Accelerating payments versus making good decisions

Here at Saverocity, our glorious leader Matt and I have a difference in opinion, which is always more fun than agreement, so I thought I’d take a few minutes to give the strong form of our disagreement. I don’t think either of us actually holds the strong form of these opinions, but the strong form illustrates the difference most dramatically.

Anyone who has met Matt knows he’s an excellent financial planner and thus takes the sensible view that accelerating the payment of debt offers a guaranteed return (the interest rate on your debt) while investing in risk assets offers an unknown return (whatever return the asset you invest in happens to produce). That’s a view I emphatically share.

The confusing thing about this to me is that accelerating payments on a loan is still more expensive than taking the right loan out in the first place. It may be true that making two mortgage payments per month will let you pay off a 30-year mortgage in 23 years, but it’s also true that for all 23 of those years you’ll be paying the interest rate on a 30-year mortgage. Why not just take out a 23-year mortgage to begin with?

That’s not a rhetorical question: there are reasons you might prefer a lower “minimum” payment while reserving the option of making excess payments in any given year. But if you’re planning to make excess payments every single year for the life of the mortgage, you should take out a shorter-term mortgage at a lower interest rate!

Similarly, the way student loans work in the United States is that you are offered a loan with a fixed amount based on your year in college, you take out the loan, you spend the money, then you repay it (hopefully using income-based repayment, the best form of repayment). But of course one thing you might do is borrow less money, if you knew you didn’t need the full amount of the loan, for example if you could supplement your financial aid with work while in school. In other words, just as above, accelerating repayment of a loan is a poor substitute for borrowing less money and paying less interest during the lifetime of the loan.

This thread in the Saverocity Forum sums up both of our views in our own words. But since this is my blog, I’ll close with my words:

“If something has changed since you made that decision, or if you have learned more things and consider yourself better-informed and better-educated about the risks and rewards of investing in the market while carrying a mortgage, good, reassess your situation and potentially arrive at a different conclusion.

“On the other hand, if you made the decision impetuously, and are now making another decision impetuously, then your problem is making impetuous decisions, not carrying a mortgage while investing in the stock market! Fix the real problem, which is not your mortgage/stock allocation.

“And finally, you need to consider the possibility that your younger self was right. Maybe it was that younger self that thought through everything and decided that carrying the mortgage while investing in the market was worthwhile, and he thought through all the risks and rewards and arrived at a sensible conclusion, and would be furious that you, older self, are second-guessing his careful homework.”