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Personal Financial Planning - Mortgage acceleration as a planning tool

By  May 12, 2011

Topics: Finance & Investing

Accelerating your mortgage has a big positive impact on getting debt free. Reducing interest increases your equity rapidly. The true cost of buying your home is not the purchase price, but the total price plus the interest you pay over your mortgage term. In a 30-year mortgage, you pay about twice as much as your purchase price (based on 30-year repayment at 5%).

The following are based on a $100,000 mortgage at 5% and with a 30-year repayment term:

-- Without any accelerated payments, your 30-year mortgage is half paid off only after 20 years.

-- Paying an extra $50 every month takes five years off your repayment term -- and reduces interest expense by more than $17,000.

-- Paying an extra $123 per month pays off that 30-year mortgage in two-thirds the time, 20 years. It also saves you almost $35,000 in interest.

-- Increasing monthly payments by $254 every month cuts the 30-year term in half, to 15 years. It saves almost $51,000 in interest.

It isn’t just the lower interest that counts, but the more rapid increase in your home equity. Increasing and protecting your equity is of utmost importance. In the past, the belief that home values would rise indefinitely created an unhealthy situation where homeowners refinanced  to take out cash, over and over as values rose. When the market collapsed, these unfortunate homeowners found themselves with no equity and, in many cases, debt above their home’s value.

In the future, owning a home without a mortgage will become the new American Dream. It is not enough to simply buy a house and make payments for three decades -- and refinancing is no way to build equity. By accelerating your payment, you build wealth. The cash you put into additional principal earns a compound rate equal to what you pay for your mortgage for the remainder of the years you owe money to the bank.

You first need to set up an emergency reserve fund in cash or easily withdrawn savings. Accelerated equity is not available unless you refinance or apply for a home equity loan. Both of these are counter-productive to the underlying goal: paying off your mortgage to reduce interest expense and build home equity as quickly as possible. That is the safest and most practical route to financial freedom and security.

Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches three options courses: “Swing Trading with Options,” “The Amazing World of Options,” and “Synthetic Options Strategies.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to the CBOE newly-formed blog.