This question from Calvin was posted in our HTM Facebook Group…
“Should additional mortgage payments be considered when determining my savings rate?”
Matt & Joel’s response: The short answer is yes.
Interestingly enough, many of the post commenters didn’t seem to agree with us on this! But here’s the nuts and bolts of savings rates and why additional mortgage payments should be included…
Net worth growing or shrinking?
We can see why it’s a debatable topic. Since additional mortgage payments don’t boost your cash on hand, it’s easy for folks to think those payments don’t qualify as “savings”. They can’t physically see that cash pile growing in their checking account or HYSA…
But, paying down that mortgage loan does actually increase your net worth! Every additional debt payment lowers your liability, which pushes your net worth in a positive direction.
For example, if you were to make $10,000 in extra mortgage payments throughout the year, you can certainly include that $10,000 in your savings rate calculation.
You “saved” that money. And it’s reflected in your growing net worth!
This is a great reminder for everyone to track their net worth regularly. It exposes the positive activities that contribute to growing wealth, vs. the negative ones that detract from it.
What about regular mortgage payments?
OK so do regular mortgage payments count toward your savings rate? And what about credit card or car loan payments?
Since regular mortgage payments are mostly interest (only a small portion is principal paydown), we don’t typically include them in your savings rate calculation.
Interest on any loan comes at a cost. It’s an expense, not part of your savings.
But principal payments are technically savings. Because they lower your debt, increase your net worth, and lessen the amount of interest owed going forward.
Technically, if you want to include the interest portion of your regular mortgage payments in your savings rate calculator, go for it! It just takes a lot of manual calculation, and might not move the needle too much anyway, that’s why we don’t typically include it.
Liquidity and cash savings
Just because we include debt payoff in your savings rate doesn’t mean that it’s not incredibly important to have cash in the bank.
Liquidity is still really important – having access to cash at all times in case of emergency. If you lose your job and are strapped for cash, you still need money to live. You can’t eat your house!
Paying your mortgage off early, while an incredible accomplishment, will take time. And it’s too risky to put all your eggs in that basket to the exclusion of a cash backup too.
So yes, additional mortgage payments are part of your savings rate because it’s money you could have otherwise consumed.
Putting those saving elsewhere
As regular listeners will know, we’re not huge fans of early mortgage payoff if you’ve got a locked-in low rate.
If you’ve taken out a mortgage more recently, (Calvin mentioned in the comments that his is 6.25%), the calculations change a bit. It might make more sense to pay down the mortgage and make it a higher priority.
But the goals here are to make sure you aren’t getting too risky (not enough liquidity), while building your net worth (debt payoff AND investing).
And one great way to pay off your mortgage early without feeling like you’re going overboard, sacrificing other financial goals, is to make bi-weekly payments. You end up making the equivalent of just one extra payment a year when you do that. On a traditional 30-year mortgage that can erase roughly six years at the back end!
If you do have a low fixed interest rate, it might be smarter to put any/all excess savings into retirement accounts for long term investing.
Make sure you’re maxing out your Roth IRA, taking advantage of 401k contributions, HSA, and any other tax-advantaged account you have access to.
Investing in highly diversified index funds will grow that money in more meaningful ways over the long term. And those investment contributions are absolutely included in your savings rate!!
The Bottom Line:
Additional mortgage payments should be included in your savings rate. Although the money isn’t visible as cash savings or new investments, that money directly impacts your net worth in a positive way, lowering your debt liabilities and future interest.
Paying a little extra into your mortgage is a noble thing to do. But don’t go overboard. Liquidity is a crucial part of any savvy financial plan. And you can probably get a better return on those dollars by putting that money into long term retirement accounts.
A happy medium might be to set up bi-weekly mortgage payments and invest the rest.
Hope that helps, Calvin!
For the full version of this discussion, check out Podcast Episode #850 (it’s the last question in the episode)
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