In my strong opinion, prioritizing the completion of your mortgage repayments before entering into retirement is the wisest course of action. Regardless of a low-interest rate, achieving a mortgage-free status is highly recommended.
This perspective holds more weight, particularly if your retirement funds aren’t substantial or if you lack a sizeable amount in immediate cash savings. This is largely attributed to the fact that your mortgage payment is probably your most significant recurring monthly obligation.
However, the concept of making additional payments is generally not advisable.
The Advantage of Settling Your Mortgage Early
Many individuals argue against settling a mortgage early if the mortgage interest rate is at 3%, and the return on investments can yield a rate higher than that. If we could predict the future with certainty, such an argument might hold water. However, given the unpredictability of life, I lean towards the contrary.
Imagine a scenario where you’ve benefited from the all-time low interest rates of 2021, securing a rate of 3% by refinancing a $100,000 mortgage for three decades. As a result, your monthly mortgage payment becomes a manageable $422.
But what if you had an extra $100,000 at your disposal to settle that loan right away? The $422 that was once reserved for mortgage payments would now be freed up. Alternatively, you could perceive it as an increase in your monthly disposable income by $422. In essence, it’s akin to earning a 5.07% interest rate on the $100,000 for the remainder of your mortgage term. In this instance, you are securing a guaranteed 5.07% return over the next 27 years.
1. Despite the accessible mortgage interest rate of 3%, it would have required a 5% rate for me to just balance the books!
Undeniably, if your investment profits surpass expectations, that’s an ideal scenario. However, the reality highlights there are no assurances with investments.
Take, for instance, the S&P’s performance in August 2000 hitting a record peak of 2709. Fast forward to September 2002, it had dwindled down to 1389, reflecting a 40% decline in value. A return to the previous high was only evident as late as April 2015 when the S&P registered 2719. This suggests a 15-year span of negative returns.
Let’s use a hypothetical scenario of a $100,000 mortgage. Which of these options would have been more enticing? A guaranteed $422 increment in accessible funds or a grueling 15-year wait to recover the initial investment of $100,000?
I personally detest stressful situations and seeing my $100,000 plunge to $51,000 would certainly be distressing.
There will be those who counter that if that $100,000 were invested in the S&P from March 2009 at 1157 through to February 2024 when it reached 5069, the initial $100,000 would have amounted to a whopping $438,115. Indeed, this is a significantly superior return compared to the 5.07% that would have been secured from my fully paid mortgage.
2. The examples cited are grounded in real-time scenarios. The crux of the matter is, are you comfortable with the risks involved and prepared to face a 15-year period of losses if it comes to that?
Have you considered making additional payments towards your mortgage?
Since forever, financial advisors have suggested two primary strategies. One is opting for a 15-year mortgage rather than a 30-year mortgage. The other is making mortgage payments every two weeks. Sometimes, individuals choose to make an additional mortgage payment whenever feasible.
Regardless of the strategy, you end up paying more than necessary towards your mortgage. Sadly, those extra payments don’t affect your monthly mortgage instalments.
Moreover, your mortgage serves as an illiquid asset. In case of emergencies where you need funds, they aren’t easily accessible.
Some may argue that in such situations, one can always resort to an equity line of credit, but let me stop you right there. That’s a poor decision. Any funds drawn through the equity line of credit necessitates repayment. During financially challenging times, this would mean saddling yourself with an additional monthly payment.
An Insightful Overview of the 15-Year Mortgage
The primary appeal of a 15-year mortgage has been the potential of saving an ample amount in interest. Undeniably, this aspect holds true.
Another key advantage is that a 15-year mortgage typically carries a lower interest rate.
Information provided by bankrate.com reveals that the average rate (February 26, 2024) for a thirty-year mortgage stood at 7.28%, whilst the 15-year mortgages held a rate of 6.7%. Now, consider the monthly payment for a $100,000 mortgage.
30-year mortgage @7.28% = $684
15-year mortgage @6.70% = $882
Difference in monthly payment = $198
By investing an extra $198 every month, you can also achieve substantial savings in interest.
Total interest payable on a 30-year loan = $146,316
Total interest payable on a 15-year loan = $58,785
Total interest saved opting for a 15-year loan = $87,531
The decision seems quite clear-cut. If you have enough emergency funds set aside and the additional $198 won’t adversely affect your quality of life, it might be a sound choice to consider.
An improved strategy!
If you’re someone without a large nest egg, you can opt for a 30-year mortgage instead of a 15-year one. Subsequently, take the variance in monthly payments and keep it in a secure place, such as an investment portfolio or a secure savings account, depending on your personal preference. Personally, I recommend that anyone above 55 years, without a substantial savings cushion, should remain in risk-averse and secure investment channels.
To illustrate, imagine you decide to invest that extra $198 every month with a 3.5% return. After 15 years, you’ll have collected a hefty sum of $46,785. By the 19th year, your accumulation would be $63,990. Considering that your 7.28% mortgage debt would be around $58,531 in the 19th year, you could easily pay off your mortgage.
Here’s where it gets exciting. You have effectively assembled a pretty impressive emergency fund! For instance, after 10 years, that $198 monthly contribution would have become $28,400. This cash can be used to cover unexpected expenses or even to purchase a vehicle outright, thereby avoiding monthly payments.
But there’s an even more lucrative strategy at your disposal. This is a tactic I learned about in 2023, and it might be something new to you as well. It’s known as mortgage recasting or re-amortization.
In this setup, you and your lender agree that you will make a substantial payment towards your mortgage. Consequently, the bank adjusts this payment into your balance and recalculates your remaining mortgage payments.
To provide a clearer picture, let’s assume you have a $100,000, 30-year mortgage. You have been maintaining a monthly payment of $684 for 10 years while saving $198 monthly at a rate of 3.5%. In 10 years, the recalculated mortgage balance would be $84,552. If at this point you’re on the verge of retirement and looking to cut down expenditures, get in touch with your bank to discuss a mortgage re-amortization based on a payment of $20,000 towards the balance. Following this, your new balance would be $64,552 with 20 years left. After re-amortization, your new monthly payment would be $511, a reduction of $171 per month.
The remainder of your mortgage term remains the same, but your monthly payments are considerably reduced. Opting for a re-amortization is significantly cheaper compared to refinancing. Recently, my re-amortization cost was just $300.
A word of caution: As with adding an extra payment to your mortgage or choosing a 15-year mortgage, you lose ready access to your cash. Unlike these options, however, re-amortization lowers your monthly payment.
Final Thoughts
Heading into your golden years with limited income sources other than Social Security, it’s essential to minimize your fixed monthly expenses. Also, maintaining a robust savings account for unexpected circumstances is a prudent move. Bearing these factors in mind, my advice leans towards a 30-year mortgage instead of a 15-year one. Avoid making unscheduled extra payments on your mortgage as they don’t yield significant benefits.
Instead, concentrate on bolstering your savings. Later, contemplate a re-amortization of your loan when it can meaningfully decrease your monthly obligations.
However, bear in mind that not every financial institution or mortgage provider offers the option of mortgage recast or re-amortization. Furthermore, such opportunities aren’t usually well-publicized. If re-amortization isn’t an option for your mortgage, think about refinancing it. Look past just the interest rates.
For instance, suppose you currently have $25,000 that can be utilised for re-amortizing a $100,000 mortgage. You have been on a 30-year mortgage at 3.5% for a decade. In such a scenario, I’d recommend refinancing with a bank that allows re-amortization. Using a fresh 30-year mortgage of $64,552 (as detailed above), your new monthly mortgage payment at 7.28% reduces to a mere $442. This results in a $242 drop in your fixed mortgage payment. Since your mortgage qualifies for re-amortization, you have the option to further decrease your mortgage payment once your savings are replenished.
3. It’s vital that you avoid acquiring additional debt that demands the funds you’ve liberated by undertaking this action.
The ultimate objective is to boost your disposable income enabling you to establish an emergency fund or enhance your retirement enjoyment.
