Mortgage Myth: Making 13 Mortgage Payments a Year Can Significantly Reduce Your Payments
There is almost a cultish idea permeating the internet, and that is that a mortgage must be paid off as quickly as possible. One simple idea is to make one extra annual payment a year or making 13 payments to reduce interest paid and pay off the home fast.
On the surface this sounds quite reasonable. But is it?
After reading this post you may think otherwise. In fact, you’ll see that buying a home with a mortgage could be the best investment decision the average person will ever make.
Let’s Look at the Numbers
Let’s look at a $325,000 home purchase with a $62,500 down payment. We have a loan amount of $260,000 for 30 years fixed rate of 6.25% with a monthly payment of $1,975.86.
Here’s what it looks like when a one-time extra monthly payment is made yearly.
The loan is paid off 6.83 years sooner and total interest saved over the life of the loan is $84,206.16. Total extra payments made were $45,774.09 or $1,975.86 a year over 23 years. Which really means the net savings after removing the extra payment was $38,432.07 or $1,670.96 per year.
Let that sink in for a second.
You received fewer dollars in annual value return $1,670.96 than you paid in $1,975.86. Or, you got back $0.845 for every dollar you spent.
From an investment standpoint that’s not such a great deal, is it?
The Amazing Value of Homeownership
In 1964 the median value of a home in the United States was $20,500 and in June of 2022 it was around $388,700.
When we adjust for inflation using the Federal Reserve inflation adjustment calculator that $20,500 should be worth $194,432.99. But we see a very different picture, don’t we?
We see the value today almost DOUBLE the inflation adjusted price from 1964. That includes the raging inflation of the late 1970s and early 1980s.
As you can see buying a home with a mortgage is probably the single best investment the average person will make.
Now that we may be back to higher inflation, homes with mortgages have excellent track records. Owning a home with a mortgage very well could be the best protection against inflation there is.
In this case inflation is working FOR the homeowner and AGAINST the lender. It’s unequal and here’s why.
Mortgage Myth Busting Time
In the original mortgage above the person put down about 20% or $62,500 and lender put up $260,000. As inflation grows, dollars become worth less or buy fewer things – yet the value of homes tend to rise.
Who is the beneficiary if this property moves up to say $400,000 after 30 years? The lender does not participate in this potential gain.
So now the home equity has grown by $75,000 meaning the $62,500 the buyer put down is potentially worth $137,500 more than DOUBLE. Plus the loan is paid off and the buyer enjoyed potential tax advantages of interest deductions, and perhaps invested that extra payment in an IRA or some other non-table investment, getting MORE than a dollar back for the dollar invested.
Remember in the other scenario of making the extra payment, it created a negative yield per dollar invested.
There’s a saying you can’t make the water boil by watching the pot. The same is true with home values and inflation. We KNOW inflation is the normal, in fact it’s the Federal Reserve’s job to keep inflation at around 2% annually.
You can see it here in their mission statement.
In summary, keeping up with inflation is fantastic, but if you run the numbers, it’s as simple as this: Don’t try to force it.
Over a long period of time purchasing a home with a 30-year mortgage as a big tradition of success on its side. It’s simply what it does. In fact, you’d be hard-pressed to find a better way for the average person to build long-term wealth and keep up with inflation.