Additional Mortgage Principal Payment Benefits

[etotheix]

Hello all,

I found this forum trying to figure out if additional mortgage payments were a worthwhile investment.  This post by Heart of Tin really made the math click.  Unfortunately, I couldn't access the google docs spreadsheet referenced in the thread, but I wrote my own that functions essentially the same.  Assuming our PMI payments end when we reach 80% LTV with value at the original purchase price, our IRR on additional principal payments works out to ~5.2% (excluding the tax benefit or mortgage interest deductions).  Pretty decent return, but < 7% frequently espoused as the long term stock market return on this forum.  We have a pretty secure income, plenty of cash on hand (easily 6 month expenses in actual cash + >6 month expenses in liquid assets), and as much as I like looking at our NW day to day I have 0 intention of liquidating any stocks or funds we own ("Our favorite holding period is forever").

Once the PMI is gone, we don't envision making additional payments toward principal.

If we were to make 0 additional principal payments, our last PMI payment would be 6/30/2023.  With an additional $500 per month payment, our last PMI payment would be on 11/30/2019.  (side effect being the mortgage payoff on 4/30/2040 vs 9/40/43).

Given the uncertainty in future tax rates & deduction schemes, should I be including the effect of the deductions in the assumed rate of return?  It doesn't make a significant difference this year, but it obviously would be more significant in future years.

Based on this scenario:

Cons:
Near term cash flow hit ($500/m)
Potential unrealized gains on $500/m

Pros:
Mid term cash flow benefit ($150/m)
Essentially guaranteed IRR of 5.2% (less tax benefit)
Reduce likelihood of ending up underwater in event of economic downturn

Anything else?

Relevant Background Information:
320k outstanding balance
4.25% interest rate
345k purchase price
Zestimate of $370k
No intention of selling
After next month, 0 debt at > 4.25% interest rate

[MDM]

etotheix, welcome to the forum.

Yes, Heart of Tin had some very nice posts - too bad she hasn't been around in months.  Had some trouble with the link in the OP: http://forum.mrmoneymustache.com/investor-alley/pmi-or-investing/msg204396/#msg204396 should work.

With current 10-year Treasury at 2.05%, the 5.2% return is a good candidate to do before other taxable investing if one follows the guidelines below.  That would also support your decision not to pre-pay more on the 4.25% mortgage once PMI is gone.

In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct.   
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA    
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic.)
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial