Overpay mortgage or save money for repairs/renovation?
December 4, 2022 7:31 PM   Subscribe

I just bought a house and my mortgage rate is 7.25%. Until I can refinance, should I aggressively overpay my mortgage, or put that money towards house maintenance, repairs, and eventual renovations?

It wasn't my preference to buy a house when the interest rates are so high, but I found a great little house that I got for under market price, so the mortgage is easily affordable even at the high rate.

The house itself is 75 years old, and while it has some newer mechanicals and features (e.g. new gutters, new drain tile system in basement, etc.), I know that things can pop up and I should try to keep cash on hand for these expenses. I have about $10K in a dedicated savings account only to be used for house stuff, and will plan to add $200 or $300 each month to this fund as well.

Some months, I'm fortunate enough to have some money leftover, even after bills and savings, and I thought it made the most sense to take any extra money and throw it at my mortgage principal, since I'm paying a relatively high interest rate. However, a friend of mine argued that it won't make much of a difference in the long term, especially since I'll (hopefully!) refinance in the next few years, and that it's better to just keep amassing cash because houses create so many expenses.

I should also mention that I have a whole list of renovation plans for the house, as the kitchen and bathroom are quite dated and I'd love to finish the basement. I probably won't be able to afford them all, but I'd like to start saving up for some major renovations down the line (think 10+ years away). But if overpaying my mortgage is going to save me tens of thousands of dollars, maybe I should focus on that first then worry about saving for renos later?

I'm a first-time homebuyer and not used to such financial calculus, so any insight would be much appreciated. Thank you!
posted by leftover_scrabble_rack to Work & Money (22 answers total) 3 users marked this as a favorite
Best answer: I would prioritize things this way with respect to the house, YMMV

1) Essential maintenance -- to preserve the value of this house and your other possessions in it, and to keep yourself healthy

2) Emergency fund -- have several months of expenses for emergencies

3) Pay down principle -- this will save money, potentially a lot of it, you and your friend don't know when refinancing will be an option

4) Save for renovations

This assumes no or little other debts, that you are adequately saving for retirement, have health insurance sorted, etc.
posted by jclarkin at 8:05 PM on December 4, 2022 [5 favorites]

If there's no penalty for overpaying your mortgage, just do it. $10k is a reasonable amount to have in a contingency fund for the house, especially if you plan to grow that over time. Why not pay down some of the principal and reduce the amount you pay in interest? Even if you refinance in five years, for every $1000 you pay extra now, you're saving over $350 in interest over five years. That's not nothing!

If you want to start saving for major renovations in 10+ years, do that in five years or more (or bear it in mind when you refinance and you can adjust your monthly payment at that point to make this feasible).

The only exception would be if there are major expenses that are likely to come up in the next few years that will significantly cut into your $10k, like perhaps a new roof or other major projects. If not, then I wouldn't hesitate to put money towards the principal.
posted by ssg at 8:07 PM on December 4, 2022 [2 favorites]

If you pay off your mortgage, you can view this as getting you a return of 7.25% minus your highest rate of federal tax (that is, 7.25% minus 20% of 7.25%, if 20% were your top tax rate). Even if your tax rate is comparatively high, that's quite a good rate of return, much better than savings accounts. Note, however, that it's a 30 year investment (or at least until you refi) as you typically can't pull that money back out of the mortgage once it's been paid. Also, if you refi and take more cash out then you don't get your tax break back on the interest in that money, is it's not all roses. I would suggest that anything you pay into your mortgage you view as invested until you sell your house.

Second: this isn't really about paying the mortgage or maintenance; it's more about liquid assets in an fund that you can spend on house maintenance, versus illiquid assets that you've 'invested' in your mortgage. Typically I would find an emergency fund that will most likely see me though house maintenance, crisis, loss of job, whatever, for 80% of the possibilities, and assume I'll be getting a loan/selling the house or something for the worst case scenarios. But if you want to do discretionary work on your house, ask yourself: is it worth 7.25% a year in lost investment returns to do that?

Third and finally: is there a better (for you) way to invest your money than paying off your mortgage? In recent years, with low rates, it probably made more sense to buy shares than pay off a 3% mortgage, for instance, but now your options are different now thanks to the different rates and market conditions - plus this is a gamble, not a certainty, with most investments, that you'll make more money that way. If you can't make sense of that idea by yourself that's where I would find a (fee only) financial advisor.
posted by How much is that froggie in the window at 8:14 PM on December 4, 2022 [2 favorites]

Congratulations on your new home! I'd keep that $10k handy for any emergency repairs or unanticipated disasters that arise during your first year of living in the home. Problems can happen at any time but getting a feel for the house will certainly help. Likewise, I'd wait at least a year before making any changes other than paint or changing little details: you'll know what is a must and what is a plus, and certain things may grow on you. $10k is a wonderful amount of money to have but, in case of emergency, can suddenly disappear. However, that's better than accruing (more) debt! I know there are many approaches you can take here but that's what I'd do in your shoes.
posted by smorgasbord at 8:17 PM on December 4, 2022 [2 favorites]

Paying down the principle is never a bad idea, and if rates come down and you want to refi, a lower principle ought to make that deal better.

If there are no pressing needs for renovation/repairs, and you have 10k for any emergency, I'd shove a few hundred bucks at the principle when you can and see where rates go and have fun arranging your knickknacks in your new home.
posted by vrakatar at 8:19 PM on December 4, 2022

Best answer: If you pay extra every month on your mortgage, say $100, you'll make a substantial dent on your long term interest payments. Likewise many mortgage companies will let you pay every two weeks rather than monthly, another strategy to bring down your long term interest payments.

In any event, better to pay extra in a way that you can sustain long term than throw money at your mortgage. The mortgage ain't going away any time soon. Best you live within your means, save up for disasters/renovations/maintenance with a healthy fund for that and pay your mortgage regularly. And be ready to refinance with a chunk of money ready for that.

That's how I do it anyhoos.
posted by diode at 8:29 PM on December 4, 2022 [2 favorites]

I would play around with numbers in Excel to see how much those extra payments really are helping in the long term. It's good not to pay more in interest than you have to, but liquidity is important too; if you shove $5k into the mortgage, you can't easily get it back out if you suddenly need a new furnace.
posted by Blue Jello Elf at 8:45 PM on December 4, 2022 [4 favorites]

Best answer: Have you thought about bi-weekly payments? One extra payment a year pushes down the primary rather painlessly.

If you do send extra to your lender, make sure to write "Please apply extra to principal." When I got my first year-end statement, I found they had applied all extra funds to the escrow account.
posted by Marky at 11:31 PM on December 4, 2022 [7 favorites]

I personally would make a distinction between an emergency fund and maintenance costs. The maintenance cost rule of thumb is 1% of the cost of the home. So I’d up your emergency fund (10k + 1%) and then make extra payments.

Also co-signing the biweekly payments.
posted by warriorqueen at 3:08 AM on December 5, 2022 [1 favorite]

It depends on what scenarios you're planning for, but I would personally keep more than $10k in liquid assets available in case of an emergency. There are definitely home repairs that would cost more. And that can be done in an interest-earning way (not 7.5% but not nothing). That said, if this $10k for house stuff is separate from other savings (e.g., an unemployment contingency fund) that could be drawn upon if needed, then prepay away.
posted by slidell at 4:55 AM on December 5, 2022 [1 favorite]

I feel like $10,000 is a sufficient amount to have as cash on hand for emergency infrastructure repair needs, especially if you have a $200-300 surplus each month and can therefore juggle short-term 0% interest options out there to handle a $2-3,000 repair on credit without even needing to touch the emergency fund. As far as your longer term remodeling needs, I would pay down extra principle now with the thought that you will probably want to refinance at some point when interest rates are more attractive and you can take some of that equity back out again at that point for those--especially if you are going to take the standard deduction and not itemizing.
posted by drlith at 6:17 AM on December 5, 2022

Best answer: I would argue that ideallly (as in, if your financial situation allows), you should have more in the range of $25k available for house emergencies. My personal experience has been that there are an endless string of ~$200 expenses (new kitchen faucet, kitchen backsplash starts sagging off the wall, two outlets stop working, etc.). Those are simply ongoing and I just pay out of my regular monthly budget.

Then, more intermittently, there are expenses in the $2k to $10k area -- a new furnace is the classic example, or having your dishwasher stop working and then when you pull it out you discover that there was a slow leak that has rotted a section of the floor. In a good year none of these happen, in a bad year you might get two or even three, and you want to be able to pay for this out of your house emergency fund (even if you then make the decision to use a zero interest card, say).

Lastly, there are the big, major expenses that are probably above what you have in your house fund and hopefully come very rarely if ever. Things like finding out you need a new foundation, or not just a new roof but also new rafters, say. Your house fund is what allows these to be a bummer and total pain in the ass, versus being a major catastrophe.

That was a long answer to say that I basically agree with the prioritization by jclarkin up above. Once you are fully covered on the other items, then go ahead and pay down the mortgage if that makes you happier/more comfortable.

For many people (probably even most people), having such a large house emergency fund just isn't very possible, and then you are going to be in a somewhat more complex situation of needing to carefully triage work, look for cheaper interim solutions that allow you to push out major expenses, and investigate credit options for unavoidable major expenses. With our first house, the furnace started to fail and for financial reasons I continued paying ~$900 year in short term fixes for several years before feeling comfortable to pull the trigger on a $6k furnace replacement. It would have been cheaper to replace it on day one, but I simply didn't feel like we could afford that then, so we chose to pay more over time to delay the big expense. Those are the kinds of tradeoffs you do when you don't have a large financial buffer.
posted by Dip Flash at 7:11 AM on December 5, 2022 [2 favorites]

However, a friend of mine argued that it won't make much of a difference in the long term, especially since I'll (hopefully!) refinance in the next few years, and that it's better to just keep amassing cash because houses create so many expenses.

You need to load your current mortgage data into an amortization calculator to get a clear idea of how much interest you'll save under various principle pay-down scenarios and "next few years" definitions. In the general sense, your friend is right. Paying down principal now will help you much more at the end of your mortgage (years 20-30) than it does at the beginning of it (years 0-10).
posted by Press Butt.on to Check at 7:12 AM on December 5, 2022

Best answer: Some basics:

Use of the rule of 72 for determining how long some interest will double in value:

72/ 7.25 = 10 years. So over 30 years you will pay 3X in interest.
72/5 = 15 years. So 2X in interest over 30 years.
72/3 = 24 years = So barely 1X over 30 years.

So you can see that agressively paying down your interest above around 5% really makes a huge difference in your loan. You should pay down as much as you can as quickly as you can.

Quick math at $500k for 30 years: $768k @ 7.25%, $494k @ 5%, $274k @ 3%.

And if you can later as rates go down, refinance.
posted by The_Vegetables at 7:40 AM on December 5, 2022 [1 favorite]

In the general sense, your friend is right. Paying down principal now will help you much more at the end of your mortgage (years 20-30) than it does at the beginning of it (years 0-10).

No it won't, because mortgage calculations are yearly simple interest: 7% of $500k is $36250, $400k is $29,000, and 7% of $25000 = $1812.

It helps far more at the beginning of the mortgage than the end.
posted by The_Vegetables at 7:43 AM on December 5, 2022 [2 favorites]

Agreed, it saves money to pay down now. But amortization makes the difference in savings is (potentially much) bigger if the loan kept longer than if it is ended after 5 years (aka refinanced). You can only see the actual savings in interest by using an amortization calculator. Simple math only applies if the loan lives through its full payment schedule.
posted by Press Butt.on to Check at 8:00 AM on December 5, 2022

. You can only see the actual savings in interest by using an amortization calculator. Simple math only applies if the loan lives through its full payment schedule.

I'm sorry, but you don't seem to understand the math of mortgage well enough.

There are no scenarios where paying a higher interest rate will be to your advantage, so there is nothing to put into an amortization calculator that would help make any decision.

If you want to make a choice between a 20 year mortgage at 5% and a 30 year at 5%, by all means put that into a calculator, but you don't need a calculator to know that lowering your rate as quickly as possible will save real money.
posted by The_Vegetables at 8:20 AM on December 5, 2022

7% is even high enough where theoreticals like "would I earn more in the stock market than paying my mortgage down?" are extremely risky and unlikely to make a big difference.
posted by The_Vegetables at 8:25 AM on December 5, 2022

The question, as I understand it, is "I have an extra $200-300/month in my budget for housing. Should I pay down my existing mortgage with that money or use it for other things like repairs and remodeling?" I am tying to help the asker understand exactly what they will save in interest if, for example, they refinance in 5 years. That's the only portion of the bigger question I am trying to help with.

To find that number the asker needs put their existing loan into an amortization calculator and see where they stand in terms of total principal left at payment number 60. Most calculators also have a feature that's let's you add early principal payments to see how total interest is changed. To make a more informed decision on the bigger question, they need to see what the difference is at payment 60 if they start now at payment X with an extra $200 (e.g.) a month.

I personally will always chose to pay down debt. It sounds like you agree with that strategy. But the friend is right that, if they refinance in 5 years, the savings may not be a big as they might first think. It's not simply 7.5%.
posted by Press Butt.on to Check at 9:02 AM on December 5, 2022

To be clear, I get the interest "savings" will be on lower principle they will be refinancing. The total interest will be same at payment 60 no matter what. I did not communicate that notion well.
posted by Press Butt.on to Check at 9:17 AM on December 5, 2022

Response by poster: This is all very helpful! To clarify, I will for sure be putting $200 or $300 into my house fund, which has $10K in it already. But I will sometimes have extra money even after that, and I'm wondering how to prioritize it.

I think my takeaway from this thread is to do both -- overpaying even a little bit should help in the long run, but it's also useful to build up cash reserves.

Very happy to hear more opinions if you've got them! I was waiting for someone to say, "OMFG YOUR INTEREST RATE IS SO HIGH PAY THAT SHIT DOWN IMMEDIATELY" but no one has, so that's helpful in and of itself.
posted by leftover_scrabble_rack at 9:23 AM on December 5, 2022 [1 favorite]

May I also suggest getting a home warranty? I bought a house last year that is 92 years old. It has saved me a tremendous amount of money in repairs, because even though everything passed the inspection, the upstairs heating and cooling unit soon needed a $1600 part. I didn't have to pay that at all, as it was included in my warranty. There is a monthly fee and a fee when a technician comes out, but it has definitely saved me money.
posted by poppunkcat at 5:56 AM on December 6, 2022

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