Why We Paid Down Part of Our Mortgage

Recently my wife, Colleen, and I modified our mortgage. I’d like to share some of our thinking because it illustrates some of the trade-offs made in personal finance.

But first, a little background. As you would expect from a financial advisor, my wife and I have the basics covered:

• We have an emergency fund in excess of one year of living expenses.
• We have a saving and investing plan we are following, which includes 401(k) contributions, 529 plans and standard brokerage account investments.
• Other than our mortgage, we are debt-free.

Why we made a suboptimal decision
We decided to pay off a portion of our 3.75%, 30-year mortgage and refinance to a 15-year mortgage at 2.75%. The interest we will save is likely less than the return we would have seen had we invested the money instead. So modifying our mortgage was a suboptimal decision from a financial perspective.
Why would I have done this? Am I not a super-rational financial advisor?
Yes, but our family has several values that led us to our decision:

• Conservative finances: Although we invest aggressively, we strive to manage our finances conservatively, and minimizing debt is part of that. We do this because I run my own business and could have income volatility, and it gives us peace of mind.
• Freedom and flexibility: Like many of you, we aspire to have the option to retire early. Or live overseas. Or take a sabbatical. Having a shorter mortgage will allow us the flexibility to take advantage of opportunities without having a long-term debt hanging over our heads.
• Belief in enforced discipline: When we have extra cash, despite our best intentions, we tend to spend it. Having excess cash in our account is a constant siren song for mindless spending. Even the most disciplined saver will relent and spend some of the cash eventually. Having it tied up in equity makes it harder, but not impossible, to access.

​I like to think of it this way:

The money doesn’t drive your plan — the plan drives your money. Financial analysis and planning can provide structure for your life, but don’t drive the meaning or make your goals. You do.
Here’s an abbreviated list of our pros and cons of the mortgage modification we chose:
PROS

• Shorter loan term.
• Lower interest rate.
• By paying down some of the balance up front, our monthly payment stays about the same.
• Saves significant interest cost over the life of the loan.
• Aligns with our values.

CONS

• Our interest tax deduction goes down.
• After 15 years, the interest deduction goes away.
• The cash used to pay down the balance would probably earn more if invested for 15 years.
• It will be difficult to access the equity in our house if we need it for some reason.

We calculated that every $1 we paid off when we switched from a 30- to a 15-year loan will save us more than $1.15 in interest. We chose the guaranteed savings over the potential return on investing. People in a different situation might make a different decision. That’s why it’s called personal finance.
This also highlights the importance of running the numbers. You have to do the analysis (or have someone do it for you). We spent lots of time reviewing the options and calculating the impact. We thought about it, and talked about it, for weeks before finalizing a decision.
The financial analysis didn’t make the decision, but it did provide the structure and information to help us. Ultimately, our personal values trumped the math, but we still did the math first.
This is not an analysis of whether you should modify your mortgage, rather an illustration of how to think about tackling financial issues.
​
STEPS WE TOOK TO MAKE OUR DECISION

1. We discussed our values that would affect or be affected by this decision very early in the process.
2. We developed financial models and impacts of the various scenarios that we were considering.
3. We weighed the pros and cons.
4. We made a decision.

Hopefully this example will serve as a guide for financial decisions you might make.

Author's note: After publication of this article interest rates spiked subsequent to the presidential election. As a result, we have not refinanced to a 15 year loan since we did not lock in a competitive rate. However, we will still be paying down our mortgage. It just shows that flexibility in your planning is key.

For more on this topic see Fun with Mortgage Math.

​This article was originally published on Nerdwallet.com.