Paying off mortgage early or reinvesting in other ways

[Jeff Libby]

I have been wondering what would be a better strategy, making two extra mortgage payments/ year or using that money elsewhere. 

I'm going to use a basic mortgage calculator for the doing the math on this example.

If I have a 200k house with a 165k loan amount and 3.75% interest, and .5% tax the monthly payments are roughly 850 for 30 years. If I paid bi weekly instead of monthly I would save 16k in interest over the 30 years but I would be paying an extra 1700/ year which could possibly go somewhere else instead. The mortgage would be paid off in 26 years instead of 30, so after the 30 years I would have a paid off house and approximately accumulated about 36k from rents since it doesnt have to go toward a mortgage payment.

Now lets say I invest that 1700/ year somewhere with minimal risk, growing at 7%. After 30 years I would have put 50k into it but it would compound to 170k, making me 120k profits on it. After 30 years in this scenario, i would have paid off the house, but accumulated 170k (minus taxes)

It seems that it would make more sense to invest the 1700 instead of using it to pay off the mortgage early but I'm sure I am missing a lot of variables so I want to get input from you smart people.

[Bill Gulley]

Originally posted by @Joe Villeneuve:

@Bill Gulley Prepayment doesn't save on interest.  Here's what happens.

1 - Interest payment is based on 30 year mortgage
2 - Extra payment goes to principle, which pays down the principle, but the interest is minimally affected...and most of the regular payment is interest.
3 - The actual effect comes at the end of the mortgage, which if you sell or refi...you never reach

That's funny  Joe, you're telling me what happens.

Payment goes to outstanding principal, the next accrual period the interest is charged on the outstanding balance, interest is paid on a smaller balance and therefore the interest paid is less.

It is not a minimal effect of the amortized period, saving can be considerable.

Have no idea what you're saying in #3 "actual effect". You accrue more equity, equity in the walls don't pay interest, the only benefit is how the equity might be used, if at all and the rate of appreciation can be applied to equity. But, it does accrue tax deferred.

This is a classic "use of cash" model retiring debt at a higher interest rate than other alternative uses. :)