Should You Try to Lump Sum Your First Mortgage?

by Kevin on March 9, 2009

Last week I told you of my struggle of deciding how best to pay off our second mortgage. For now we’ve decided to save up the money as it comes in every month and then when we have enough, pay it off in a lump sum. We will use that extra savings as an additional buffer toward job loss and the general economic down turn.

The next obvious question is…

Should I try to lump sum payoff our first mortgage?

My answer to this is a resounding no. The primary reason we are saving up the money and then paying off the second mortgage as a lump sum is to use the extra money as a buffer. In our situation it will cost us roughly $5,000 to $6,000 over the life of the loan in extra interest. That seems like a lot of money, but I think this is the best option for us.

Now remember, that’s on our second and much smaller mortgage.

Imagine the kind of interest charges we would incur if you tried to lump sum payoff your house? We’re probably talking well into the five-figures here.

Every situation is different, but here’s what I would do.

How to Pay Off Your Mortgage

In our situation once we have the second mortgage paid off we will have a decent amount of extra cash flow sitting around at the end of the month. Naturally you would think we might want to do the exact same thing and save up the money before one huge lump sum payment would pay off the mortgage.

But I think that would be much too costly in the long run. Yes, we’re giving up $5,000 by using this method on our second mortgage. For a first mortgage that is much larger (about 7-8 times as large), think of the difference in interest costs. I haven’t calculated it exactly, but I know it would be enormous.

That having been said, here’s how we would plan to pay off our first mortgage if we didn’t have a second mortgage today:

  1. build up a very solid emergency fund (if not already in place), 6-12 months worth of living expenses would work for us
  2. evaluate all savings goals and insure they are being funded (paying for a new car with cash, saving up for future childcare expenses, etc.)
  3. this is really part of #2, but evaluated all investing activities and adjust IRA and 401k contributions to fit goals
  4. take all extra cash flow and apply it immediately to the mortgage at the end of every month

Let me note that in the four steps above I am assuming you have no other debt than mortgage debt. If you do have other debt it is likely at a higher interest rate than your mortgage and should be targeted first. In fact after I had a decent emergency fund up then I would focus on that debt — before saving for a future car or college savings for your kids.

I can’t tell you how much money this would save us as for now it is all theoretical. I do know that on a typical 30-year mortgage you pay for the house price twice over the life of the loan. Those interest payments will kill you!

Every situation will be different so you need to be able to come up with your own plan. This is just my general guidelines for paying off your house.

Imagine writing that last check for your mortgage and never having to pay on that home again. Sounds pretty good, huh? Good luck using the above.

Readers: are any of you paying off your first mortgage with accelerated payments? Anyone living in a paid off house? I’m guessing not many are, but I’d love to hear from you in the comments.

{ 10 comments }

Finance Nerd March 9, 2009 at 7:57 am

My first is actually an I/O, but with a fixed rate. The reason for this is that we had to carry a mortgage on two houses for a while when we moved and our old house didn’t sell. So, we wanted to minimize the amount we had to pay every month until the old house sold.

But, once the old one sold, we kept the I/O on our new house, mainly because it makes it easier to focus our payments. If I am going to pay $x of interest and $y of principal every month, I would rather put all of $y on the second, so I can get rid of it faster.

So, we pay about $1000 extra a month on our second, and hope to pay it off in about 5 years. Then we can take all of that and add it to the first and get that paid off too. I won’t lump sum the first, I’ll just pay that much extra every month.

Corporate Barbarian March 9, 2009 at 12:41 pm

We used to throw every extra available dollar at our mortgage each month. We wound up shaving about 9 years off of our 30 year term. Putting extra money towards your principal really does make a huge impact.

LAL March 9, 2009 at 9:11 pm

I’m just too much in need of cash to be able to pay off the mortgage. Too many things are going on before I can pay off the mortgage.

Golfing Girl March 10, 2009 at 1:23 pm

We have no debt except for the house (15-year mortgage with balance of $110K). Once our EF is at 10K (it’s 3K now), we’ll put every penny on the mortgage. Our goal is to have $100K in equity (assuming selling at tax value of $190K – realtor fees to net $100K). Once we have this, we’ll likely move to a better school district using our $100K downpayment. We live in a relatively low cost of living area, so we can likely get another home for $200K and sell ours for about $190K.

When we get our new house we’ll put every penny on that new mortgage. I can’t wait to live in a paid for home!! (Please keep in mind we already fund retirement at 25%, make monthly deposits into our 5-year-old’s 529 plan, and plenty of life insurance, so we’re not sacrificing those things to get the home paid for.)

Kevin March 10, 2009 at 3:40 pm

@Finance Nerd: Yikes. Interest-only makes me nervous. I would rather not buy the new house until the old one sold — what if it never sells (or sells at 25% less than you are expecting)? But as I’ve said before on here, every situation is different. That having been said, an extra $1k per month is solid. Good luck with that.

@Corporate Barbarian: Yea, you can run through an extra payment calculator and the difference in years and dollars is staggering.

@LAL: Yea, every situation is different. Like I said if you have other debt or really important savings goals, then the mortgage extra payments can wait.

@Golfing Girl: Sounds like a great plan.

Do You Dave Ramsey? March 10, 2009 at 3:55 pm

More sound advice Kevin… I used to think – and I’m sure this is true of so many people – that paying off a mortgage is an impossible task. Yes, it is a big task, but not an impossible one.

Consider that the actual monthly principle amount on a 30 year loan is so small, it is easy to double your payment power without actually having to double your full payment.

So once you’ve (relatively) easily trimmed a 30 year mort into a 15 year obligation the mighly snowflakes can help you chip away from there.

Good luck with your efforts… I’m eager to get back in the job market so I can pound our 2nd mort and begin attacking the primary!

Thanks!
Dave

Finance Nerd March 10, 2009 at 6:28 pm

NDP, I agree that in many cases an I/O mortgage is risky. However, there are some cases where it can be useful, such as having a first and a second.

With an amortizing loan, your payment on your first is higher, which leaves you less money to pay down the second. On an I/O you can just pay the interest and put all of your principal to the second, paying it off much more quickly.

Look at it this way, if you had a first and a second, and the payments totaled $1500 per month, with $1000 of that being interest and $500 being principal, wouldn’t you rather that all of the principal went to one loan so you could pay it off faster? That is much more focused than paying $250 of interest on each.

Finance Nerd March 10, 2009 at 6:28 pm

Sorry, that should be paying $250 of principal on each.

Finance Nerd March 10, 2009 at 6:33 pm

As to owning two homes, it was a pain. The problem was that we built a new home, and when we signed the papers the market was doing fine. But by the time it was done 7 months later, the market had tanked. Had we seen that coming, we would have done it differently.

As it was, we paid on two houses for an entire year, and ended up taking an offer that was less than we owed. It was a financial crusher, and many people have told me they would have just walked away, but I didn’t feel right doing that, so I paid off the deficiency on the old house.

But I didn’t feel like backing out of the deal was an option because a) I had made a commitment to do it, and I don’t break commitments easily, and b) we really needed to get into that school district for my son who is a special needs child.

Kevin March 14, 2009 at 3:18 pm

@Do You Dave Ramsey: Yea I think that JD Roth at GetRichSlowly had been paying extra on his mortgage and the extra amount was the principle payment. He effectively doubled his principle payment every time.

@Finance Nerd: I see what you’re saying, but for me it would still make me nervous 🙂 I can see how if you bought near the top and then couldn’t sell that it would put you in a rough spot. Glad you seem to be through it now, too.

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