Monday, February 18, 2019

Are additional payments on your mortgage worth it?

       A couple of years ago, we caved into the nesting instinct and bought a house.  So far economically it was not worth it, as the house upkeep is quite significant.
With a 2.7% interest rate on 20-year mortgage, every $1 K paid in the first year saves $0.7K on the interest over the period of the mortgage. However, if you are investing the same amount it at 5% into something else you
could get as much as $2.6 K.  The question is: are the additional mortgage payments worth it or?
      The challenge with British mortgages is lack of certainty. Unlike the USA in England is almost impossible to get a long term fixed rate mortgage. All the risks are with the house owners. We made an overpayment (~$7 K) last year and want to do the same this year. We asked our bank to maintain the same monthly payments. This will either reduce overall mortgage time or (should the interest rate increase) maintain the same monthly payment. There are no expectations that the salaries will follow up the inflation.

       It’s almost impossible to get a long term fixed rate mortgage. Mainly for two reasons: the banks refused to take any risk transferring it to the citizens and a juicy 0.5% commission, every time you get a new mortgage.

$325 K – 20 year mortgage at 2.73% (1,760 monthly payments) – cumulative $427 K ($102 K is interest).
$325 K – 20 year mortgage at 2.73% (1,760 monthly payments) – cumulative $427 K ($102 K is interest).

$325 K – 20 year mortgage at 2.73% (1,760 monthly payments) with annual $7K overpayments – cumulative $399 K ($74 K is interest) – paid within 15 years.
$325 K – 20 year mortgage at 2.73% (1,760 monthly payments) with annual $7K overpayments – cumulative $399 K ($74 K is interest) – paid within 15 years.

What would you do? What are your assumptions going forward?

4 comments:

  1. I follow your blog for a few years, and often you play the "golden past, bleak future" song. Intentional or not you think the future might be not as bright as the past. You should pay off (parts of) your mortgage earlier. If you are not right about your outlook, then it won't matter, because the better future "heals" the not so optimal decisions in the past. But if you are right, and the future is not so great, then you have less debt. Also, a not so great future might mean the returns on the stock market where not 5 %, but maybe just 2 %.

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    Replies
    1. Hello EurFi! Thank you for stoppig by and following my ramblings towards financial independence. I miss your blog updates!

      You are correct in your observation. You are also correct that my income for the past two years has been 50% lower than in the prior 7 years. I still have not used to that idea yet. My apologies for the song's mood.

      I am taking a conservative view that perhaps I will not able to repeat the higher income cycle. I am also quite worried about the future for the family and potential impact reduction in income might have. Even now I understand that our income is above average.

      On the other hand the average market returns and inflation is a known facts. For example between 1900-2011 average inflation in the UK was 4%, in the USA - 3.1%. This is lower than the current one. Average S&P500 return for the past 90% years was 9%.

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    2. Thanks for your kind word towards my blog. I'm not sure there will be more updates. I'm concentrating on my own happiness at the moment.

      What do you mean with "worried about the future for the familiy"? I think my kids might have a harder time than I have now. There can be lots of changes coming to the job market that really affect them. For this reason I'm saving some money for them (thinking about 100k each) and thus will probably not retire anytime soon.

      My opinion stays, you should pay off (parts) earlier.

      You mentioned the income change in the past, but I did not remember that it was a 50% cut. Wow!
      How did you feel afterwards? Did it change over time (can you cope with it better now)?

      My dad also had a sharp reduction once. I will ask him about it. I can only imagine how bad it feels.

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    3. Hi EurFi,
      Concentrate on happiness is a way to go. I need to do it more often too, although now I am quite confused on what does it mean for me.
      I have the same worries in general about the kids future. I agree that they are likely to be first generation that will be worse off then us despite being smarter and better educated. My biggest worry is that in case the salary slip further this could quite devasting for the family.

      As for the salary drop it was mo sicologcal issue. When I got on a high salary, I had a very good boss at the time. He warned me not to buy a million dollar house or expand the life style. So I kept the low profile and was able to save $60-70K a year and buy ocassional treat for the the wife. Unfortunately I was investing in high dividend stocks instead of growth and did not gain as much as I should have.
      When salary dropped by 50% my annual savings reduced to $10K a year and I had to forgo thoughts about financial independence and goal of $2 million in savings (real terms). I rolled all the savings into the low cost mutual funds and planning to keep them there for the next 25 years. If I get lucky their will double in real terms.

      There is not way to describe but being able to predict the future income when it is perceived does not cheer me up a lot. I would be very much interested to hear story about your dad and how did he cope with it.

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