Mr. Cubert at Abandoned Cubicle, who is a very talented, determined, and resourceful fellow (and a fellow Midwesterner!), has this strange article out there, extolling the virtues of Cash Flow Indexing. In a nutshell, CFI determines which loans to pay off first, freeing up, well, you guessed it: Cash Flows. It does not take into account the interest rates or the term of the loan. Mr. Cubert does a great job explaining why this works for him. I’d suggest you read his article first. This post, if not a refutation, is certainly an addendum to his!
One thing that is ignored in the CFI method is how not paying down your highest rate loans first, makes you pay MORE INTERST, in the long run and the short run. There’s no going around this fact. You are freeing up CFs at the expense of paying more in interest.
Here is a Google doc (which you can download and play around) I created, a pretty simple one at that, which shows the affect of paying more – extra towards the principal – on 2 hypothetical loans: a 15-year $150k mortgage at 4%, and a 5-year $20k car loan at 0.9%. To make for an easier comparison, we’ll assume both of these loans are taken out at the same
The CFI of the mortgage is 135, while the car loan is 59. According to CFI principle, the car loan is an “inefficient” loan and should be paid off early.
An extra payment of $1,333.79 every month will wipe off the car loan in one year, saving interest payments to the tune of $66.19. Whereas the same extra payment when applied to the mortgage would save interest payment of $296.72 over one year. The CFI method would certainly free up the monthly payments that was going towards the car in year. That is indisputable. What is also indisputable is that you are paying more by following CFI.
One thing that I still agree with Mr. Cubert is here: “A technically smarter move would be to put any extra income towards higher yielding investments, as opposed to paying off the mortgage. But this is a long-term cash flowplay for us. At early retirement, we plan to avoid as many recurring monthly payments as possible. Which is cash flow.” We hope (and planning) to be mortgage free in the next 4 years.
I should stress another point here. I will take a 0% loan any day, even if I had the money to pay it in full and not take out the loan. Heck, we have checking accounts paying 1.55% now! With inflation, which is around the 2.5% mark now, any loan below that mark is essentially lending you money and paying you interest on that loan!!
In the first worksheet I’ve provided the year 1 numbers. The second worksheet has the whole life amortization schedule for the mortgage. You can plug in your own monthly extra payments to see how soon you can pay off your loan and how much interest you save.