John Wood

Comments:

• I agree, Jonathan - if that was the only principal-only payment ever made on the mortgage, and you had to "claim" your 11-payment savings about 28 years and 9 months later (as in our example), the compounded annual return would be about 3% (technically, 3.10%). But what if one continues to make other principal-only payments and pays off the mortgage in 10 years? Would you agree that the return on these first 11 skipped payments after mortgage payoff, monetized after only 10 years of waiting, would increase the compounded annual return on the $1,923 principal-only payment to 9.19% (as the ROI calculators will confirm)? I mentioned above that the 3% rate applies over the life of the 30-year mortgage, but the whole point of paying extra principal is to shorten the mortgage, which increases the compounded annual return on the extra principal payments above 3%. Ok, truce. We both agree paying down a mortgage is a good thing. I say let's focus on our agreement, and not worry if we agree on the math.

  Post: On Second Thought

  Link to comment from September 13, 2023

• Hi Jonathan, Ok, I'll give this one more go, and then I'm done, and we can agree to disagree. If you agree that the January payment plus the $1,923.81 of extra principal payment reduces the balance owed on the loan from $99,485.71 to $97,389.61 -- which is the balance owed as of 12/31/2024 if I just made the $421 mortgage payment each month in 2024 (confirmed by the amortization schedule above) -- what do you call the $2,707.19 of 2/24 - 12/24 interest payments I didn't make because I made the $1,9231.81 extra principal payment? If I don't make the extra principal payment, I owe the $2,707.19 of interest for the 2/24 to 12/24 monthly installments. But I skipped those installments with the $1,923.81 extra principal payment, so what is the $2,707.19 of avoided interest, if it's not return on the $1,923.81 principal-only payment? You agree that prepayment reduces the length of the mortgage, and perhaps you'll agree that the $1,923.81 of extra principal payment above took 11 months off of the end of the mortgage (i.e. the 2/24 - 12/24 skipped payments noted above). Contrary to your thesis, the return is not the interest on the final 11 payments (which, I agree, would be small) -- the return is the 11 payments of $421 that I don't make at the end of the mortgage because I made the $1,923.81 principal-only payment. The last 11 payments of $421 = $4,631 in skipped payments, resulting from my $1,923.81 payment in 2024. The $4,631 in skipped payments, less the $1,923.81 principal payment = $2,709.19 of return -- the exact same figure as the 11 interest payments skipped in 2024. If the $2,709.19 savings (derived in two ways above) is not return on the $1,923.81 principal payment, what is it?

  Post: On Second Thought

  Link to comment from September 11, 2023

• Honorable gentleman can disagree, but let me offer this: Taking your link and example above, let's assume that, on 1/1/2024 I decide to pay all of the principal that applies for 2024, so I issue the $421 payment for the January installment (as I owe the interest for January), and then I add $1,923.81 in principal only payments, which covers the principal owed on the 2/24 thru 12/24 installments). I've now skipped 11 mortgage payments, and my principal balance is $97,389.61 (i.e. the balance as of 12/31/2024 in the amortization schedule). The interest avoided on those 11 skipped payments is $2,707.19 -- a 40.7% return on my $1,923.81 "principal only investment" at the beginning of the year. I don't disagree that the monthly interest payment works out to 3% of the outstanding loan balance, but it's the leverage embedded in the fact that a much smaller principal-only payment wipes out a much larger interest payment in the early years of the mortgage that produces returns far in excess of the 3% nominal rate (in 2024, roughly a $175 principal-only payment avoids roughly a $245 interest payment - about a 40% return on each additional principal payment that year).

  Post: On Second Thought

  Link to comment from September 11, 2023

• We are kindred spirits when it comes to mortgage management, Donny, and you're correct -- the bankers won't show you this, the financial advisors wont' show it, and it's one of the more powerful financial tools available to build wealth safely over time.

  Post: On Second Thought

  Link to comment from September 11, 2023

• Hi Jonathan, I'd have to respectfully disagree with you on this one. I had a 30-year mortgage that I paid off in 9 years with extra principal payments, and I definitely avoided 21 years of the remaining interest payments that I would have otherwise owed if I had not paid the extra principal (not to mention freeing that former mortgage payment up to invest in higher yielding options for 21 years). The only way that happened was by skipping the interest payments with the extra principal payments (to get a visual of this, take an amortization schedule, pay down $2,000 of principal, see how many monthly payments that skips, and the interest associated with those skipped payments is never paid). To your example of the 3%, that only works if the interest is applied "linearly", like a credit card or HELOC (i.e. under your example above, the interest on every mortgage payment would be fixed at 3%). In my example above, 3 years into the loan, the interest is over 79% of the $1,897 payment, at $1,054.50. The 3% interest figure works out over the life of the loan because the final payments have little interest involved, but it's definitely a higher rate than 3% for the first 20 years [at least] of the mortgage).

  Post: On Second Thought

  Link to comment from September 11, 2023

• I think paying down the mortgage beats bonds under almost any scenario, regardless of any interest rate difference. For example, take those 3% mortgage holders and today's (roughly) 5% T-Bill yields (the best "bond deal" in the market currently). If you keep the mortgage debt to buy the T-Bill, the 3% mortgage interest becomes a cost of funds (because you could have avoided this cost by using the money to pay down the debt), so your actual return on the T-Bill is 2% (i.e. the 5% nominal return less the 3% mortgage cost of funds = 2% net return). You could earn 50% more just paying down the mortgage and capturing the 3% net return on the avoided interest charges. But the mortgage payment return is much greater than that, because interest on bonds is a "linear return", while the mortgage interest is front loaded. For example -- confirmed by any mortgage calculator (I used Bankrate's) -- a 30-year, $450,000 loan at 3% interest results in a $1,897 monthly Principal & Interest payment. If we assume the homeowner bought at the beginning of 2020 (about the time when mortgage rates were 3%), their September 2023 payment would consist of $842.50 of principal, and $1,054.50 of interest. Now assume the choice of investing $2,540.17 (a figure used to simplify the example) in a 5% T-Bill, and also assume that the 5% rate held for an entire year. The interest earned for the year would be roughly $127. However, paying this same $2,540.17 down on the mortgage principal would eliminate the October thru December 2023 installments, and you'd avoid $3,150.83 in interest charges for those months, for a net return of $610.66 -- a 24% return on your $2,540.17 investment. Even at the historically low rates of 3%, paying down the mortgage is still likely to beat bond investments handily (for at least the first 20 years of the mortgage).

  Post: On Second Thought

  Link to comment from September 9, 2023

• Informative article, Greg. To give you an idea of the (un)affordability situation in California,16% of California households can afford a median-priced home in the State today, down from a peak of 56% in 2012 (Source: 8/21/23 edition of Barron's).

  Post: Shortage Hits Home

  Link to comment from August 26, 2023

• I concur, Doc Savage. I live in California, where we have a "CEQA" (California Environmental Quality Act) law that has been weaponized by those with their own agendas, such that any new development plan anywhere in the State has a significant chance of facing litigation before a shovel ever gets close to going into the ground.

  Post: Shortage Hits Home

  Link to comment from August 26, 2023

• Just to give Buffett his full due, his average annual return from 1965 thru 2022 was 19.8% vs. 9.9% for the S&P 500 (per the 2022 Berkshire Hathaway annual report), which equated to a cumulative return over that period of 3,787,464% vs. 24,708% (a 153-fold difference). Now that is beating the market.

  Post: Can the market be beaten?

  Link to comment from August 5, 2023

• Well said, Purple Rain. I'd offer a related version: "I win when my investments beat inflation."

  Post: Can the market be beaten?

  Link to comment from August 5, 2023