As a followup to my earlier note about refinancing our mortgage, I wanted to point out an interesting way of looking at things…

In the comments to that post, **Laura** brought up the concept of the mortgage “**crossover point**, ” which is the point at which you are paying more toward principal than toward mortgage interest.

In looking at the amortization table for our original and new mortgage, I realized that this is a very powerful concept. Here’s a breakdown:

Under the terms of our old mortgage, and assuming no pre-payments, it would’ve taken 231 months, or 19.25 years, to reach the mortgage crossover point. Given that we were 21 months into our mortgage, that means it would be another 17.5 years before getting there.

Of course, we were were overpaying our mortgage every month, so we would’ve reached the crossover point much sooner. Those payments notwithstanding, however, we were still looking at a relatively long time horizon before our money was working more for us than for the bank.

What about the new mortgage? As it turns out, it will take just over 10 months to reach the mortgage crossover point. So, ignoring the possibility of mortgage pre-payments, we’ll reach the crossover point in January of 2009. Not bad at all.

@ CPA 1298

IMHO, a split is best.Take the extra you would be paying against your mortgage, split it in half, and invest half. If you don’t have alot of investments built up already, the mortgage can wait.

If you’ve got a quarter mill in stocks already, then pay the mortgage off at any speed you so desire 🙂

Zach

Caldwell: You’re arguing about something entirely different. My only point was to look at the fraction of your payment that goes toward principal vs. interest. Nothing more, nothing less. No matter how much you inflate (or deflate) the economy, it’s still a straight up, dollar-for-dollar comparison. When the amount of your payment going toward principal exceeds the amount going toward interest, you’ve reached what I (and another commenter) have termed the crossover point. I understand the effects of inflation perfectly well, and you’ve made a valid (and important) point about how the value of the money that you owe decreases over time. But it has nothing to do with the simple point that I was making.

I continue to be torn between prepaying the mortgage and investing. I’m refinancing from a 6.375% 15yr to a 5.75% 30yr this week. My investment is buy-and-hold index funds, so I don’t have virtually any trading costs and the funds are low-turnover. I would love to be completely debt free, but I can’t help but think that this is more of an emotional decision than a logical one.

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Caldwell: Valid point in general, butâ€¦ no matter how much your money devalues between now and the crossover point, that point will still occur when the dollars toward principal = dollars toward interest. {Comment by nickel}

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…so what’s the significance of a ‘crossover point’ anyway ??

It’s significant because (without inflation) it marks the calendar date where the borrower starts seriously reducing the ‘principal’ (outstanding balance) of the money originally borrowed– and that’s the only way to ever pay off a loan.

However, in our real American world, inflation has already seriously reduced that owed principal… long before that nominal crossover point.

If one borrowed $100K on a 30-Year Mortgage in January 1977, the ‘principal’ owed to the lender would be $100K in January 1977 “U.S. Dollars”.

However, in just 5 years (.. by Jan 1982) inflation reduced the actual value of that principal to only $63,000 (.. in 1982 Rubber-Dollars). The borrower did not have to wait 19.25 years on a paper to seriously reduce the principal he owed the lender — and it required no borrower effort or cost.

And even at a nominal 19.25 year paper crossover point (..April 1996) — the real principal remaining was $38K. The mortgage borrower had already effortlessly reduced the principal he owed by over 60%… despite what the original 1977 amortization schedule said.

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That’s why inflation is such a disruptive force in our economy; few people understand it or can compensate for it overall. And inflation is always a deliberate Federal government policy (“legal counterfeiting” for government spending), not some mysterious force of nature or economics.

The official CPI inflation rate is now about 4% annually. That rate is now over 7%, using the previous method of Federal calculation (before they ‘adjusted’ their methodology in the mid 1990’s to reduce “Official” inflation rates).

Food & Fuel prices today average 13% higher than Jan 2007, even by official government statistics.

What do think the U.S. Dollar wil be worth after 30 years, on a new mortgage today ?

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Caldwell: Valid point in general, but… In any given year a dollar of principal is equal to a dollar of interest. Now, if you were making an argument based on returns on money that you invest vs. prepaying your mortgage, then I’d buy your argument. But, in this case, no matter how much your money devalues between now and the crossover point, that point will still occur when the dollars toward principal = dollars toward interest.

…always remember you’re using a ‘Rubber-Ruler’ when calculating with ‘U.S. Dollars’ — especially with long term stuff like mortgages.

“Inflation” constantly reduces the actual value (purchasing power) of a Dollar. That makes it much harder to calculate the ‘true’ mortgage crossover point.

Of course, inflation is good news for mortgagees because you’re paying back the lender with paper Dollars worth less than those you borrowed to buy your house

Over a 30 year mortgage period, say 1977 to 2007 — the Dollar lost over 70% of its value. $100,000 in 1977 is worth well less than $28,000 today, even by the official U.S. government statistics.

Rubber-Rulers give you wrong answers.

Ron,

Try this…

http://www.bankrate.com/brm/popcalc2.asp

Is there some software to help figure this stuff out? I could use some help.

This is a big difference between 15 and 30 year mortgages.

For 30 Years: At a rate of 4%, you are looking at 14 YEARS to reach crossover. 8% is about 23 years.

Even though a 15-year may cross over around 1-2 years, the general advice of it not making sense to prepay (or do a 15-year) makes sense.

An interesting point. Ran some numbers, and factoring in how much I overpay, my current interest rate, theoretical 15 year mortgage interest rate, it comes out that my monthly payment would increase by $30 more than what I overpay, minimum payment would increase by $90, be done 3 and a half years earlier, and save me $14000 in interest. I need to call my motrgage broker!