Monday, February 19, 2007

No Early Mortgage Repayments?

Super Saver at My Wealth Builder posted about his strategy for making additional payments on his home mortgage to ensure that it is repaid by the time he retires.

We have the same issue with the remaining term of our home mortgage extending nearly 10 years beyond my hoped for retirement at 50. I do not wish to carry a home mortgage (or any other debt) into retirement. There are four ways of dealing with the issue:

1. I could make additional monthly payments calculated to achieve full repayment when I turn 50. This option may not be practical because there is a minimum partial repayment threshold;

2. I could make periodic lump sum payments every 6-12 months to achieve full repayment when I turn 50. This is the approach that Super Saver has adopted;

3. I could direct the money that would have been used to make early repayments under option 1 or option 2 into other investments. The logic behind this approach is that with mortgage interest rates well below the long run returns on equities (and some other asset classes), my net wealth will be higher at the end of the day (although not without some risk). When the time comes to retire, the other investments will be sold and used to discharge the residual balance of the mortgage (hopefully with a bit left over);

4. sell our home and buy something smaller. As our children will still be living with us at that time, this will not be an option until much later and can be excluded for present purposes.

With the interest rate on our home mortgage currently at 5.0% (it is a floating rate) and the long run return on equities averaging around 10% pa (+/- a bit depending on which market you are looking at) and a reasonable time period to work with (9 years), we have elected option 3.

We recognise that this is not a risk free proposition. Equity markets can be volatile. There have been bear markets that have lasted a long time. Even though the odds are in our favour, it is possible that the lump sum we accumulate will be less than the residual value of our mortgage. If this happens we can (i) carry a small mortgage balance into retirement ( thanks), (ii) sell some other investments or (iii) defer retirement until the balance has been cleared (I would not expect this to be long).

I ran some numbers comparing annual lump sum additional repayments with annual investments in other assets returning 8% per annum. The difference (after adjusting for inflation at 3%) is enough to fund a long weekend for two at a good hotel in Sanya once a year which is a nice addition to our retirement lifstyle.

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