Keep More of What You Earn

By Michael Jensen, CPA, CFP

It has become normal to live paycheck to paycheck with monthly debt payments consuming a greater share of your take-home pay. Debt payments have become a part of our lives whether it’s for a home, vehicle, student loans, or other debt. What would your life look like with no payments? Wouldn’t it be nice to invest in your future instead of paying for past purchases?

There are many ways you can improve your personal financial picture through tax and financial planning. However, I’d like to focus on one of the biggest purchases you’ll make in your lifetime. Your home and the mortgage that comes along with it.

You search Zillow, find your dream home, your offer is accepted, and a lender approves you for a mortgage. All you need now is to rent a moving truck and tune-in to HGTV for decorating ideas. For the rest of the article I’m going to assume you purchased a $375,000 home, put $75,000 down to avoid private mortgage insurance (smart), and took out a $300,000 mortgage at 4.75% with a 30-year term.

Things are going great in your new home. You’ve met the neighbors, unpacked most boxes, and just received the first mortgage statement in the mail. Your first payment due is $1,565 with roughly 75% of that going to the bank in the form of interest. After the first 12 payments, you’ve paid $14,150 in interest and reduced your loan by roughly $4,630. Over the course of the 30-year loan you’ll give the bank close to $263,400 in interest and pay $563,400 in total (187.8% of the original loan balance).

Let’s say you took out a 15-year mortgage instead with a 4.25% interest rate. Rates are lower due to the reduction in risk that the lender assumes with the shorter payback period. The mortgage payment is now $2,257 ($692 more), but you’ll save yourself $157,155 in interest and eliminate 15 years of payments.

What if you stayed with your 30-year mortgage but added $500 to your monthly principal payment (for a total payment of $2,065)? The additional $500 per month in principal payments would cut 12 years off the loan and reduce your interest paid by $116,000. You now own your home outright and no longer have a mortgage payment. The amount you were paying towards the mortgage is now available to invest, spend or give however you’d like.

What if you invested the same $2,065 each month over the remainder of the original 30-year note (12 years) in an investment earning a 7% annual return? At the end of those 12 years you’d have over $466,000 in that investment. That’s a $582,000 swing if you consider the $116,000 you would have paid in interest.

Now consider the tax deductibility of mortgage interest. The reality is most taxpayers will no longer benefit from tax deductibility of mortgage interest under the new Tax Cuts and Jobs Act law. The Tax Policy Center estimates that only 10.9% of taxpayers will be able to itemize deductions for 2018, down from 26.4% in 2017.

Some would argue that you should invest excess funds instead of paying extra on your mortgage since you can “earn a greater return”. Market returns are not guaranteed and investing involves risk. However, paying additional principal on your mortgage yields a guaranteed return in a shorter loan payback period, reduction of total interest paid, and a quicker path to owning your home outright.

Should you stop everything and pay off your home as quickly as possible? It depends. In our profession, there is no one-sized-fits-all answer. I’m simply trying to illustrate how you can improve your financial picture by being intentional and telling your money where to go instead of wondering where it went. You determine what your dreams and goals are, and we can help you develop a plan on how to get there.

Michael Jensen, CPA, CFP® | Manager
MJensen@MHCScpa.com