Almost a year ago, I wrote about our new strategy for paying off our mortgage. We’re no longer paying additional principal each month when we pay our mortgage – we just pay the amount due. But we’re putting as much as we can into a municipal bond fund that is earmarked as a mortgage payoff account. It’s no longer that exciting to look at the amortization schedule each month when I log on to pay our mortgage, since the time frame to pay off the mortgage is only going down one month at a time now. But it is exciting to see the balance in the municipal bond fund steadily increasing while the mortgage balance keeps on going down. Right now it seems like there’s a long way to go, but those two numbers are creeping closer together every month. And someday, they’ll match. When they do, we’ll be able to pay off the mortgage in a lump sum. Or not – we could choose to keep the money in the municipal bond fund, earning dividends, and continue paying the mortgage a bit longer. It’s up to us and we can change our mind at any time based on whatever else is going on in our financial situation at the time.
I’ve had some readers email me over the last year with questions about our strategy and why we have the money in a municipal bond fund rather than a regular savings account. Before we opened the account, we spent some time comparing options and settled on the municipal bond fund as the best solution. The main drawback, of course, is that bond funds are not FDIC insured and there’s no guarantee that you won’t lose money. But we decided that the risk was worth the rewards, which are plentiful.
First, you don’t pay federal taxes on dividends from municipal bonds. We do pay federal taxes on interest earned in regular checking or savings accounts. If you’re looking to accumulate a significant amount of money – enough to pay off a mortgage, for example – in an account, the dividends/interest earnings will start to add up to a good chunk of money over time. Not having to pay federal taxes on that income is a major advantage of a municipal bond fund. So even though our mortgage payoff account is in a “taxable brokerage account” (ie, it’s not in a retirement account), we don’t pay federal taxes on the earnings. We pay state taxes on most of it (except the portion that is derived from our own state’s municipal bonds), but those are a fraction of what the federal taxes would be if we had the money in an account where we did have to pay federal income tax on the earnings.
Another major plus with the municipal bond fund is the yield. Our online “high yield” savings account pays less than 1% interest. Our local credit union has the highest interest I’ve ever seen on a checking account (3%) but they only pay interest on balances up to $15,000 (that’s great for a checking account, but not for an account where you’re trying to amass enough money to pay off a six figure – soon to be five figure! – mortgage). Our municipal bond fund account pays us more than 3% (currently 3.11%) in dividends, and has consistently done so over the two and a half years that we’ve had the account. There’s no upper limit on how much we can have in the account, so we can keep our money there as long as it takes us to save enough to pay off the mortgage – and we’ll be earning dividends the whole time.
What about the security of our money? Well, that’s a tough one. Since it’s a brokerage account, it’s not FDIC insured. And yes, we could technically lose money. We all know that over the past few years, some municipalities have defaulted on their municipal bonds. But those instances have been few and far between. Although we wouldn’t feel comfortable buying individual municipal bonds (or individual stocks for that matter), we do feel comfortable buying shares in a municipal bond fund that is diversified across many bonds from municipalities all over the country. Honestly, if they were all to default, our problems would be far bigger than just financial ones.
And of course flexibility was a major factor in our decision to stop overpaying the mortgage and start putting the money into a municipal bond fund instead. The interest we earn in the bond fund is slightly lower than what we pay on our mortgage, but the money is still ours to do with as we wish right up until the day we pay off the mortgage in one chunk. If we overpay the mortgage, our outstanding principle drops, but we can’t change our mind and use that money for something else if we got in a bind. But having the money in a municipal bond fund gives us that flexibility. We’ve never taken any money out of that fund in the time we’ve had it, and we don’t plan to until we’re ready to pay off the house. But life happens, and it’s nice to know that the money is there in an emergency. If we lost our income, we could use the money in the house payoff fund to continue making regular mortgage payments while we went about building a new income source. There’s a lot of peace of mind in that.
So while we’re still firmly in the get-the-mortgage-paid-off-asap club, we like our current hybrid strategy. Are you paying off your mortgage faster than scheduled? Do you do it by paying the mortgage lender directly, or are you saving the money in another account with a plan to make a lump sum payment? Do any of you invest in municipal bond funds?
As with anything you read online about personal finance, make sure you make your own decisions and choose the strategy that will work best for your needs and your risk tolerance. Don’t do something with your money just because someone else is doing it!
This article was written in collaboration with peachy.co.uk