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Paying Down Your Mortgage Gives You A Guaranteed Rate Of Return

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date : July 28, 2009

Dear Valued Reader,

The last few years have certainly been interesting. The S&P 500 over its worst stretch lost 59% of its value. This has led consumers to really rethink how they should build their wealth. Options most people think about today are somewhat limited:

-CDs/money markets
-Stocks/mutual funds and variable annuities
-Commercial real estate

For other options, you may consider a Fixed Indexed Annuity (FIA) Your money never goes backwards, and the gains are locked in every year (gains up to a cap). Click here to watch an educational PowerPoint Presentation on FIAs.

I wrote an entire book on how to properly use the equity in your home to grow wealth. Click here to learn more about that book. The book is for those who are financially stable.

Example of a guaranteed return when paying down mortgage debt

Assume Mr. Smith has a $250,000 home with a $200,000 mortgage. The loan has a 30-year amortization with a 6.25% interest rate. His monthly payment is $1,231.43 per month (principal and interest).

After Year 1, Mr. Smith made mortgage payments of $14,777.16. Unfortunately, Mr. Smith only had debt reduction of $2,343 (which means $12,434 went to the bank for interest payments). It is for this reason we all despise our mortgage payments.

What if Mr. Smith took $10,000 he had in CDs and used it to pay down mortgage debt?

How much would that save him in interest payments over the life of the loan? In other words, what guaranteed rate of return would Mr. Smith get on his $10,000 if he used it to pay down mortgage debt?

Mr. Smith would not be paying debt on $10,000 at 6.25%. Each year that saves him $625 in interest payments. This is not the rate of return for most because most can write off the interest payment.

-If you are in the 20% income tax bracket, the affective annual rate of return is $500.
-If you are in the 30% bracket, the return is $437.50.
-If you are in the 40% bracket, the return is $375.

This is the guaranteed rate of return when not paying interest on $10,000 of home mortgage debt vs. paying interest on it.

Simple vs. Compound Interest

The returns alluded to above are simple interest on $10,000 and therefore, the return over a 26-year loan would be:

$500 x 26 years = $13,000
$437.50 x 26 years = $11,375
$375 x 26 years = $9,750

Why 26 years? Because, if Mr. Smith moved $10,000 from CDs to pay down the primary mortgage, it would be paid off in 26 years instead of 30.

The magic of compounding interest

Interest on a mortgage is compounding (which is why with the Mr. Smith example the total amount of interest paid on a $200,000 mortgage is $243,316).

What’s interesting in this example is that when Mr. Smith puts that $10,000 down on the mortgage in Year 1, the amount of interest over the life of the loan is $196,078 not $243,316 ($47,238 less).

Therefore, the amount of interest savings in the respective tax brackets is:

-$37,790 in the 20% income tax bracket
-$33,066 in the 30% income tax bracket
-$29,342 in the 40% income tax bracket.

Could you do better?

The numbers above should not blow you away. However, these are guaranteed numbers that you know will occur if you pay down your mortgage early as Mr. Smith did in the example.

If you put $10,000 into a side account, look at how much you’d have as an account balance using different gross rates of return over a 26-year period:

6% = $26,637
7% = $32,519
8% = $39,641

For the above numbers I used a 1.2% annual expense and a 20% expense on the growth every year.

What if in the 24th year of the mortgage the stock market tanked 59% like it has recently?

The side account balance would be $17,722 if the gross return was 8% the first 24 years.

Should you pay down your mortgage to receive a “guaranteed” rate of return?

It depends. If you like certainty, the answer is that paying down mortgage debt is not a bad thing to do (even if there are better alternatives). It does take risk out of the equation although money in a home is sometimes illiquid and that needs to be taken into account (meaning you can’t get your hands on it unless you can refinance, sell the home, or obtain a home equity line of credit).

Using HEAP to pay down your mortgage

If you choose to pay down your mortgage with your surplus earnings, you really should be using the Home Equity Acceleration Plan (HEAP). HEAP is a no-risk mortgage acceleration plan that will help you pay off your mortgage 5-10-15+ years early with a plan that does not require you to change your lifestyle.

If you want to learn more about how HEAP works, please email us at info@trustmakers.com.

Until next time,

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