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What Bobby Bonilla's deferred comp deal teaches us about paying off your mortgage early, Part 2


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In the first part of this post, I explained how the Mets weren't crazy in their decision to defer Bobby Bonilla's salary in 2000. They were swindled by a criminal and never should have attached an 8% interest rate to his $5.9M, but it's easy for us to say that in hindsight.

Let me explain my rationale by comparing the Mets’ deferred comp deal to your home mortgage. For this example, let’s pretend you are the Mets, and the bank is Bobby Bonilla.

Let’s assume you have a $1,000,000, 30 year fixed mortgage at a 4% interest rate. You’re paying about $4,800/month for the next 30 years.

In other words, you defer paying your mortgage in full year one and instead attach a 4% interest to it and pay the bank over 30 years, just like the Mets did with Bonilla's contract.

I agree, emotionally we’d all feel better not having that monthly mortgage hanging over our heads, but in most cases, I advise paying the minimum and never contributing additional money toward the principle. I advise deferring additional payments and instead investing any free cash.

Why?

Because your mortgage is probably hovering somewhere around 4%, half of Bonilla’s 8% interest rate. And with the right investment strategy, you can outpace your mortgage interest with your investment portfolio like that Mets tried to do with Bonilla’s contract.

Let’s assume you have $5,000 extra per month you want to put toward the principle. If you pay an extra $5k every month you’ll repay the loan in full in 10 years, 6 months, and in turn you won’t pay $493,656.57 of scheduled interest charges.

Now let’s say you take my advice and pay the minimum $4,800 each month and put the extra $5k in an investment account. Assuming a 6.5% rate of return (no, I can’t predict the future, but this number is commonly used when investing in the S&P):

Great job paying your loan off 20 years early. You avoided paying an additional $500k in interest charges….

But if you paid the minimum and invested the extra $5k each month you could have over $5 million in the bank.

“But I paid the loan off 20 years early. What happens if I invest that extra $9,800/month for the remaining 20 years?”

Assuming the same 6.5% rate of return, here’s what it looks like:

You’re still better off paying the minimum on day one. And let’s face it, the reason you paid off your mortgage early was because you didn’t like paying $4,800/month to the bank. It was an emotional decision. You liked the idea of having that $4,800 at your discretion.

What are the chances, if you’re being honest with yourself, you would invest the ENTIRE $9,800 each month for 20 years after your mortgage is paid off? You don’t think you’d splurge on anything in 20 years with that “extra” $4,800 each month?

If any of that "extra" $4,800 is spent on something other than your investment portfolio, it only strengthens my case.

Moral of the story? Don’t pay extra toward the principle in your 30 year fixed mortgage, the Mets weren’t crazy, and Bobby Bonilla is the real winner in all this.

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Investment advice offered through Beck Bode, LLC, a fee-only Registered Investment Advisor in the Greater Boston area.