Missing opportunity cost of mortgage prepayment
"You seem to really have your financial act together.  Your combination of assets, and ongoing savings makes you the ideal candidate for paying it off. One way to look at it is that your mortgage offers you a place to 'invest' at a fixed 2-7/8% rate. ""I'd really like to not have a house payment"" is all I need to hear.  The flip side is the lecture that talks about long term market returns, the fact that the combination of your deductible mortgage, but 15% cap gain rate means you need 2.5% return to break even, and odds are pretty high that will occur over the next 15 years. ""pretty high"" does not equal ""guaranteed"". And I won't debate the value of sleeping soundly vs an excess 5-8% return on this money that you'd maybe achieve.  You haven't missed anything. In fact, though I advocate saving first, you are already doing that. This is above and beyond. Good work." One other consideration is that by paying off your mortgage early versus, for example, investing that capital in a mutual fund is that you are reducing your net liquidity to some degree. That is, if you find yourself needing an emergency infusion of cash it is easier to sell a stock/fund than to sell your house or get a equity loan.  I suppose if you were planning to need a lot of cash to start a business or invest in real estate, then maybe it would make sense to keep your cash more liquid. However, in your situation I agree with Joe. Pay it off. It feels REALLY good to write that last check! I agree with Joe that you seem to have your stuff together. However I can't disagree more otherwise.  You are getting a loan at such a cheap rate that it would be almost impossible to not substantially beat that rate over the next 15-20 years.  You paying off your home early might give you warm fuzzy feeling but would make me queezy.  This is a MONEY website.  Make money. For our purposes let's say your home is worth 500k, you can get a fixed rate loan at 3% over 30 years, and you can earn 7% on your investments per year.  Note that I have earned 12% on mine the past 15 years so I am being pretty conservative. So let's not get into your other stuff because that is fine.  Let's focus just on that 500k - your house. Interest only Loan for the whole thing-  The flip side is you pay off your house.  Your house could be worth 400K in 30 years.  Probably not but neighborhood could decline, house not kept up, or whatever.  Your house is not a risk-free investment.  And it fluctuate in many areas more than the stock market.  But let's just say your area stays OK or normal.  In 30 years you can expect your house to be worth somewhere between 700k to 1.5 million.  Let's just say you did GREAT with your house.  Guess what?  At 1.5 million selling price you still lost 1.5 million because of your decision plus sunk your money into a less liquid option.   Let the bank take the risk on your house price.  The warm fuzzy feeling will be there when you realize you could rebuy your house two times over in 6-7 years. Note: I know my example doesn't use your exact numbers.  I am just showing what your true cost is of making a decision in the most extreme way.  I am guessing you have great credit and might be able to find an all interest loan at 3%.  So not doing this is costing you 1.5 million over 30 years.  Given a lower home price after 30 years or a higher rate of return this easily be much more.  IF you earned 12% over the 30 year period you would be costing yourself 16 million - do the math.  Now you are talking about doing something in-between.  Which means you will basically have the same risk factors with less return.
When I was a contractor I prioritize this way. 6 months salary nest egg while contributing to tax deferred retirement then after that you can pre pay your mortgage.  Remember you can't skip a month even if you prepay.  So once you pay that extra to your mortgage you lose that flexibility. Surely the yield should be Yield = (Rent - Costs) / Downpayment ? As you want the yield relative to your capital not to the property value. As for the opportunity cost part you could look at the risk free rate of return you could obtain, either through government bonds or bank accounts with some sort of government guarantee (not sure what practical terms are for this in Finland). The management fee is almost 30% of your rent, what does this cover? Is it possible to manage the property yourself, as this would give you a much larger cushion between rent and expenses. The value of debt is that it allows you to profit from the return of equity beyond the amount of actual net equity you own.  Of course, this only works if the cost of borrowing is less than your return on equity.  Market timing matters a great deal but isn't accounted for in this view.  For my answer I would like to hand-wave away market timing considerations.  One plausible justification is that you could default on your current home and then immediately go buy one of equal value.  If you buy a new home of a lesser value (due to lack of funds) and then prices appreciate, then you missed some opportunity cost but probably not $100k worth of it. Moving on, here are some helpful assumptions I'll make. I'll ignore performance of your portfolio after retirement and only seek to optimize F, which will be your net worth upon retirement.  In either case, your current net worth is earning the R2 rate.  We can convert this for both your current net worth and future savings using conversion formulas. Present to future value F = P (1+R2)^x Annual to future value F = S ( (1+R2)^x - 1 ) / R2 Adding these together is sufficient to obtain F in the case that you have no borrowing power.  The case where you do not default and maintain your credit score is different due to an initial $100k penalty and the amortized value of borrowing power.  In a completely theoretical sense, you get an effective (R2-R1) yield on all borrowed money.  The future value will be the following: F = A1 (1+R2-R1)^x One step is missing, however, which is to convert this value (the value of having a good credit score) into present value to compare to value of your defaulting. P of borrowing power = F / (1+R2)^x = A1 { (1+R2-R1)/(1+R2) }^x Now, let's put some specific values in.  Say that you can borrow $300k with your good credit history and this applies for the next 25 years, after which you retire.  The borrowing rate is 7% and the time-value of money to you is 10%.  I would then calculate: P of borrowing power = $58 k < $100 k This indicates that it would be more economical to default.  Of course, some people might point out that it will be removed from your record after 7 years.  If you plug 7 years instead of 25 years into the equation, almost no assumptions about rates will lead to the option of keeping your house being preferable. So in a nutshell, the value of your credit is probably less than $100k in a purely mathematical sense.  But there are other factors too.  If you don't have that borrowing ability maybe you wouldn't be able to borrow money to start the business of your dreams.  If you are a rock star entrepreneur, then time-value of money to you could be 1,000% yield, sure, then maybe you could make the above numbers work (to favor keeping the house).  I've also neglected ethics.  As other people point out, it would be like stealing from the bank. There are few different types of MI you can choose from, they are: Borrower-Paid Monthly (this is what most people think of when they think MI) Borrower-Paid Single Premium (you may have QM issues on this) Lender Paid Single Premium Split Up-front and Monthly The only way to determine which option will ultimately cost you less is to come up with a time estimate or range for how long you anticipate you will hold this mortgage, then look at each option over that time, and see where they fall. To answer your question about the single-premium being added to your loan, this typically does not happen (outside of FHA/VA).  The reason for that is you would now have 90%+ financing and fall into a new pricing bracket, if not being disqualified altogether.  What is far more typical is the use of premium pricing to pay this up-front premium.  Premium pricing is where you take a lender credit in exchange for an elevated rate; it is the exact opposite of paying points to buy down your rate. For example:  say a zero point rate is 4.25%, and you have monthly MI of say .8%.  Your effective rate would be 5.05%.  It may be possible to use premium pricing at an elevated rate of say 4.75% to pay your MI up front--now your effective rate is the note rate of 4.75%.  This is how a single premium can save you money.  Keep in mind though, the 4.75% will be your rate for the life of the loan, and in the other scenario, once the MI drops off, the effective rate will go back down from 5.05% to 4.25%.  This is why it is critical to know your estimated length of financing. It's easiest to get your payment from the PMT function in Excel or Google Sheets.  So a $100,000 30 year mortgage at 3% looks like this: The basic calculation is pretty simple.  You take the annual interest rate, say 3%, divided by 12, times the existing principal balance: The idea is that borrowers would like to have a predictable payment.  The earlier payments are proportionally more interest than principal than later payments are but that's because there is much more principal outstanding on month 1 than on month 200. Without commenting on whether or not it's needed I don't think we are going to see a QE3 and all the political pressure is for some reason to start raising rates.  Regardless of how it plays out it's safe to say that the Fed Rate isn't going any lower.   You should also watch closely what happens to Fannie and Freddie.  If they are dismantled and government backed mortgages become a thing of the past then I think it'll become impossible for a consumer to find a 30 year fixed rate mortgage.  Even if they are kept alive, they will be put on a short leash and that will serve to further depress the mortgage market. Long story short, I'd lock your rate in. There are a few ways to look at this question. Assumptions. Per the original post's assumptions, this answer: In other words, if the owner paid the mortgage on its original schedule, the deal could boil down to a $ 40,000 up-front payment, in exchange for $ 200,000 of equity after 30 years.  Or the deal could boil down to a $ 40,000 up-front payment, in exchange for a $ 810.70 monthly payment starting in 30 years. While the owner is paying down the mortgage, the return on equity is the principal payment divided by the equity.  The principal payment is the net rent minus non-financing costs and interest, so it is actually a profit. The initial return on equity is 6.321 % APR, or 6.507 % APY.  This is calculated by dividing the $ 210.70 monthly principal payment by the initial $ 40,000 equity, and converting from monthly return to annual return. After 30 years, the return on equity is 4.864 % APR, or 4.974 % APY.  This is calculated by dividing the $ 810.70 monthly cash flow (which is no longer reduced by mortgage payments) by the $ 200,000 equity after 30 years, and converting from monthly return to annual return. The cap rate is the same as the return on equity in the absence of debt.  In this example, 4.864 % APR, or 4.974 % APY. The return on equity declines from 6.507 % APY initially to 4.974 % APY after 30 years. This is because the cap rate exceeds the note rate (4.974 % APY vs. 4.594 % APY), and the leverage decreases from 5x to 1x. The weighted average compound annual growth rate of the equity during the 30 years is 5.511 % APY.  Per the original poster's answer, this is computed by taking the 30th root of the 5-fold increase in equity.  Because the owner made no extra principal payments (besides those already discussed), the relevant amounts are the initial $ 40,000 owner payment and the final $ 200,000 owner equity.  5.511 % APY corresponds to a 5.377 % APR. The internal rate of return if the owner never sells can be computed by treating the deal as a $ 40,000 up-front payment, in exchange for an $ 810.70 monthly payment starting in 30 years.  The internal rate of return (IRR) is not a very useful number, because it assumes that you can somehow reinvest the eventual dividends at the same rate.  In this example, the IRR is 5.172 % APR, or 5.296  % APY.  In this example, the IRR is calculated by (iteratively) finding an interest rate for which (initial investment) * (1 + IRR) ^ (number periods before dividends start) = (periodic dividend) / (IRR - growth rate of dividend).  For example: $ 40,000 * (1.004309687)^360 = $ 810.70 / (0.004309687 - 0) = $ 188,111 I then converted the 0.431 % monthly IRR to an annual IRR. The deal can be thought of as a return on equity, plus a return on paying down the mortgage. When computing the return from paying down the mortgage, the initial equity is irrelevant.  It does not matter whether you start with a $ 160,000 mortgage on a $ 160,000 property, a $ 160,000 mortgage on a $ 200,000 property, or a $ 160,000 mortgage on a $ 1,000,000 property.  All that matters is the note rate on the mortgage, which is the applicable compound interest rate. The return on paying down the mortgage equals the note rate of the mortgage.  For a 4.5% note rate, this works out to a 4.594% annual percentage yield (APY). You can confirm this by looking at your amortization schedule.  Suppose you have a $ 160,000 mortgage with a fixed 4.5% APR note rate for 360 months.  Your monthly payment is $ 810.70.  In the first month, $ 600 goes toward interest, and $ 210.70 reduces the principal.  In other words, the $ 210.70 principal payment eliminated the need for a $ 810.70 payment 30 years later.  Notice that: . $ 210.70 * (1 + 0.045 / 12)^360 = $ 210.70 * (1.00375)^360 = $ 210.70 * 3.8477 = $ 810.71 which is within rounding error of $ 810.70. The interest rate is 3/8 % per month, which is an APR of 4.5%, and an APY of 4.594 %. "If this is an issue of opportunity cost then there is a benefit. Mortgage interest rates are extremely low, low enough that they can effectively be used to indirectly fund investments. If one stores equity in a house, ie ""pays it off"", then that wealth returns only the rate of growth of the house less expenditures. If one borrows against the house to fund investments, then the above stated returns which on average exceed the mortgage interest rate can be augmented by the investments, yielding a greater return. The tax benefit is more of a cherry on top. If one is using this as a justification to spend then it is frivolity." "The can and the should have been discussed in other answers and comments,  and so I will discuss the how.  As others have noted, it is important to make sure that the additional money goes to reducing principal and not towards  prepayment of interest.  Unfortunately, very few bank tellers understand how mortgages work and very few bank officers - even loan officers - understand how mortgages work too. Thus a statement that you want the extra money to go towards principal will likely be met with a blank look. Furthermore, what they do with the money and how it is entered on the bank books that afternoon when the transactions are recorded may have no resemblance to what was discussed and agreed to earlier in the day.  Based on my personal experiences and  many arguments with banks about how they handled my prepayments and how interest was computed, I would  recommend the following (which is easier now that automated payments are possible for the standard monthly payment and additional payments are possible via electronic funds transfer). Make sure that automated payments are made on the day that the payment is due, not at the end of the ten-day grace period that banks love to grant you for making the monthly payment. Yes, there is no penalty for late payment as long as you pay before the end of the grace period, but interest continues to be charged and so more of each graciously delayed payment goes to interest  and less towards principal. Make the additional payment on the same day as the standard monthly mortgage payment is made. This ensures that at worst just one day's interest is owing when the additional payment is made. Also, payment in the middle of the monthly cycle is an almost sure way of getting ripped off on the interest because the bank's computers will post the payment in the manner most favorable to them, and usually contrary to the terms of your mortgage.  I have  complained to banks about mishandled mid-month payments and won every time, and on many occasions the bank officer would grudgingly say ""We have always done it this way and nobody  ever complained till you did today."" I doubt very much if the bank's programs got changed as a result of my complaints. If you are not sure how mortgages work and how interest  is calculated or don't have the time or inclination to go hassle with the bank each time but do prefer not to get ripped off, make the payment as described: on the dot and at the same time as the regularly scheduled monthly payment. The amortization schedule that the bank should have given you shows how much the principal amount is after the monthly  payment is made on each due date.  Assuming that you have  not been taking advantage of the grace periods and so the schedule is correct, make an additional payment not of a round sum but an exact amount (down to the last penny) that will jump you from principal owing after today's regular payment to principal owing after the regular payment N months from today. Here of course you choose N based on how much extra money you were planning on paying towards your mortgage.  By making the extra payment, you will effectively have cut the length of  the mortgage by n months and the same amortization schedule will apply over the shorter period.  Since very little of the principal is repaid in the early life of the mortgage, an additional principal-only payment can reduce the length of the mortgage by years. Paying a specific amount that matches the amortization schedule also helps if you ever need to hassle with the bank. It is their print-out you are arguing from, and not trying to explain to a clueless bank officer how the bank did not compute interest  correctly after you paid $1500.00 extra at beginning of last month." yeah, i get that it's not optional. just sucks that nothing has changed substantially since i closed on the loan 11 months ago (same PMI, same HO, essentially the same property taxes) and now i have to pay more. seems like the closing docs could have taken into account timing of those payments so that i primed the pump with enough from the beginning. "I read the linked article as gef05 did, it states that the bank must stop charging PMI. But. My understanding is different. I understood that the requirement to remove PMI at sub 80 loan to value only occurred after the natural amortization time had passed. For example, you buy a $100K home, you will be at 80% LTV the day you owe 80K. This date can be calculated at the closing as you know your numbers by then. There's nothing stopping you from asking the bank to stop charging PMI sooner, but I believe they already have an end date in mind.  Besides the appraisal request, what exactly did they give as the reason they won't cancel PMI?  Edit - I just re-read the link. The line ""you show that the value of the property hasn't gone down"" makes the bank's appraisal request reasonable, IMHO." i prepaid roughly $400 at closing into escrow. that's my minimum allowable balance. paid in all year, and now taxes and insurance are paid in december. after december, they're projecting a $200 balance, which is $200 too low. homeowners insurance hasn't changed, pmi hasn't changed, property taxes are virtually identical to estimate at closing. the difference is that the $400 initial payment didn't factor in timing of those payments out of escrow. pretty lame if you ask me. Different bonds (and securitized mortgages are bonds) that have similar average lives tend to have similar yields (or at least trade at predictable yield spreads from one another). So, why does a 30 year mortgage not trade in lock-step with 30-year Treasuries? First a little introduction: Mortgages are pooled together into bundles and securitized by the Federal Agencies: Fannie Mae, Freddie Mac, and Ginnie Mae. Investors make assumptions about the prepayments expected for the mortgages in those pools. As explained below: those assumptions show that mortgages tend to have an average life similar to 10-year Treasury Notes.  100% PSA, a so-called average rate of prepayment, means that the prepayment increases linearly from 0% to 6% over the first 30 months of the mortgage. After the first 30 months, mortgages are assumed to prepay at 6% per year. This assumption comes from the fact that people are relatively unlikely to prepay their mortgage in the first 2 1/2 years of the mortgage's life. See the graph below.  The faster the repayments the shorter the average life of the mortgage. With 150% PSA a mortgage has an average life of nine years. On average your investment will be returned within 9 years. Some of it will be returned earlier, and some of it later. This return of interest and principal is shown in the graph below:  The typical investor in a mortgage receives 100% of this investment back within approximately 10 years, therefore mortgages trade in step with 10 year Treasury Notes. Average life is defined here: The length of time the principal of a debt issue is expected to be   outstanding. Average life is an average period before a debt is repaid   through amortization or sinking fund payments. To calculate the   average life, multiply the date of each payment (expressed as a   fraction of years or months) by the percentage of total principal that   has been paid by that date, summing the results and dividing by the   total issue size. Why won't anyone just answer the original question? The question was not about opportunity cost or flexibility or family expenses. There are no right answers to any of those things and they all depend on individual circumstances. I believe the answer to the question of whether paying off a 30-year mortgage in 15 years would cost the same amount as a 15-year mortgage of the same interest rate is yes but ONLY if you pay it off on the exact same schedule as your supposed 15-year. In reality, the answer is NO for two reasons: the amortization schedule; and the fact that the 30-year will always have a higher interest rate than the 15-year. The way mortgages are amortized, the interest is paid first, essentially. For most people the majority of the monthly payment is interest for the first half of the loan's life. This is good for most people because, in reality, most mortgages only last a couple years after which people refinance or move and for those first couple years the majority of one's housing costs (interest) are tax deductible. It is arguable whether perpetuating this for one's entire life is wise... but that's the reality of most mortgages. So, unless you pay off your 30-year on the exact same amortization schedule of your theoretical 15-year, you will pay more in interest. A common strategy people pursue is paying an extra monthly payment (or more) each year. By the time you get around to chipping away at your principal in that way, you will already have paid a lot more interest than you would have on a 15-year. And, really, if you can afford to substantially pay down principal in the first year or two of your mortgage, you probably should've borrowed less money to begin with. In theory, IF the rates were the same (they're not) and IF you paid the 30 off every month in the EXACT same way as you would've paid a 15 (you won't) you will pay the same amount in the end. You have to decide if the flexibility is worth more to you than the cost savings.  For example: a 300k mortgage at 3.5% will have a monthly payment of ~$2150 for a 15-year and ~$1350 for a 30-year, both will start with ~$875/month of that being in interest (gradually declining with time). What I think most people undervalue is the freedom and peace of mind that comes with a paid off or nearly paid off home... and 15 years is a lot more tangible than 30, plus a lot cheaper over all. If you can afford a 15-year mortgage without putting too much stress on your budget, it is definitely the better option for financial security.  And be careful of the index fund opportunity cost advice. On average it may be a good idea when you look at the very long run, historically, but a lot of people get less than average returns depending on when they buy and what the market does in the short run. There is no certainty around what returns you will get from the stock market, but if you have a 30-year mortgage there is a lot of certainty around what you will owe every month for the next 30-years. Different mixes of investments make sense for different people, and most people would be wise to get some exposure to the stock market for its returns and liquidity. However, if someone's goal is borrowing more money for their house in order to invest more money in the stock market for their retirement, they would actually be better served in achieving security and independence 15 years sooner. You probably won't save much, if anything at all, by getting another fixed-term mortgage. The last part of a mortgage is mostly principal payments.  If you borrowed $200k (guessing) at 4.75% then during the last five years you'll pay about $10.5k in interest, as opposed to $41.7k in the first five years and $27.9k in the second five.  Another fixed rate loan won't get you a whole lot lower than 4.75%. If you can score a teaser rate (say 2.5% for the first five years) on the balance at the beginning of year 11, and pay the same amount that you were before ($1,555) then you'd knock out the mortgage in 57 months and save yourself a little under $5k.  If the refinance costs only a few hundred, then you might make out. Anyway, you may find other similar options that have a low teaser rate but (goody for you) you won't be around long enough to see it jump up.  Just watch for prepayment penalties. I'd probably just bump up my payments, though.  I went through a refinance and I felt like my hand was forced a lot in that process, but your mileage may vary. :)