Should Millennials Make Extra Mortgage Payments?

My Millennial money tips this month focus on extra mortgage payments, credit card rewards, and the differences between FSAs and HSAs

“Debt.” Even just hearing the word can create uncomfortable feelings for many of us.

And rightly so, in many cases. Personal finance author Morgan Housel believes that, “As debt increases, you narrow the range of outcomes you can endure in life.”

*Editor’s Note: I originally published this article in my Millennial finance newsletter, which you also can get twice each month (for free) by adding your name here*

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How You Probably Think About Debt

You’re best off with no debt, right? Maybe. Perhaps you want to minimize your future risks. Or you may just feel good about paying off an outstanding loan. But quantitative financial analysis still should play a role in your decision.

And Millennials often make two calculation errors, in particular, when evaluating whether they should make extra mortgage payments.

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When Millennials Make Extra Mortgage Payments: Mistake #1

If you bought a house before 2022, you may have lucked into a fixed mortgage interest rate below 3.5%. And with such low-interest debt, investing your extra savings may earn you a better long-term financial return.

When Millennials make extra mortgage payments, we essentially earn a return equal to our interest rate. Let’s assume you locked in a 3% mortgage rate. That extra payment represents, in part, interest you don’t need to pay in the future. So you’ve earned yourself a guaranteed 3%. In this way, you can think of extra mortgage payments like a government bond with a fixed return: you know exactly what you’re earning.

But many Millennials don’t compare this rate of return to historical stock market returns. Over the past 30 years, for example, the S&P 500 generated 10.1% growth per year, on average. Of course, we have no idea whether this growth rate will continue. But if you have an extra dollar to put toward either your mortgage or in the stock market, quantitatively, you’re better off — in most cases — in the stock market.

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When Millennials Make Extra Mortgage Payments: Mistake #2

Some Millennials also misunderstand how extra mortgage payments will impact both their short and long-term finances.

In the Short-Term

The confusion, according to personal finance author Jonathan Clements, comes from “a mortgage’s shifting mix of principal and interest.” “Most of each monthly payment,” he writes, “Goes toward interest early in a mortgage’s life, with more getting put toward reducing the loan’s principal balance as time goes on.”

In the short-term, making extra mortgage payments won’t drastically alter your financial life.

With a fixed-rate mortgage,” Clements says, “extra principal payments shorten a mortgage’s length.” But, he notes, “Here’s where folks often get confused: The monthly payments you miss aren’t the upcoming ones, but rather those at the end of the loan.”

Even if you paid twice the amount of your mortgage payment last month, you still can’t choose to skip your mortgage payment this month.

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Over the Long-Term

Now let’s go back to that rate of return analysis. In the early years of your mortgage payment schedule, most of your payment goes toward interest. Only in the later years of the mortgage does the majority of your payment reduce the principal balance.

But extra payments when the dollar amount of interest is highest does not earn you a better return. Your return during those initial years still matches the fixed mortgage interest rate.

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The Best Reason for Millennials to Make Extra Mortgage Payments

Here’s where Clements explains the best financial reason for making extra mortgage payments:

“Making extra-principal payments early on is worthwhile for the same reason it’s worth investing when we’re young: compounding. Whether you make a $1,000 extra-principal payment in the first year of a 5% mortgage, or the 10th year or the 20th, your $1,000 effectively earns 5% a year. But if you make that $1,000 extra-principal payment in the first year, you’ll earn 5% a year for far longer — and the result is you’ll shorten your mortgage’s loan length by significantly more.”

From Clements’s perspective, if you’re conclude that you want make extra mortgage payments, you’re better off doing so as early in the loan payoff schedule as possible.

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The Bottom Line on Extra Mortgage Payments

For many Millennials, your financial calculations may not support making extra mortgage payments. But that doesn’t necessarily matter. For many people, the reason to pay down mortgage debt ahead of schedule is non-financial. It’s personal, it’s qualitative.

As personal finance author Ben Carlson has written, “A home — and to a lesser extent, a mortgage — is a very personal asset. Debt is a very personal topic for many. Some people don’t mind using leverage in a responsible manner, especially at low-interest rate levels. Others avoid debt like the plague and pay it down as quickly as humanly possible.”

For example, Morgan Housel, who began our story, is only 38. But he and his wife have paid off their mortgage in Washington state. In his book, The Psychology of Money, he offers his rationale for doing so:

“The independent feeling I get from owning our house outright far exceeds the known financial gain I’d get from leveraging our assets with a cheap mortgage.”

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The Millennial Finance Newsletter: May 28, 2024

For your days ahead: 3 perspectives, 2 articles, and 1 idea from me.

​Three Perspectives

1 / How a credit card rewards program really works.

2 / Tips for (and perspective on) caring for a parent at the end of life.

3 / What the hell is financial planning, really? (I like these four analogies from my friend, Meg)

​Two Articles

1 / The key differences between HSAs and FSAs (one of the most common sources of confusion among my clients)

2 / Should Millennials make extra mortgage payments? (editor’s note: see the article discussed above)

One Idea From Me

As you all know, family leave options in the U.S. aren’t great! But D.C. residents are (relatively) fortunate to have access to a policy that’s better than most. I often get questions about how to take full advantage of the local and/or federal parental leave programs, so I put together the following guide:

1 / “You can apply for multiple DC Paid Family Leave events in a single year. You just cannot exceed 12 weeks of benefits in any given year. The only exception occurs when DC grants you two weeks of prenatal leave, giving you 14 weeks of benefits in total. Keep in mind that only those who need medical care during pregnancy can receive prenatal leave.

Finally, parents have a full year to apply for DC parental leave benefits. So if your partner gave birth on August 1, 2024, you have until July 31, 2025 to take your leave. This rule also applies if you assumed guardianship for a sibling’s child or adopted or fostered a child. But if you don’t take parental leave within the year, you lose the benefit.”

You can read more in D.C. Parental Leave: Everything Parents Need to Know in 2024.

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Your Questions About Making Extra Mortgage Payments

I hope these articles help! Please feel free to send me an e-mail at kevin@illumintfc.com with any follow-up questions. You also can subscribe to my newsletter here to learn more about how you can turn your money into memories with your family. I typically send the newsletter twice each month.

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Recommended Money Reads for Millennials

If you liked this article, you may also want to check out:

• The 5 Best Finance Podcasts for Millennials in 2024
• 2024 Tax Season Updates: The Child Tax Credit & More

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About Kevin Mahoney, CFP®

Hi, I’m Kevin. I’m the founder of Illumint and a financial advisor in Washington, DC. I specialize in financial planning for Millennials like you. As a Millennial father and Certified Financial Planner™, I empower our peers to invest with confidence and flexibility. If you’re new to Illumint, I’m glad you’re here – you now have access to free personal finance tips written specifically for Millennial parents. I encourage you to read, watch, or listen to the ideas I share about exchanging your money for memories with your kids. And then when you’re ready, please send me your thoughts & questions!