please correct me if I'm wrong.)
posted by The ____ of Justice at 11:43 AM on August 20, 2010

I would say that $30K is about the minimum I'd want to have in my emergency fund these days. Pay off a car, maybe, but not a house. $10K just won't get you into that better of a place in re your mortgage.
posted by Etrigan at 11:48 AM on August 20, 2010 [3 favorites]

Even if you decide not to use all the 30k you should add at least one month's payment extra per year (applied to the balance) It will knock thousands and years off the long term.
posted by Gungho at 12:06 PM on August 20, 2010 [2 favorites]

Is paying off the mortgage early a good idea in what one believes is a tanking economy? Or not?

Well, if your mortgage is paid off, then you don't have to worry about losing your house. other then a natural disaster, of course.

The only reason not to do it would be if you thought some investment you thought you could make that would yield better then the interest on your mortgage. Since you think the economic outlook is bad, my guess is you don't. So you might as well do it.
posted by delmoi at 12:11 PM on August 20, 2010

Also: is there an early time penalty for paying off the mortgage? If so, then probably not.
I would say that $30K is about the minimum I'd want to have in my emergency fund these days.
Without needing to pay rent, an emergency fund doesn't need to be as hefty. I would imagine of both lost their jobs, that emergency fund would mostly be used to make mortgage payments anyway. So it probably won't make much of a difference.
posted by delmoi at 12:14 PM on August 20, 2010

I wouldn't put $10,000 towards the mortgage in one lump sum. A $30,000 cushion is far better than a $20,000 cushion. Perhaps you can put a little extra towards your mortgage each month (I read that making one extra payment a year can help you pay your mortgage off several years early).

You might want to research conservative investment ideas and find an independent financial advisor to help you pick the safest investments.
posted by parakeetdog at 12:16 PM on August 20, 2010 [2 favorites]

I also want to point out that even if you make a $10,000 lump payment, that doesn't give you a break from paying your mortgage for several months. You will need to pay the full payment the following month. If you lost your job, the bank most likely will not allow you to skip payments even though you paid $10,000 in advance.
posted by parakeetdog at 12:19 PM on August 20, 2010 [2 favorites]

Yeah, I would say 9-12 months is better than 5-6. Unless you have an aggressive plan to pay off your mortgage in the next ten years, and are extremely confident in your ability to stay where you are once that's done, the most I'd recommend is the 13th payment annually. And I agree it's too late for gold. Look into better interest rates for your liquid savings, though, on general principal.
posted by SMPA at 12:27 PM on August 20, 2010

I would say that $30K is about the minimum I'd want to have in my emergency fund these days.

Without needing to pay rent, an emergency fund doesn't need to be as hefty.

The OP owes $200K on the house. $10K, or even the entire $30K, isn't going to make a substantive difference to the mortgage now.
posted by Etrigan at 12:27 PM on August 20, 2010 [1 favorite]

One other consideration - is that 5% rate fixed? My personal view is that interest rates will rise considerably in the next few years as governments attempt to inflate their debt away. In that case, you might as well keep the cash liquid and benefit from rising interest rates while your mortgage starts to look cheaper and cheaper.

If you don't have a fixed rate mortgage, this doesn't apply of course. Also, we could get deflation. But still, I'd wait and see before tying the money into the mortgage.
posted by crocomancer at 12:28 PM on August 20, 2010

While the future value of cutting your mortgage obligation by, let's say, $15,000 (assuming 30 years to on a $200,000 mortgage at 5%) brings a principal and interest payment from about $1,074 to roughly $805.This excludes your escrow payments for taxes and insurance, YMMV, but you save nearly $270/month, or over $3,200 per year - pretax. Looks nice. Assuming a Federal tax bracket of 20%, figure you lose 3200*0.2= about $645 in Federal tax breaks for interest expense in the first year. All this changes as time goes on, of course, and the best non-popup-ad site for mortgage calculators is on Bloomberg.
You'll have even better positive cashflow (and consequently interest you can deduct) if your term is 15 years.

If your have a 30-year mortgage, and refinance to a 15-year mortgage, at an assumed best rate of 4.44 percent (current rate + 50 basis points), your payment goes up to $1144/month, or $75 more per month. I wouldn't do that - the transaction costs would not be worth it. Instead, would look for other ways to increase your pprincipal amount with less impact - say, prepaying $75 a month if you can pull it out of your existing cashflow - *not* the saved money. That way you have the benefit of steadily increasing your principal. If you can't make the prepayment amount, skip it.

Nthing about preservation of liquid capital. I've been out of my old job sice June, and due to a small emergency fund plus a generous severance (plus, now, unemployment insurance), I can make it through to the end of the year, possibly later. I'm not eating cat food yet, and I can still afford the occasional six-pack of snooty beer, but I've drastically cut back on expenses (and, yes, have gone into a bit of debt for completely unplanned expenses like a reconditioned engine at $4,000).

Your monthly mortgage spend looks pretty manageable. The appeal of shaving off a couple hundred a month is imediate, but if your circumstances change abruptly (as mine did), you'll want every dime available.

If it matters, my retirement money is 55% in high-quality corporates (bought em cheap, don't recommend them now as they're rich), 20% cash and 20% common and 5% preferred.
In a much more hostile interest rate environment, I'd say go for it, but let it run and still save your heinies off.
posted by nj_subgenius at 12:28 PM on August 20, 2010 [3 favorites]

You are getting a tax deduction on the interest, and the rate is relatively low. I wouldn't bother paying down more principal. You never know when you will need that cash.
posted by eas98 at 12:33 PM on August 20, 2010 [1 favorite]

Firstly, try to move more savings into high interest accounts. Breakable CDs and savings accounts give you sufficient emergency fund liquidity with a better return. You're not investing at a size that would break FDIC, so there's no worry here. Leave enough in checking to avoid risking going negative between paychecks, which I'm assuming is a number less than $20k.

I think people make comparisons to the 1930s too readily, given the whole Dust Bowl thing. On the other hand, I hear wheat prices are up a lot given what's going on in Russia. If you're truly scared of food shortages cash settled futures can offset that risk, but you'll need faith in rule of law and the commodities exchanges. Failing that, ammo and canned food I guess. But seriously, we convert corn into ethanol, and feed lots of livestock. We have plenty of room to adjust. You should be more worried about draining the aquifers.

Finally, whether to pay down the mortgage or not. Some days I say it's a riskless return of 5 percent, which is impossible to find in the market for savings and CDs. But this neglects an opportunity for you to default on a massive non-recourse loan, which you're giving up by paying off early. I'm guessing you like this house enough to consider default a very last resort, in which case paying it down is attractive. Unless you have substantiated risk in your workplace like previous rounds of layoffs or other adverse events to the business, it's not a bad idea to move 10k into home equity.

If you're still really scared, develop a cost cutting plan to implement immediately when you're hit with income loss. If both employers offer insurance, figure out what you need to do to switch now. Find the contact numbers / addresses you need to cut netflix and cable and etc. Find out where the UI office is so you can apply immediately upon losing a job. And develop a list of people who you'll tell, and what you'll tell them, something along the lines of "Sorry friends and family, no fancy nights out until we're both working again. If anyone's hiring clever hardworking people, let us know!"
posted by pwnguin at 12:36 PM on August 20, 2010

I would recommend getting your excess cash out of your checking account and into laddered, FDIC-insured certificates of deposit. Keep some cash liquid for emergencies, then put, say, $5,000 rolling over every 3 months, $5,000 rolling over every 6 months, etc. The interest rates will suck, but they'll be better than what you're getting now.

Me, I would not pay down my mortgage. $30K isn't all that much money for two people if your incomes go south. Also, while it's true that you'd have that much more equity in your house, you're going to qualify for a home equity loan, to get it back out, only if you're employed and your credit is good.
posted by Short Attention Sp at 12:55 PM on August 20, 2010

I'd say do not make the lump 10k payment. It may provide temporary satisfaction - "Look at how much closer we are to owning the place!" - but in the end you've made a small dent and are left with fewer liquid assets, which as you've noted are important right now. And I'm not sure I agree with the people who think you don't need a very large emergency fund. Having a mortgage is equivalent to paying rent from an emergency fund standpoint, and as a couple many of your expenses are doubled (e.g., food) - so your fixed costs are significant. You need that fund.

However, since you have savings (i.e., are not paying off high-interest debt) and since investment returns are uncertain at the moment, paying off a little extra per month is a great idea. As has been pointed out, every little extra bit towards principle receives a guaranteed 5% yearly return. That's considerable for a guaranteed return in an uncertain market. Just like every month a certain % of your income goes to savings and a different % goes to retirement accounts, take a small % from your usual spending cash and put it into paying off the mortgage early.

Sure, it's not as satisfying as a 10k jump in your home equity, but at the end of each year you can add up the money you're saving over the life of your mortgage. That sounds pretty satisfying to me!
posted by Tehhund at 12:57 PM on August 20, 2010

As long as you have an emergency fund, there is no prepayment penalty on your mortgage, and you can safely tie this $10k up in your house then this is probably the way to go.

Think of it this way - where else are you going to get a low risk investment with 5% return on your money in this market?

If you pay off your mortgage you can compare it directly to a long term investment at a 5% return - take a look at CD rates. Plus this is a tax free 5% return - the bank is not going to send you a 1099-INT at the end of the year for paying your mortgage off early.*

If you are at all afraid of the risk of deflation this makes even more sense - your house may lose value in deflation but you will still owe the bank the same amount - and at least you won't be paying an additional 5% on that 10K for it.

It is easy to lose money on investements in this economy as it does its back and forth tango - but I get a solid 5.125% annual return on every dollar that my mortgage is paid off.

Finally - I recommend to everyone - have avaiable at all times a spreadsheet that amortizes your mortgage - all your outstanding credit for that matter - look at it often. Look closely at the amount of money you are paying to the bank over the course of your mortgage, play with decreasing the principal at different points in time based on what you can afford - its an eye opener.

*I am not going to discuss the mortgage interest deduction on here as I have very strong feelings about it and as a newbie it is probably best I keep that rant to myself.
posted by tr_tex at 2:23 PM on August 20, 2010

First off, I don't think the economy is really headed for a great depression kinda event. You need to read more blogs that aren't so negative. We have lots of problems, we are working through them and while the situation may not improve real soon now, I honestly don't see us fighting each other for food either. There are several long term trends that are really good-the yuan is gaining (long term needs to rise more to cure trade imbalance), savings rates are coming back, the government is finally and haltingly taking steps to cure some of the deregulation and bring down the deficit and oil price seems stable.

To answer the question-10k is a nice chunk to pay off the mortgage and will save you lots of money long term (and yes, download an excel spreadsheet that keeps track of your mortgage amortization and update it monthly). However a better strategy right now-keep your 30k in whatever high yeild you can get, try to pay a little extra every month on the mortgage (i found 1-200 on a 165k mortgage paid great dividends without too much coming out of my budget). And keep trying to add to the 30k savings, when you hit 35k or every raise or whatever, take out a chunk at apply it to the mortgage. A paid for house is never a bad idea.
posted by bartonlong at 4:21 PM on August 20, 2010

Personally I'd dump the lot into the mortgage. I'd like the idea of a 15% reduction in my debt & debt repayments. And banks love people with debts and savings and we all know how banks have our best interests at heart.

That said, the situation & mechanics are different where you are. A good article, from a UK perspective, on savings and debt repayment. We do have free healthcare & income support tho'...
posted by i_cola at 4:27 PM on August 20, 2010

i would open a 10k or 20 line of credit, then pay 10 or 20 against the house. Still leaves you with 10 or 20 available for emergencies,,
posted by dripped at 4:31 PM on August 20, 2010

I am not your financial advisor. I don't even own a house. But I'm wondering if you have a home equity line of credit (HELOC). If not, why? A HELOC can be your emergency fund.

Also, the odds that you will lose your job at the same time that your wife loses her job are pretty slim so if you think you need six months of living expenses in case you lose your job, maybe you really need closer to three months.

That said, you sound particularly risk averse. If that's the case, I think the idea of laddering CD's is a good one.
posted by kat518 at 5:43 PM on August 20, 2010

FWIW our financial advisor, speaking to our financial situation, recently said this is the wrong time to be dumping lots of cash into a house. If you run into problems the Bank will have amnesia about how much you dumped in and will still expect timely payments or else. They will also not be willing to give you a Home Equity loan (or increase an existing line) because you will no longer be those wonderful upscale people but rather those bad risk people. Plus the loss of tax deduction and reducing liquidity. I am not a financial advisor and your situation may be different than ours.
posted by forthright at 7:12 PM on August 20, 2010

I remember early days of mortgage payments and anxiety about how little equity I had and how long it would be before I had any. I poured in as much as I could in prepayments and it was a good decision BUT I bought at a time when, during the life of my mortgage, the house quadrupled in market value. Very few parts of the country are in that kind of a real estate market right now. I suggest you scrutinize the RE market and not put a chunk of money into the mortgage until you are sure the market has stabilized. The biggest danger is having to sell or default in a falling market and kicking yourself because you could/should have kept the money.

I concur with having emergency budget plans for job crises, adding to savings and laddering CD's.
posted by Anitanola at 9:33 PM on August 20, 2010

I vote for keeping it liquid, while increasing your mortgage payments. The most important debt to pay off is anything high-interest, which includes most consumer credit. Perhaps focus on a goal of being free of non-mortgage debt in two or three years. This is even better than saving more.

If you can get a HELOC with your existing equity, consider it, but also look into how it might affect your credit score in case you need to take out some other type of loan, like for a new car. Whatever you do, make that an emergency fund, because this is definitely not the time to cash out on your home.

The economy may double-dip into recession again, but the real problem ahead is that we're flirting with deflation. This can actually be somewhat good -- it increases the buying power of wage-earners -- but not good in that it increases the relative burden of debt. But debt on a house is not the same as other debt, because of the utility of having a place to live, and the presumed long-term nature of the investment means you may be able to look beyond the current economic situation to 10 or 15 years from now.
posted by dhartung at 10:30 PM on August 20, 2010

I'm not a financial advisor. But you might talk to your financial institution about whether they would match your current rate with a home equity line of credit. Under this model, they will free up a matching line of credit based on equity you pay down. So, if you pay down $10k with the balloon payment, they offer you a line of credit of $10k.

So then you don't use the line of credit unless there's an emergency. If there's an emergency and you need $10k, you write out a cheque on the line of credit. Your mortgage goes right back to where it would have been. But, in the mean time, you've been saving on your interest costs and directing more of your monthly payment to principal. In case of emergency, your total debt load is no different. (Although, in the US, I think you can write off interest on a mortgage, so that might be a consideration if you live there.0

Please do not confuse this with getting a LOC where you are just tapping into the equity you've paid down through regular payments or through an increase in property value.

HOWEVER, there is a risk with this. If you lose your job and your credit is shot, the bank may decide not to give you the LOC anymore. But, on the other hand, if you paid down the mortgage, they aren't going to give you back the balloon payment either.

So what I would suggest is talking to the bank about an LOC. If you have other emergency fund money and good financial discipline, the LOC that matches your balloon payment may be a viable option. (Perhaps hedge this by paying down $5k and getting an LOC for $5k? Or whatever split feels safe. Do note that you don't actually use the LOC unless you are in an emergency situation. Regardless of what the bank would prefer. ;) )
posted by acoutu at 2:14 PM on August 21, 2010

Response by poster: Thanks for the immensely helpful answers! The LOC is an interesting idea. We will go ahead and put SOME of it into the mortgage. As to how much, my partner and I now seem to be split on the amount.....*sigh*
posted by The ____ of Justice at 11:29 AM on August 23, 2010

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