The Benefits of a Mortgage Sinking Fund

My family’s only remaining debt is our home mortgage, and one of our top two or three financial goals is to pay off our mortgage early.

For the last couple years we have been throwing some extra payments against the mortgage off an on, without much regularity.

We have enough money in savings to make a large dent on the mortgage, but I’m not comfortable reducing our cash savings – what if we had an emergency, or what if we experience another 2008 in the stock market and I can buy some dirt cheap dividend stocks.

I think I have the ultimate solution – a mortgage sinking fund.

For those unfamiliar with the concept of a sinking fund, let me first explain the idea.

A sinking fund, in personal finance terms, refers to a dedicated fund where savers put away a portion of their earnings towards a larger goal, usually in equal payments.

For instance, we have long maintained a “Christmas Sinking Fund” where we put $50 a month towards our annual Christmas budget of $600.

In November, we withdraw the money and go shopping for the kids (and each other).

By saving a little all year long, it smooths out these large, once or twice a year expenses.

The Benefits of a Sinking Fund Over Making Extra Mortgage Payments

For now, we have decided the approach we will take is to save money in a dedicated account we’ve self-labeled, “Mortgage Freedom Fund.”

We will continue to pay our regular monthly mortgage payment and only that monthly payment required – nothing extra for now.

Rather than making extra mortgage payments, we will instead pile that money into our savings account until the balance grows high enough to make a single mortgage payoff payment.

Based on our slowly declining mortgage balance, and pathetic interest rates on savings, that probably won’t happen for a couple years. We are OK with that.

Having more cash on hand is preferable to us given current economic conditions.

  • What if I lost my job?
  • What if I got sick, or was in an accident, and we lost our primary source of income for several months?
  • What if something happened to me and my wife and kids had little cash on hand to survive until insurance paid out?

That pile of cash could serve as sort of a mega emergency fund Рan additional benefit of using a sinking fund.

Taking the glass if half full approach, if we do experience a major market downturn in the next couple years (and I suspect we will see another one), there will be many opportunities to buy excellent stocks at ridiculously cheap prices.

I kick myself for being in debt a couple years ago and not having the cash reserves to make moves in early 2009, just as the market bottomed.

I could have easily doubled my money from that point to now.

Another reason we are reluctant to plow money into our mortgage is because house values still seem to be declining around us, and getting an equity line in a crisis seems rather far-fetched.

Besides, I’d much rather have the liquid cash on hand than a line of credit.

It’s exciting to extrapolate out our savings growth and our amortization schedule on our mortgage and see the point where these two balances meet.

At that point, we will write a check and be 100% debt free! And then it will be time to build some serious wealth.

This post appeared in the Carnival of Personal Finance – Global Stock Markets Edition

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  1. The sinking fund sounds like a great idea. We have been paying extra on our mortgage for 15 years, but this sounds like a better way to attack it, especially if the investment yields more than the mortgage interest.

  2. How funny — I hit on this same conclusion a couple months ago. I have 29 years left on my 30 year mortgage. If I am very aggressive, I can pay it off in 7 years. However, the thought of not having liquidity has kept me from paying the required extra toward the principle. I am the sole income for a house of three adults, so this adds to my concerns.

    I decided to pay the extra into a high (relatively) yeild checking account for two years. After two years I’ll assess the situation — I’ll either then pay one year towards the principle, or I’ll keep stocking up. At the very least, I’ll always have more than one full year of mortgage payments in reserve.

    I know I’ll lose a little ground on interest, but I don’t mind. I’ll sleep better at night.

    • To me, a good night’s sleep counts for a lot. Since writing this, I’ve considered investing in only slightly higher-yielding investments – still relatively safe – to grow that side of the equation a bit faster. I’ve picked up a couple dividend growth stocks and a CD that should mature around the time I’m ready to make a pay off.

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