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Comment by rayiner | Hacker News Reader

> 1) Pay all your debt now, unless you have a sure way to make money at a higher interest rate CONSIDERING INFLATION (ie if you hold debt at a fixed 2% annual rate and can access 3% guaranteed placement, don't pay your debts if inflation is <1%)

If you can get 3% nominal and hold debt at 2%, it doesn't matter what inflation is, since your debt isn't in inflation-adjusted dollars. Indeed, the higher the rate of inflation, the less it makes sense to pay off debt. If you have debt at 5%, and your real rate of return is only 3%, it might still make sense not to pay off that debt if inflation is > 2%.

Paying off debt is not risk-free, in the sense that paying down loans now is a bet on future inflation being low.

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You make a good point. Consider making an extra payment on a 30-year fixed-rate mortgage. The "savings" you recognize are not showing up tomorrow, next month, or even five years from now. What you are really doing is shortening the maturity of your loan (knocking off payments at the end of the term). So, in most cases, making extra payments on a mortgage is essentially making a bet on future interest-rates / inflation in years 25-30 from now.

You would have to have some pretty awesomely low interest loan rates or severe inflation for early payments on a mortgage not to be a net win. A loan we had recently for a house (loan taken out at financial crisis loan rates) worked out at such that an early payment of $1 saved a payment of $7 at the end ($6 being interest). That was enough to motivate us to stick every spare dollar on that loan.

Not particularly. Say you have a mortgage at 4.5% (which is doable these days with great credit). If inflation is 4% (the average rate of inflation from 1980 to 2000), then anything with a real rate of return of more than 0.5% is a better place to put your money than paying down your mortgage.

Yes. It was over 10% when we got our mortgage, and although we negotiated down to 9.89%, its still pretty steep. When wages are so low and houses so expensive here (470k American dollars is average Auckland house price, arrange wage is 42k ish). I am slightly old fashioned and, well, wrong I suppose, in my aversion to debt. Right now out rates are a a bit of a low, but we are paying off debt when saving would actually be more profitable.

It's not wrong. It's just a matter of your personal projections. The only thing wrong is taking action at odds with what you think will happen. E.g. if you're ranting about impending hyperinflation thanks to QE3, you should be taking out massive amounts of dollar-denominated loans and use them to buy property whose value will keep up with inflation.

Sure, no doubt in many cases the interest savings would be worth it. The real benefit of looking at the timing of savings is apparent when comparing multiple loans with different contract terms, and trying to figure out which you should be paying off quickly. All else being equal, two fixed-payment loans - one with 120 months remaining and the other with 360 months remaining - each have different "savings profiles". That is, they have different points in the future when the savings are actually going to recognized as well as different interest savings amounts. It can get kinda difficult trying to figure out if saving $1000 in 10 years is better than saving $1500 in 30 years, for example.

Yes - my choice as always been to go for more later - even when its far from clear that more is actually more. What is clear to me is that less debt is less debt, and that's a gain right now.

The only savings is interest. Also your talking about a 5% rate for 40 years ignoring the tax deduction and inflation.

This is a misunderstanding of how traditional mortgage payments and interest are calculated.

A mortgage payment includes a fixed amount of "principal + interest". The interest portion is calculated each month based on the outstanding principal.

Every dollar of principal you pay early reduces the amount of interest you pay in every payment thereafter.

You are correct that you still have to pay the same monthly payment, but it is knocking off the immediate next payment (which is high interest, low principal), rather than knocking off the last payment (which is high principal, low interest).

Paying additional principal near the beginning of a mortgage thus makes a lot of sense (it eliminates interest on that amount for the next 360 months).

To clarify, my definition of savings refers to "payments you would not have had to make". Regardless of the proportion of principal to interest, the payment is still the contractual amount you have to pay each month. If you have a fixed minimum payment, any extra payment you make is not impacting the amount due next month.

To your point, yes, next month's payment has a higher ratio of p:i, but you have not "saved" anything...yet. In the end, the extra payments you make are just going towards reducing the maturity date of the loan. You are correct that the relative impact of making these extra payments early on does have a tremendous influence on the total interest saved over the life of the loan (and determines how many minimum payments you will chop off the end of your term). I didn't make that clear in my initial comment.

Just to add to this - floating rate loans are common here, with a fixed date of mortgage ending. So an early payment in this situation leads to a lower payment next months (probably by a few cents or a dollar to 2 if you made a decent lump sum payment). It isn't much, but depending on initial mortgage setup a saving for next month can be realised.

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