Recently, I found myself in the situation where I had a little extra money. Not a ton, you understand, but it felt significant to me.
Now, as I’ve argued before, the first thing you do when you receive an unexpected windfall is to do nothing at all. Sit. Wait. Give yourself time to think, to relax. Financial matters dealt with with urgency are almost always a less-than-optimal outcome.
So because of this, I don’t need to make any decisions now.
Nevertheless, I can’t sit and look at this tiny windfall and not think about my own debt boss character: my mortgage.
For my situation, I think it might make the most sense to throw extra money at my mortgage.
And yet I’m hesitating. That, to me, is interesting.
And I bet you’ve hesitated before making some financial decisions of your own.
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Squirrel the money away
Mortgages are giant. There’s no other way to describe them. They are, most likely, the largest purchase we will ever make (though give college tuition a few years (that’s a joke (hopefully))).
They are so large that they can feel too large to comprehend.
And this is where the resistance comes in.
Let’s say you have a $300,000 mortgage (inflated for some rural areas, laughably small for major cities, but I have to start somewhere). Let’s say that you have a $5,000 chunk of change that you have at your disposal.
Now, $5,000 is a lot of money to most people (me included). Feeling an account padded with $5k would feel good, relieving even. And yes, I mean “feel good” literally. I believe that as you add to your emergency fund, you feel viscerally more at ease in your day to day life.
So in this scenario, there’s a clear argument for squirreling this $5k away.
Pay down the mortgage
And yet, there’s this mortgage, quietly eating your future away with its interest payments. Did you know that at 4%, a $300,000 mortgage will cost you upwards of $1,000 a month in interest payments alone? After 10 years have elapsed on a 30 year mortgage (which sucks, by the way), by which point, you will have paid over $100,000 in interest payments.
This is the cost to “run in place”.
So about that $5k. It feels pretty puny against the gaping maw of $300,000, doesn’t it? One could throw that at the mortgage, but what would be the point? You’d be at $295,000, a change of 1.7%.
Big whoop. It would feel better to just put it in savings.
Don’t always trust your gut
And yet, we must also keep in mind that our feelings about money can only take us so far in terms of guiding us. This is because we feel the short term much more than the long term.
Cases in point: We feel a hole in our budget very clearly. We feel a lack of an emergency fund. But do any of us really feel how prepared (or not) we are for retirement? Well maybe, but it’s much easier to bury that in favor of what’s in front of us.
So what would happen if, in this hypothetical example, we threw that $5,000 against a $300,000 mortgage?
Our balance would now be $295,000. The terms of the mortgage wouldn’t have changed, of course.
But the interest would change. Assuming happened with 20 years remaining on the mortgage, you’d need to pay about $200 less interest over the course of the first year. And this would compound, too, so over 20 years this one-time $5k payment to your mortgage would net you over $2,000 in interest reduction.
So it’s something, but it’s not a lot.
Now, you can change the inputs here (interest rate, mortgage size, amount of windfall, etc.) and you might get a different answer. For example, if your interest rate is high, you’ll more benefit more from a principal payment.
Get your house in order before you get your house in order
Now, remember that we don’t want to even be talking about paying extra on a mortgage until we’ve gotten some other things in place.
- If you have debt other than the house, that takes way more priority than paying down a mortgage.
- If you don’t have six months of bills and expenses in the bank, then don’t continue until you do.
- I would put retirement savings as a higher priority than extra mortgage payments, at least up to a point.
If you have all of this done, is it worth it to throw extra at the mortgage? My head tells me yes.
But I’m still hesitating.
But enough about me. What would you do with a little windfall?
