“No method of applying extra principal payments to your mortgage is the wisest or most cost-effective way of paying off your house.”
Douglas Andrew
Warning! The contents of this post may not be suitable for individuals that remain shackled by depression era thinking.
So you want to pay off your house…ok, here is an example of how to do it smarter, faster and cheaper. For illustrative purposes let us suppose that we have two home buyers, buyer A and buyer B. Buyer A thinks he is conservative so he takes out a 15 year fixed rate mortgage for $400,000 on his new home at 6.00% which calculates to a monthly principle and interest payment of $3,375. Buyer B knows that liquidity is the new conservative so she takes out a 30 year fixed rate mortgage for $400,000 mortgage at 6.25% with a $2,463 monthly payment and deposits the $912 per month savings (15 yr fixed payment – 30 yr fixed payment) in an conservative side fund earning an 8% rate of return. After 15 years buyer A’s mortgage is paid off and he has received $53,861 in mortgage interest deductions. However buyer B has done even better. She had enough money in her side fund to pay off the remaining balance on her 30 year mortgage after only 14 years, 1 year ahead of buyer A and in that time she received $78,559 in mortgage interest deductions, $24,698 more than buyer A!
So now buyer A’s mortgage is paid off so he starts depositing the $3,375 per month that used to be his mortgage payment into a conservative side account again 
earning a 8% rate of return. Over the next 15 years (a total of 30 years) his investment account grows to $1,187,633. Buyer B on the other hand chose not pay off her mortgage in year 14 when she could have but instead continued to deposit the $912 per month in her side account. At the end of the same 30 year period her mortgage is now paid off and her side account has grown to $1,338,953! That’s $151,320 more for her retirement that buyer A, not to mention that she has paid almost $70,000 less in income taxes than buyer A as result of the additional mortgage interest deductions. (Mortgage interest deductions assume both buyer A and B make the same amount of money and are in a 25% tax bracket)
This is an example of mortgage planning in its most basic form. This simple form of arbitrage is just the tip of the iceberg. A paradigm shift is taking place in the way that individuals perceive their mortgage; it is no longer a necessary evil but a financial tool that can be utilized to their advantage. For more on this topic please read: How The Affluent Manage Home Equity To Safely and Conservatively Build Wealth. If you are thinking that these strategies are aggressive or reckless you might want to read this study prepared by the Federal Reserve Board of Chicago that concludes that this simple form of arbitrage is what those of us that make more than we spend should be doing but are not.
So we can now all agree that a mortgage is not a necessary evil and something eliminated as quickly as possible but a financial tool to be used to our benefit which brings us to next weeks topic:
The Interest Rate Game, Who Wins, Who Loses and Why. In addition we will discuss why the equity in your home has a 0% rate of return.