Prepaying For A High ROI

It has gotten cold down here this winter... folks are building sand men!

It has gotten cold down here this winter… folks are building sand men!

In November, we paid in full three different bills totaling close to $3,000 that weren’t due (or due in full) for 5 or 6 months.

Why did we do this? Quite simply, the pay in full or pay in advance discounts amount to some of the best ROIs around. How so? Let’s look at some examples.

Property Taxes

We get our property tax bills in November every year, but technically we don’t need to pay them until March of the following year. That’s 4 months that we could hold on to the cash instead of handing it over to our local government for them to hold on to. Four months when we could be earning interest on our money instead of letting our local government put it to use immediately (or earn interest on it themselves).

To induce us to hand over our hard-earned cash as early as possible our government gives us a nice little discount to pay in advance. For each month we pay in advance of March, we get a little more than 1% off of the total bill. So if we pay as early as possible (in November), we get 4.17% off the total bill. 4.17% might not sound like much, but let’s annualize it.

4.17% for 4 months becomes…

(1+0.0417)^(12/4)-1 = 13.03% annualized.

Unless your savings account is getting a better return (CAGR) than that, or you are using your funds to pay down credit card or other debt that’s at a higher rate than 13%, I really can’t see any downside to not prepaying this bill. And if you’re using an escrow account through your mortgage holder, make sure they’re paying it early to get the maximum discount, too!

Car Insurance

If you weren’t impressed with the ROI on prepaying property taxes, let’s take a look at what the ROI is when you pay your car insurance in full every six months instead of paying it on a monthly basis. (Something Mr PoP had never even thought about doing before we got married and I told him he/we needed to be taking advantage of the pay-in-full discounts!)

Our most recent renewal rate was $298.84 for 6 months of car insurance premiums. (That’s for 2 drivers on one car – and it’s about $30 less than our last renewal, so yay!) We could pay $298.84 all at once, or we could pay $68.87, then four more monthly payments of $68.85, followed by one last payment of $68.80. Altogether the total for the monthly payment schedule is $413.07.

Prepaying gives a savings of $114.23, which is a total discount of 27.7% on the total bill. 27.7% seems good enough to get your attention, but that’s not the end of the story. To that, we look at the internal rate of return (IRR) you’d need to be earning on a savings account that would allow you to put in $298.84 and pay out according to the 6-month bill schedule, and end with a zero balance after the final payment. In this case, the IRR is ~82%.

You’d need a savings account earning 82% interest each year to be able to deposit $298 and withdraw those 6 monthly payments and end with a $0 balance.If you’ve got one of those, then by all means pay monthly. But if not, you’re better off paying car insurance all at once with this kind of prepayment discount.*

And these are just the tip of the iceberg.  There are many other places that prepayment discounts come up – cash prices for health care, race entry fees for sports events, tuition / day care, etc.

Is Prepaying Always A No Brainer?

Well, there can be some downsides to prepaying to consider as well.

  1. Prepaying can transfer some risk to you. If the company goes out of business or otherwise decides not to honor the payments that you have made, you’re at a disadvantage because you need to fight to get your money back. (And that doesn’t always work as I found once…) Paying with a credit card can mitigate some of the risk since the credit card companies generally all have some sort of purchase protection insurance on them, but you’re still left to deal with the hassle of the claim.
  2. Prepaying can induce you to overbuy. This is really what a lot of marketers are hoping for when they offer a discount for making a purchase *rightnow*. Whether it’s putting a deposit down for your next cruise where $100 gets $300 in cruise credits or stocking up on Groupons for services that you would have never thought about purchasing before seeing the Groupon. By prepaying for these deals you’re often locked into spending both time and money on some future date that you hadn’t explicitly planned to. And that’s how you’ve overbought.  So try and only prepay for something you know you would purchase anyhow.
  3. Prepaying can decrease your leverage with a service provider. One prepayment option that Mr PoP and I have considered but haven’t pulled the trigger on yet is our pool maintenance. We pay $65/month for pool service (I swear it’s cheaper than us DIY-ing), and we could prepay 11 months and get the 12th month free. This equates to an 8.33% discount over the course of the year, and like the car insurance the IRR would actually be higher (though not as high as the 82% for the car insurance!). So why haven’t we done it? Simply because as we currently do not have a contract, we’re pretty sure the quality of our service would decline once the pool service provider has a large chunk of our money. As it is, our pool guy tends to get lazy and I need to write a note on the bill every few months along the lines of “Pool has not been vacuumed according to schedule. Please address.” And then our pool gets vacuumed. Until we get a really fastidious pool guy, we’re not likely to be prepaying this one.

So you need to balance the prepayment discount (and the IRR or CAGR that you achieve through it) with the some of the downsides of prepayment to make sure it’s the right decision. But for us, more often than not, we grab that prepayment discount as long as it’s something we were sure we would buy anyhow!

* Mathematically you’re even better off charging the prepayment total to a credit card and paying the card down monthly according to the car-insurance payment schedule. Even with an interest rate on the card as high as 18%, you’d pay it off in full about 6 weeks early.

 

What kinds of prepayment discounts do you take advantage of? Which do you pass up?

30 comments to Prepaying For A High ROI

  • Smart moves, Mrs. PoP! I’m all for pre-paying on things we know we’re going to use–like car insurance (we also pay in full every six months). A lesser example for us is buying in bulk. We’re happy to “pre-pay” for 48 rolls of toilet paper from Costco because it’s far and away the cheapest option and we know we’re going to use it all up. I agree with you, I’m wary of pre-paying, or bulk buying, items we’ve never used before (like the Groupon example you mentioned). That just makes me nervous :)!
    Mrs. Frugalwoods recently posted..How We Live Frugally In The CityMy Profile

  • That is some awesome ROI on your money. I don’t have to pay taxes yet, so no deal there. I will check into my auto insurance to see if I can match that great return your getting. Good Post.
    EL @ Moneywatch101 recently posted..Financial Champion or Financial WimpMy Profile

  • Our car insurance company charges $3 per month if you want to make payments. That’s not a lot of money but it adds up! We pay the policy every six months instead. I also like prepaying because it makes my life easier. I don’t want to make a car insurance payment every month.
    Holly@ClubThrifty recently posted..Why We Are Still Prepaying Our MortgageMy Profile

    • Totally agree on it making life easier – it’s one less bill I have to keep track of every month! (Just need to make sure to pay attention for the renewals…)

  • Debbie M

    Like Holly, my auto insurance company pre-payment premium is not very big but it’s big enough. My property taxes have no pre-payment premium at all. But I usually pay that bill when I get it so I don’t forget. Except this year when I’m moving most of my deductible expenses to next year for tax reasons. My homeowner’s insurance also has no pre-payment premium.

    I like to prepay my gym memberships. I really do go for a full year. And you get the added benefit that if you want to stop paying them, you just don’t sign up again instead of calling them and begging them month after month to stop charging you. So far, when the gym has gotten bought, they honor that payment, though not the promise that rates will never go up (though one gym did do that for about three years).

    And I’m taking a Spanish class–I think they might let you spread that out over time, but I just pay when I register. Also, I get the longest term on my pre-paid cell phone because it’s the cheapest per month that way.

    I basically always prepay if there’s a premium for it. It’s only been recently that I’ve realized I should consider whether the company might go out of business before I get all the benefit.

    • Our current gyms haven’t ever offered prepay discounts, but my old one did! I would buy 3 month memberships for a discount to the month-to-month pricing and it worked out really well.

  • we always pay in full simply because I hate owing money on anything!
    Newlyweds on a Budget recently posted..How Much It Cost to Buy Our First Home in Southern CaliforniaMy Profile

  • No, we never did get any of that 4.5K back from the daycare that went out of business.

    And we’re glad we didn’t prepay at the current daycare since we’re leaving it in January!

    I do, however, prepay all our insurance and stuff. I wish we got a break on our property taxes–that would be awesome!
    nicoleandmaggie recently posted..Things to be paranoid about part 2My Profile

  • Smart moves! I’m all about pre-paying or paying things in full instead of breaking them down into monthly payments. I try to reduce reoccurring expenses as much as possible.
    Tawcan recently posted..Recent BuyMy Profile

  • I tried to switch to paying our insurance to a lump sum, but they said there was no discount, so we keep paying monthly. It’s great that you’ve been able to get a discount for paying in advance for so many things!
    Emily @ Simple Cheap Mom recently posted..Planning and a PromotionMy Profile

    • No discount! What a shame! We’ve always had prepayment discounts on car insurance, but sometimes they call it a pay-in-full discount. (Not home insurance, though…)

  • Well that makes me a little grumpy! Our property taxes are no joke but they don’t give us any incentive to pay in full at all. I’d like to just to get it over with but I don’t see why they should have a huge chunk of cash 4 months early if there’s neither penalty for paying at the designated times nor is there a reward for paying early.
    The same goes for our insurance (auto and property).
    I’d like to be incentivized, please!
    Revanche recently posted..Net Worth & Money News: December 2014My Profile

    • Well that stinks! I’d like you to be incentivized, too! We’ve always been offered prepayment discounts for car insurance and property taxes and it never occurred to me that these might not be all that common.

    • ervinshiznit

      There is an incentive if you are close to itemizing your federal deductions but can’t. If you pay property taxes twice in a calendar year, you can deduct both of your payments on your federal taxes (but that means in the next year, you won’t be able to deduct property tax at all).

  • Ivy

    We don’t have incentives for insurance – the only option on the bill is one annual payment. No incentive for property taxes either.

    We prepay the kids’ gymnastics classes and the preschool. For the latter full prepayment is better than monthly payments, but actually worse than quarterly payments. I still do full prepayment to avoid the hassle of having to remember when to pay.

  • I don’t even know what the discount is with our car insurance (Geico)–years ago it was better to prepay, so I set it up that way and moved on mentally :-).

    We had a landlord years ago who wanted us to pay six months’ rent in advance (long story, but he was not entirely satisfied with his rental management company’s selection of us). Actually he wanted my parents to cosign, but they were not about to do that for a DC apartment that cost more than their mortgage (even if I had been willing to ask, which I wasn’t). We had just sold off a car, so we had the cash. He didn’t give us a discount, but he did take off some reasonable amount of interest.
    Frugal Paragon recently posted..7-minute Microwave Granola BarsMy Profile

  • I am insanely jealous of those discounts! We don’t get anything at all like that. I would pay my property taxes a year in advance, if I could, for that discount.
    We pay our car insurance and our house insurance annually, because there are financing fees otherwise. It’s not exactly a discount, like you’re seeing, but it costs less to do things that way.
    Anne @ Money Propeller recently posted..4 Lazy Ways to Save MoneyMy Profile

  • Thanks for the money savings tip. Payments I can do without and paying it in full is the way to go. I need to do this with our car insurance, thank you.
    Even Steven recently posted..Interview of Sorts: FrugalWoods more like FrugalWeirdosMy Profile

  • […] don’t often admit to (or have) jealous tendencies but I am jealous that the POPs get discounts for paying their property tax […]

  • […] Pop from Planting Our Pennies shows how they decide which bills to prepay to help them spend […]

  • ervinshiznit

    You should consider alternating years of paying two years of property tax payments in one year, and none in the next year. Why? So you can deduct even more of your property tax payments on your federal taxes. This should give you a better annualized return than just prepaying.

    • I know some people do this with their property taxes, but it wouldn’t benefit us as even doubling up on our property taxes our itemized deductions would still be less than the standard deduction. In the end, I think we are better off having a smaller tax bill than a bigger one that would make itemizing more worthwhile. =)

  • Gosh, I wish we got a break for paying our property taxes on time. Here, you can either pay it all at once, or you can pay half and put off paying the other half for six months.

    Since it’s not so much that I have to take it out of investments — and money sitting in the bank earns nothing — I pay it all at once. Drives me nuts to have a Damocles sword hanging over my head…I just KNOW if I don’t pay it when the bill comes, I won’t remember to pay it at all. And I expect the state knows that too…they’re trying to back you into having to pay interest.
    Funny about Money recently posted..Car ShoppingMy Profile

  • […] Prepaying for a High ROI- plantingourpennies.com explains how paying for certain items upfront can save you money in the long run.  One of the only things I prepay for is insurance.  I could pay monthly, but it costs a little less to pay the whole year in advance, so that is that is what I do. […]