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
Rachel Jonat says
Thanks for sharing, FB.
We’re also trying to pay off our mortgage early.
So far our strategy is to up the payments by 15% each year (as allowed in our mortgage terms) and make lump sum payments throughout the year (allowed to do this up to 15% of principal).
We’ve decided to continue this strategy until the mortgage terms come up in 4 years and then reassess. I could see us doing something similar to your municipal bonds that would give us more flexibility at that point. We have a nice emergency fund built up but as we’re expats and my husband works in an industry that changes quickly, you can never have too much cash on hand for emergencies.
We feel the same way too, since we’re self-employed. There’s no sick leave, no paid vacation, no severance packages… being self-employed is great, but it does require more self-reliance in terms of financial planning. So we prefer to have a good-sized financial cushion, and the muni bond fund helps a lot with that.
Our strategy was to put as much down on the house as we could when we bought it 5 years ago. Then when we refinanced about a year ago, we again paid a large chunk of our savings into the mortgage. (Our goal was to get as small of a monthly payment as possible, since we knew we were going to be a one income family for several years while I stayed home to raise the children). We have never paid an extra payment towards our mortgage. We simply save as much as we can every month, with the idea that somewhere down the road, we will have enough saved up that we will feel comfortable paying off the balance of our mortgage. Other things come up, like replacing old cars, replacing the roof, etc., along the way. We have a healthy savings account to handle these larger ticket items without worry as we save to someday pay off the balance of our mortgage. In addition, our house payment is so low now that if my husband was laid off, we have enough savings to cover living expenses for quite a while without worrying about losing our home. Where we could improve things is to find a better return on our savings account. Thanks for sharing information about the municipal bond option you guys are using.
Sounds great! We’ve thought about refinancing too, in order to lower our payments “just in case.” We could cut our payment in half now by refinancing to a standard 30 year mortgage, since we owe a lot less than we did when we bought the house, and since interest rates are lower now. But so far, we haven’t. We only have 8.5 years left on the current mortgage (we got a 15 year loan and then paid extra every month for the first 3 years), and it’s hard to justify the closing costs on a refinance at this point. But it’s still a possibility.
We have not begun excellerating our mortgage payoff yet, but hope to start in 2013. We will probably do a little bit of both. Put an additional chunk on the mortgage payment each month as well as save up some in an account (ING Direct). We have only 3 months worth of expenses saved up at this point and almost $4,000 toward a new car, so I would feel more comfortable leaving any additional money (over out little chunk each month) in ING until we have another $5-10,000 in there just in case something were to happen.
Oh, how I love thinking about the day the mortgage is paid off. And with only $50,000 left on it to date, it will be here before we know it! YAY!
That’s awesome that you’re down to only $50k! We’re still over $100k (we bought our house for $215k), but we’ll cross into five figure territory in the middle of 2013, and I’m excited for that! Sounds like you guys have a great plan in place.