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The Surprisingly Large Impact of Small Savings

bucket systemThere’s an eternal debate about whether you should use an unexpected amount of free cash (Bonus?  Inheritance?) to pay down your mortgage or put the money into a retirement investment account.  The numbers on a spreadsheet tend to favor investing the money if the investment returns are higher than the mortgage interest rate (currently in the 3.5% range).  But of course there is absolutely no guarantee that this will happen.  And some people sleep better when they’re debt-free.  Can you put the value of THAT on a spreadsheet?

A more interesting discussion is whether you can use some of your lifestyle expenses to pay down your mortgage–and what the value of even small budget cuts would be over time.  You can explore this surprisingly fascinating subject on a new website: www.mortgagenudge.com, which lets you look at relatively modest shifts from the expense side of your ledger to your mortgage, and see the long-term results.

As an example, suppose you have a $250,000 mortgage at a 4.5% interest rate.  You enter this information into the website, along with your monthly principal and interest payment.

Then you move a little slider that determines how much extra you might be willing to put down on your mortgage each month.  For instance, suppose you discover that you’re spending $60 a month at Starbucks, when you could be brewing moderately decent coffee at home before your commute to work.  Let’s say you want to kick the habit gradually, so you start out putting $20.29 extra on your monthly mortgage payment.  You agree to find an additional $20.29 a month the following year, which means a little over $40.50 will be paid monthly the next year.  Your Starbucks habit will be gone in the third year, when you find those same additional savings to pay down your mortgage.  If you get a raise the following year, some of that is added to this payment, and so forth.

When the slider moves, you discover that this modest diversion of lifestyle dollars, over time, pays off your mortgage 7 years and 9 months early, saving you $48,531 in total interest.  If you want to be more aggressive, and start off with $26.29 a month–with graduated increases thereafter–your mortgage is paid off nine years and a month early, at an interest savings of $57,131.  The slider takes you all the way up to an aggressive $64.29 additional monthly payment in the first year, with increasing payments thereafter.  That cuts the 30 year mortgage almost in half, saving more than $92,000 in interest.

The key to making this interesting exercise work in the real world, of course, is discipline; making those additional payments each year like clockwork.  You can take some money out of eating out, or the cost of an unnecessary cable TV premium channel that you never watch, or some other service you no longer use–or, instead, when you receive an increase in salary, you can put some of that on the monthly mortgage check.  The point here is how substantial some of these smaller incremental adjustments can become over time; a few pennies saved can become big dollars later on.

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