On the House

Howard Rohleder

WANT A CONSERVATIVE strategy that can help you prepare for college costs? Consider prepaying your mortgage.

In 1992, when my oldest was 10 years old, we moved to a new home. We opted for a 15-year mortgage at 7.625% with 33% down. With our son’s graduation set for 2000, we began to prepay the mortgage so the last payment would coincide with the month before he began his freshman year. Thereafter, the payments previously sent to the mortgage company were instead directed to the college.

Our aggressive repayment plan was made possible by buying enough house for our needs but less than we could afford. On top of that, the large down payment ensured that the required monthly payments were relatively low.

Financial planners might say a better strategy would be to take out a 30-year mortgage with, say, a 10% down payment and then pay only the minimum required. The notion: You could take the money that isn’t going to the mortgage company—the difference between the 30-year loan’s smaller down payment plus lower monthly payments and the 15-year mortgage’s larger down payment and higher monthly payments—and instead invest in the stock market.

As it turns out, I was able to make a direct comparison of the two approaches. We had money provided by a grandparent for our son’s college, which was invested in a stock mutual fund. For most of the 1990s, it looked like a great strategy. Then the dot-com bubble burst and a big chunk of the fund gains were erased just as college was starting. Meanwhile, the money prepaid on the mortgage effectively earned 7.625% a year. What are the lessons here?

  • With a long time horizon, mortgage prepayments aren’t that burdensome. Imagine a family buying a home with a 30-year mortgage when their first child is born. Small prepayments early on, which then increase annually as the family’s income rises, might pay off the mortgage by the time the child turns 18.
  • An added bonus of prepayments: You build home equity that can then be tapped through a credit line to help pay for college.
  • Unlike 529 college savings plans, home equity can be used for any purpose, plus it shouldn’t affect financial aid eligibility.
  • Leaving college money in the stock market as my son neared high school graduation was a mistake. Fortunately, we didn’t lose money overall, though we ended up with zero growth for the years involved.
  • Low mortgage rates today make prepayments less attractive. Still, mortgage prepayments have a 100% predictable return, while stock returns are 100% unpredictable. Indeed, with the stock market averages at record highs, there’s an increased risk that future returns won’t match recent years.

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1 year ago

Interesting, and I agree that needing to choose between prepaying a mortgage vs investing isn’t a simple yes/no answer. In my case, as a brand new empty-nester, having just shipped the last ones off to colleges, we’ve been the double beneficiaries of low mortgage interest rates combined with record stock market performance. Refinancing several times over the past 20 years not only transitioned us from a 30- to a 15-year mortgage, but we both paid off the house many years earlier than expected, with the subsequent money passively in equities really on a sustained breathtaking run. My fortunate issue is, now that I’m actively paying for tuition/housing/fees, do I shift those amounts to a cash equivalent or stable income investment (haven’t done so yet). I appreciate that any day now the market can suffer a significant correction (thinking 30+%), but with the market performance this would likely (haven’t done the math) only return me to levels 5 years ago, which I would find sad but tolerable. The flipside is continued high velocity appreciation. Welcome comments.

Howard Rohleder
Howard Rohleder
1 year ago
Reply to  medhat

You might check out the Humble Dollar Guide tab, specifically looking at the articles on asset allocations and rebalancing.
It sounds as if your circumstances have changed (you have paid off the house sooner than expected and you have more in investments than you expected or currently need). It seems like a logical time to reassess your asset allocation, take some profits and sleep well knowing you won’t lose all your gains if the market tanks.

jerry pinkard
jerry pinkard
1 year ago

We did not plan paying for college that way but essentially did anyway. We got a 25 year mortgage and paid it off 8 years early at about the time our daughter started to college. I always thought of that as pay as you go but the payoff of our mortgage made it much easier to do that.

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