NOT the same old question....prepaying your mortgage
OK, after reading many posts, and most of it going over my head, I'd like to ask a question, if ya'll don't mind. I only ask that you keep unexplained acronyms to a minimum and give me time to find a dictionary and calculator. =0) I handle the "finance" portion of our household. But the "finance" of this board seems to be a bit outside my experience. So please speak slowly and simply, and give me time to process. =0)
We own (with the bank) three homes. Two rentals and our residence. At the moment I'm going to limit myself to the first rental property. We bought it in 1995 (30 years at 8%), began renting it in 1998. We refinanced in 2003 (15 years at 6%). We have put about 2.5 years of payments (because we lived there) into this house, and perhaps another $2000 in repairs/upkeep, over the life of the rental. ALL other expenses have been paid by the rent.
All this discussion about prepaying the mortgage (including that in the archives) has got me thinking. I have always put a little more towards our mortgage, even though it was only "rounding up" to the nearest $10 at the beginning. Money was tight. =0) Now the rental income allows another $50 and I put in another $50 so my total prepayment is around $100 ($107 I think) a month. At this rate the house will be paid off in 90 months. If I were to now revert to only paying what they asked, it would take about 118 months.
For simplicity's sake, I have not included rental increases, tax increases, etc... and used a base of 8% return. As close as I can figure (using common sense, quicken, pencil and paper and an online calculator):
The difference in the two paying it off sooner would give me a savings of $3372 in interest.
The 28 months of income at $650 would be $18,200. Insurance and Taxes (IT) would be another $2622 for that time period (2.3 years). So the total benefit to me to prepay the mortgage would be (3372 + 18200 - 2622) $18950. Taking away the initial investment of $9630 (107 x 90 months). Total profit would be $9320.
Taking that same $100 over the next 118 months and putting it into an IRA would give me about $17,000 (with the 8% return) (17000-9630=7370) Total profit $7370 (taxes etc... included in payoff)
Taking the 28 months (difference between 90 and 118 months) at $650 and investing it in the IRA would give me about $19,000 (again 8% return) in the IRA and still the $3372 savings in interest but I would still have to pay IT so..... (19000 + 3372 - 2622) $19750. Total profit $10120.
At the moment, I'm just trying to determine whether or not prepaying the mortgage would be a good thing, or if putting the funds in the IRA would be more beneficial in the long run. It "seems" that it would be better to put it on the mortgage and then the rent in the IRA (28 months worth). BUT as I've said, a lot of this goes over my head, so I've tried to simplify it to where I can understand (and I hope you can too) and may have left something out. I know there is no assurance that the IRA will pay the 8% at any point (and may go up to 10% -or down to 6% (or worse) - it's done it before). I also know that the house might not rent every month, so the numbers could go any which way at any time. The 8% was averaged from our actual IRA for the last 10 years. And the house has had the same renter for the last 7 years. I know that the odds in the numbers turning out exactly how I've described are slim, but I can only do so much with what I've got. =0) We have 17 years until desired retirement, and 27 years (more or less) before we have to take out of the IRA. Oh! and it's not an either/or thing. We do contribute to the IRA (though not to the max), and the Thrift Savings Plan (401k for the government) up to the matching funds. It's a question of where the additional funds ($100) would provide the greatest return (and we tend to be conservative in our investments).
With nearly everyone saying that the return with pre-paying is only the amount of interest (6%), I tend to think that my numbers may be off somewhere. There is a big difference, and it's not leaning towards the "accepted" practices. But I can't see where they are off. So are my numbers right? Or even close? Did I do it right? Or is there something that I'm missing?
Even if this was my primary residence, If I took the time difference between the early payoff and the bank's payoff, and put the amount of the mortgage into an IRA wouldn't it work out similarly? Granted it takes more of "my" money to start, BUT I do have more of it to spend. And once it goes into the IRA, does it really matter how long it's been there? For example if I have been putting money in it for 5 years and it's now, Jan 1, up to $20,000, won't it make the same amount of money if on Jan 1, I deposit $20,000? So that 31 December it would have the exact same amount in it?
Thank you if you got this far and can understand what I'm asking. Like I said "finance" does not seem to be my forte, but I'm trying to learn. =0) (Like I just remembered that insurance and property taxes would still have to be paid in 2 of my examples but were already included in the middle one!) Simple errors can cost many $$.