Our soon to be home

Mortgage Snowball or Mortgage Avalanche

Depending on your personal risk tolerance paying off the mortgage early can be either a good thing or a bad thing.

When most people consider paying off a mortgage early they are planning to either refinance to a shorter term or make additional payments.  We just closed on a new house and went for a 7/1 ARM which comes with a lower interest rate than a 30-year fixed.

Our goal is to pay this off before the loan does its first adjustment (month 84).  Assuming no additional principal payment we’ll owe $416,587.54 at month 84.  In order to get the balance to zero at this time through additional payments we’ll need to shovel $4,300 a month at the mortgage.

OR…

We make our standard payments and invest our extra money planning on an 8% annual return.  By investing excess cash we’ll only need to save $3,900 a month, or if we invest that same $4,300 we’ll have $460,000.

Mortgage Payoff Compounding

Obviously the second option has more risk, the stock market could down, interest rates could spike, the world could end.

However, the second option also includes more flexibility.  Once you make that additional principal payment the money is stuck there unless you refinance or sell the house.  Instead here are some scenarios where the investment option really pays off:

  • We lose our jobs
  • Unforeseen medical expenses (not likely unless we also lose our jobs)
  • Interest rates decrease and refinance can extend our fixed rate period and/or lower our interest rate
  • Housing market crashes and there are really great deals to be had (market timing?)

I personally like having the additional flexibility.  I’d love hear if anyone else has taken this same approach.  I feel like this is the mortgage version of the debt snowball vs debt avalanche.

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5 comments on “Mortgage Snowball or Mortgage Avalanche

  1. 5am Joel

    Great quick post. This is something most homeowners wonder about.
    Mathematically, I believe the flexible option works better in your favor. Your money can work harder for you elsewhere. I have several mortgages and don’t believe in paying down good debt.
    Cheers!

    1. Kit

      Thanks Joel. When I did the math myself I thought it was going to be a more dramatic, but as can be seen in the chart the gain is between $17k (at 6% annually) – $104k (at 12% annually).

      It is definitely up to the individual and their risk tolerance, but it does provide another option.

  2. The Frugal Wallet

    Where do you plan to put your money for the investment portion? Taxable brokerage account? If so, when you withdraw, won’t you have to pay income tax on the gains? Is the tax impact part of your calculation?

    I ask because we are at a point where we are considering the exact same things and I’m not certain how I feel about either strategy right now. I’m interested in your input on this.

    1. Kit

      We are putting our money into a taxable brokerage account as you said. I admit I hadn’t considered the tax implication when we have to sell shares to do the payoff. Hopefully at that point we’ll be at FI or a lot closer to it and able to flex our income (plus it will be long-term capital gains) so we should only be paying 10% on it.

      1. The Frugal Wallet

        That’s a good point. The reality of our situation is that we haven’t ever had to deal with long term capital gains, so I don’t have a good grip on how it all translates. We had plans to pump up my taxable brokerage account more and I keep going back and forth on it. Reading articles like this helps me stretch myself and get more comfortable with making a decision 🙂 Thanks for sharing!

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