Taking Our Savings And Paying Down Our Mortgage

I have previously analysized the mortgage on House #3 and determined we could earn a 6.77% after tax return by paying down the mortgage to get rid of the private mortgage insurance. I have been on the fence this as 1) I am not sure how quickly we could get the PMI cancelled, 2) we have been focusing our income on saving up for a down payment on a new more permanent home.

After taking a step back and seeing bank interest rates being lowered, I have decided (with my wife's OK) to take a portion of our savings start paying down the mortgage. Heres why:

The money is for a $80,000 savings goal to be used as a down payment for our new house
The money is currently earning about 3.5% before tax in high yield savings accounts and rates are going lower; ignoring the PMI the money will be effectivley earning ~3.4% after tax savings losses by paying down the mortgage balance.
We don't know what we are going to do with our exsiting house, but we will either sell it and put the proceeds in our new home, or two rent it out (only if cash flow positive).
We think $80k will be more than needed for the minimum 20% down payment and closing costs that I think we need to buy a house.

So the bottom line is it will earn a better return by paying down the mortgage, and it won't affect our house buying plans -- it just may raise the balance of our new mortgage if we decide to rent the house out. As long as aren't faced with PMI or need to take a 2nd mortgage to close the deal we will come out ahead with this move.

I plan on paying about $15k towards the mortgage over the next month or so. That won't get us to the 78% balance we need to cancel PMI, but it will get us in the ballpark. I'll then call our mortgage company and start pursuing cancellation of the PMI.

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Comments (8)

Sounds like a reasonable plan and if real estate continues it's trend your 80,000 may buy you more than 20% of your "permanent home"

http://americandividendinvestor.blogspot.com/

Posted by American Dividend Investor | March 14, 2008 9:25 AM

I don't recomment you do this. You are making this decision based on the ST deposit rates which are pegged to overnight fed funds. If the recession deepens credit will dry up. It is entirely possible based on current events that inflation will increase and that interest rates will rise above your current cost of borrowing. If your mortgages are fixed rate loans I recommend that you do not pay it off. I am levering up carefully using cash out refi on FRM. Deposit rates will rise, but more importantly, I expect that I will be able to pay for assets more cheaply in the near future. Sinking more money into your RE asset seems like a moribund stategy and an excessively conservative one at that.

Posted by ETFnerd | March 14, 2008 3:33 PM

ETFnerd,
You bring up a good point regarding interest rates. It could very well happen, but I don't expect it to happen with an extreme severity within the next 8 months or so.

Posted by 2million | March 14, 2008 8:32 PM

This may be a dumb question...Why didn't you just get two loans and go the 80/20 route to avoid the PMI? Lots of folks do this in the triangle...was this not an option at the time of your purchase? I realize it has the hassle of two payments and you have to watch the rate on the 20...but would have gotten you out of the PMI.

Posted by Anonymous | March 15, 2008 12:47 AM

Hi 2million, I was trying to find your email but couldn't locate it. I wanted to see what you thought about a calculator I coded at http://www.twincommas.com/income-tax-calculator
(And for that matter, the rest of the site. We would like to here your advice.)

Posted by Matthew | March 15, 2008 5:27 PM

Anon,
Great question -- this was a mortgage my wife took out a couple years ago before we were married. When I purchased my first property using two loans to avoid PMI. I would recommend the same for anyone if the net payments avter-tax would be less than paying PMI.

Posted by 2million | March 15, 2008 8:19 PM

Hi $2m,
Great to be back on line reading your stuff.
Have you considered refinancing the mortgage - rates aren't bad now and you could go the 80/15/5 route. That way anything you pay down on the 15, which could be a heloc or fixed heloc, could also be taken back out.
That's what I've done to lower my costs.
regards, makingourway

Posted by makingourway | March 16, 2008 12:48 AM

makingourway,
Great to hear from you. Great question about refi -- not a convenient option for us right now being overseas, but definitely something I hope to look at when we get back. Inf fact what I would be more likely to do would be to refi house #2 (with the highest interest rate at 6.5%, pull out an equity above 20%) and use that to fund the money over a longer period of time. I could very well refi this mortgage as well, but interest rates would still need to drop significantly for me to pull the trigger.

Posted by 2million | March 16, 2008 2:11 AM