Should you pay off your mortgage early? Or should you focus on investing with your spare cash? This is one of the most hotly debated topics in personal finance, with vocal proponents on both sides. Today, I thought I’d take a look at this issue from both angles and then share our approach with you.
Why you should pay off your mortgage early
One of the biggest advantages of paying off your mortgage early is peace of mind. Once you’ve paid it off, you’ll wake up every morning and fall asleep every night knowing that the roof over your head is 100% yours. For many people, you can’t put a price on that sort of security.
Beyond the comfort/security aspect, paying off your mortgage early is a bit like locking in a guaranteed investment return. For every dollar that you pay early, you’re “earning” the interest that you would’ve otherwise paid on it over the balance of the loan period. This sounds great, right? Well…
The flip side of the “guaranteed investment return” argument is that mortgage interest rates are often quite low. On top of that, interest payments on a mortgage are also tax deductible (for those that itemize). These factors make early payments lose a bit of their luster.
Resource: Paying Off Your Mortgage Early: Some Things to Consider
Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.
To see how long it might take you to payoff your mortgage, there’s a mortgage payoff calculator at this site for mortgage calculators
Why you shouldn’t pay off your mortgage early
The biggest downside to paying off your mortgage early is the (potentially large) opportunity cost that you’ll face. By this, I mean that you’ll be giving up investment returns that might significantly outpace your mortgage interest rate.
In other words, why pay off a 5% mortgage when you could be earning 8-10% on that money? Of course, one only has to look at the past year to know the answer… Those sort of returns aren’t guaranteed, whereas the mortgage savings are.
Another important point to consider is the effect of inflation. Over time, inflation erodes the value of the dollar. This means that your future mortgage payments will effectively cost less than they do now, as the money you’ll be sending in won’t be worth as much in terms of “real” buying power.
What are we doing?
Instead of pretending to know what’s best in your situation, I though I’d tell you what we’re doing. We’ve actually gone back and forth on this issue, but ultimately decided to do a bit of both. And yes, I know that answer is a total cop-out, but it is what it is.
We are currently in the fortunate position of being able to max out our retirement accounts while having enough left over to put some extra cash toward our mortgage and to work on building up a non-retirement portfolio. So, that’s exactly what we’re doing. I view it as “extra diversification.”
A bit over a year ago, we refinanced from a 30 year fixed rate mortgage down to a 15 year fixed rate mortgage. In doing so, we cut our time horizon in half. Beyond that, we’ve been sending in an extra principal payment every month, further reducing the time until we’re mortgage-free.
Related: 30 Years or 15 Years — Which Is a Better Mortgage Choice?
Admittedly, this hasn’t been an easy decision for us, and we’re still tempted to waver at times. After all, now is a great time to refinance, and I also suspect that there’s a good bit of inflation looming just around the corner.
Given the above, we’ve been tempted to refinance into a rock bottom 30 year fixed rate mortgage and pay it off as slowly as possible. At the same time, we would focus on building our investment portfolio. However, a wise man recently reminded me that “pigs get fat, but hogs get slaughtered.” In other words, it pays to be greedy, but not too greedy. In the end, we opted to stay the course.
What about you?
Where do you stand on the mortgage pre-payment issue? Are you looking to get out of debt come hell or high water? Or are you paying off your mortgage on schedule while focusing on your investments?
Thanks
Okay so we have financially knocked our brains out over our work life and got the darn mortgage paid off early.You are retired on $100,000.00/yr from all of those retirement checks.You are 62 and have $3,000,000.00 in your rolled over IRA. What now? You have zilch for a tax shelter. EVERY $ you make is taxable income.I guess you better invest in nothing that does not say tax-managed in front of it.Buy a LOT of muni’s.I guess you could transfer some of your IRA funds over to the ROTH arena IF you have additional taxable savings in another account to pay the tax with. If you don’t then you are up the proverbial creek without a you know what.I guess we should count our blessings.We could be 62,have no retirement checks,and have saved nothing over our work lives and then we wouldn’t have to worry about paying all of those taxes and been forced to go on the dole. Is this a great land or what.I am glad I am in the first position.
Folkes I have read pages of blogs on this site and I have not found to many retirees.I retired in 2010 after 40 plus years with the feds.I get several retirement checks and we live comfortably on them.We saved the max that we could thru the TSP 401k government program.We intend to let our tsp money grow from age 62 until RMD’s at 70/12.What a lot of people do not realize is their retirement money, in my case anyway is Tax-deferred and I have found it quite rewarding to have kept a high six figure 401k account away from Uncle Sams pockets.One thing that you are not factoring in here about paying off your mtg early is once you take money out of your 401k/IRA to pay off the mtg,you just exposed all of this money to The Man.I can pay off my house at any time but I am not going to do this for many reasons. One you cannot rebuild this money back into your IRA because your retired and no longer have “earned income”. I would rather see it double in 8 years and at the start of RMD’s start to pay the mtg.down. I would have no problem using “extra taxable income” if I had any to pay down mtg.
It’s around your own imagination and drive to search out the job that matches you best; it’s around – you need to simply take it.
I can even change my thoughts if I accept a piece of writing and I
can’t take action or I don’t want to take action for any given reason.
The way to gain that knowledge is to educate yourself on every
factor of building a successful business as you can.
I think it is better to pay off your mortgage as early as possible because mortgage interest becomes much higher than the original principal amount and that means one is earning for the bank rather than himself and if one wants to build wealth he or she should avoid mortgage.
Simple, always pay the highest interest rate Loan first, and the one with no tax deduction. (Heloc)
Hello all, wondering what you would do in our case.
We gross $150k per year, we both max out our 401K ($22500 each) Have $100K in a crdit union for our rainy day fund.
We are currently (last 30 months) been paying an extra $3000 a month on our primary residence. We currently owe $110000 at 4% interest.Value about $250K
We have an investment property that we are currentlty refinaincing at 4.25% with the amount owed $106000. Value about $250K
We also have a Heloc on the investment property with a balance of $195000 at 5%
My current plan is to pay off pricipal residence by 2015, when I retire hopefully in three years at 59, sell the priamry residence pay off the Heloc and move to the investment property.
What if any are the flaws with this plan? Is there a better way?
Sorry about the typos wish there was spell check…
Thanks
Days and hours of searching “Pay off the mortgage or invest?” and I still don’t know what is best!
Single, 53 next month, female (only note this as a new job at my current rate would be hard to come by in my field) $100K a year BUT this could change in the next couple of years.
200K 3/4 Broth and 1/4 401K
10,000 cash
No debt (other than mortgages)
Employer match: 6% at 100% (nice!)
Mortgage 1 just refinance $130,000 at 3.62 30 year note (valued at $235K) payment T&I $850.00 rent for $1,000 a month (darn kids have a nice mom!)
Mortgage 2 Purchased 2 years ago $200,000 5.35% boyfriend makes payment.
Mortgage 2 is a place we love in the mountains and due to the high price of gas, it will be tough to get equity anytime soon on the property.
I started my retirement account only five years ago, so I am quite aggressive due to my age on my stocks but am diversified (five year rate of return 9.8%, 3 year 11.7% and past year 26%).
First off I have no idea about any of this!
My original thought was to pay the Mortgage 1 off in five years with 3 additional payments per month, but now I am thinking I would be better off investing it and doing one additional payment.
My thoughts are this:
If I do the “catch-up” with 22,500 a year for the next five years and that money makes 7%, it would allow me a tax break on my earnings and give me the deductions on the interest $4K plus for mortgage 1 (I also get the 8K plus on mortgage 2 with tax credit on both).
If I lose my job in the next few years, I would still have the $22,500 working for me and a very low payment on Mortgage 1 that the kids are covering.
Mortgage free on 1 is appealing, but if I put the additional funds there, and I needed it due to loss of job or illness, I would have to sell the house.
On the other hand, if I needed the money, I could get it from the investments without penalty, which would grow quite a bit by the time I am 59 1/2.
AND I am so confused if do the investment route, should it be Broth or 401K.
In retirement, I do not think my tax rate will be nearly as high as it currently is, so I am thinking pre-tax investment is better than Broth for me (plus the tax advantage I would get now).
Please give me some advice as I am so lost!
In a drastic move, my wife and I cashed out our 401(K) and paid off our mortgage last year. We might regret that someday, but for now we are leaving the dream of leaving truly debt free. A mortgage is a debt, a long-term debt, slavery. No car payments, no credit card, no consumer debt, no mortgage. Now I don’t have to wonder how to come up with money for savings because I am not sending a large portion of my hard-earned money to some bank.
If you pay off your mortgage you can still invest the same amount every month in a low cost investment account via Vanguard.
p.s… I like Ric Edelman and have a couple of his books, but I think it’s funny that he thinks $1,333 is a cheap house payment. We could never imagine having to pay that much for a home. I make less than $12 an hour and my wife makes less than $8.
Here’s a view from two people in life who think a $250,000 mortgage is just insanity. My wife and I took out a 30 year mortgage for $30,000 towards our $42,000 home purchase two years ago. Our monthly payment (including an escrow to cover taxes and insurance) is $286.00. If we were to sell off some of our investments to completely pay off the mortgage, we would still have to come up with around $120 every month just to cover our property taxes ($1,000/yr) and insurance. ($450/yr) So taking $27,000 out of our investments would only save us about $166.00 per month. I would rather keep the money invested for the next 28 years. Yes, it means we will be paying more than $87,000 for our $42,000 home. (the initial $12,000 down payment, the $30,000 in principal and the $45,000 in interest) But hopefully that 27,000, invested for the next 28 years should be worth a lot more than $87,000.00.
By the way, we love our home. It was built around 1910 in a small northern Wisconsin town. It has 4 small bedrooms, 9 foot high ceilings in the living room, dining room, and first floor bedroom. (which we made into an office) It has a nice basement, central air, a 2-car garage, and a deck with a nice view of the Menominee River and the bluffs of Michigan. At 1400+ square feet, it’s a lot larger than our first home, which was only 860 square feet with no basement. We consider ourselves a frugal couple. We both still drive American made cars from the 90s. Hers is a ’99 with 85,000 miles on it, and mine’s a ’95 pickup with 187,000 miles on it. We don’t have or want cell-phones. We don’t need a GPS to get somewhere. We don’t have cable TV, and we can’t even get any local broadcast channels where we live. (we do have DSL internet access, and a Wii, with Netflix, though for the occasional TV night) We live simply, within our means and enjoy each other’s company. We both like to read books and we take pride in our home. We hope to retire in about 14 years when I’m 55 and she’s still in her 40s. Neither of us could imagine borrowing a quarter of a million dollars (and even more for some people!) to buy a home.
Pay off the mortgage in 15-18 years, then pay college costs with that money. Retirement money should be put away continously.
Congrats to Jay for paying off the mortgage!!
Now, as Carlos suggested use the money you were using to pay the mortgage to your full advantage. Here is what I’m doing.
1) I set up the money that I’ll need to pay taxes and insurance to automatically go in a Money Market account that pays 1%.
2) I’m buying ETF Dividends funds into my IRA and Rot-Ira. This ETF’s pay me nice monthly and quarterly dividends, which I used to buy more share of the funds. When retirement time will come, I’ll select for those dividends to be paid in cash in order to pay bills, etc.
Also, now that I have a dividends strategy, I really don’t care too much how the stock market doews (Up,Down), actually when is Down I jump in and buy more ETF’s shares.
It took me a while to finally figure out a strategy that is/will work for me, and now I can sleep better at night.
Contact them and ask. When I sent my pay-off check, it had an optional for me to include a nominal fee to received a recorded release. You need more than just a pay-off letter. Google “what to do after mortgage is paid off.”
If I may give you an advice, make sure you don’t spend what used to be your mortgage money. First, save a little each money in a special savings account to pay property taxes and insurance each year. It will be a great feeling to receive a little bit of interest when managing your own escrow. For the rest, invest it. You can now put your savings and investment accounts on steroids. I am currently collecting CDs to build up a large emergency fund. That’s sacred. After that, stock market, etc.
Did it! Wired the payoff to Wells Fargo. 0 Debt…what a feeling.
I have the same question as Fausto…what documentation do I need.
Thanks!
Getting into debt to invest sounds beyond dangerous. And keeping a mortgage to invest in the stock market is also risky when you look at the returns in the past decade (not just the past couple of years). I personally agree with a statement that I read months ago, which said that Warren Buffet said that investors can expect 4% this CENTURY, not 8%. It could be worse, another great depression is bound to start WHEN we eventually hit a debt dead end like Greece has. Greece is small, and other EU countries can help it. Who will bails us out when we are unable to make interest payments? We currently borrow from China and send it back to China. There is no true recovery until our debt starts being paid. Instead of paying it down, we have increased. Obama will destroy the country to get more votes!
My recommendation is always pay off your loan first before investing. I understand that you can make more by investing instead of paying off your loan. But, if this holds true, then people should be borrowing money (margin) for investing. Investing is not guaranteed 8% year in and year out. We know experts also do not recommend borrowing money to invest. Bottom line: always payoff your loan as quickly as possible. You just can’t lose by doing this.
I did it!
On Friday, I mailed my cashier’s check to pay off my house. I left the post-office shaking, and I actually shed a tear of pure JOY as I was driving from the bank to the post-office to mail the check.
As of Friday, my debt to income ratio is 0%. I am free.
Ben,
You FIRST need more money in savings to protect yourself against a potential job loss. I’ve had friends who were unemployed for over 6 months. Where I live, they typically rely on their church for help when something like that happens. I find it humiliating, and not a good situation to be in. I was raised to be independent. Others will sign up for welfare. I would rather save and fend for myself. The days of relying on credit for emergencies are long gone now. I used to keep a couple of credit cards active in case I needed them. It would be a suicidal plan these days. In the new United States, you better not rely on credit as your primary emergency plan. Save enough money to cover at least 12 months of total expenses, then invest more aggressively. Investing some money to pay down your mortgage is a great way to diversify your investments. After all, by paying down your principal, you are instantly getting a 4.6% return and getting a little closer to owning your home free and clear someday.
A copy of title? There is no such thing.
Did you receive a deed when you purchased the house? I certainly hope so. If so, you are (and always have been) the owner — the bank never owned any part of your house, the bank merely used the house as security for its loan to you (the bank would have foreclosed on your house if you defaulted on your loan). What you need is a recorded copy (from the NC County Register of Deeds) of the NCGS 47-46.2. Now you have clear title.
Yes, you need to ask for a copy of title.
I paid off my mortgage, now what?
I recently paid off my mortgage, and would like to know what kind of documentation do I need to prove that I’m the sole owner of the property(instead of the lender)?
All the give me is the followings:
1) A letter from Wells Fargo (my lender) saying that they received the pay off and the loan is closed.
2) NCGS 47-46.2 Certificate Of Satisfaction of Deed of Trust, Mortgage, or Other Instruments. Electronically submitted by Wells Fargo to my NC County Register of Deeds ( I have a certified copy of it).
Are the above document suffice to legally prove I own it? What about an updated Deed, Title or anything else?
Thank you in advance for all your help.
Fausto
I wouldn’t put any more on principal. You are doing well at 36. Just keep doing what you are doing. You have the discipline to invest extra money. At 4.625 you have a great rate. If you have a windfall from inheritance or something like that down the line, then put some to principal.
Like many people I’m debating how much extra to put down on principal vs investing. I recently refinanced to a 20 year mort at 4.625%. The principal balance is about $255K. I have about $110K in investments, about $24K in a bank savings account (I know this is ridiculous of me b/c of the absence of interest, but I’m concerned about security–job loss, etc), and about $150K in 401K. I’m 36 years old. It sounds like splitting the difference between extra principal payments and investing w/ extra cash each month is the way to go. I would really appreciate any insights/guidance. Thank you.
Fausto,
Yes, the tax benefit of a mortgage looks more like a joke with each new payment as the portion that goes into the interest payment gets slightly smaller each month.
With my 15-year mortgage, I am getting even less tax deduction. It blows my mind that Americans have been conditioned to believe that having a huge mortgage payment that will take up to decades to pay off is actually a good thing, and that spending hundreds of dollars on monthly interest in order to get a tax deduction is wise.
Today we are Mortgage FREE! We finally did it.
The feeling and the sense of FREEDOM of knowing that the home is really yours is incredible beautiful and Liberating.
Forget about the gimmick of holding a mortgage for the Tax benefits (do the math, it is a joke!), or invest in in the stock market instead for a better return (maybe, it depends).
We choose to have a GUARANTEED return on our money by eliminating the 6.5% we were paying on mortgage interest + no debt!
Now, that free up money that we can use to \\\”Play\\\” the stock market
It can be done if you set it as your goal and stick to it.
Hello,
We only owe 13k @ 5% interest on our home. We have over 100k in the bank and are thinking of paying the morgage off. However, I am unemployeed and still looking for work so we only have one real income. Do you think we should pay the morgage off or wait it out? Thank you
It’s done! Hooray!
Hey Nickel, great insight – though I have to come at this from a different angle. I don’t think most people buy a home with a return in mind, but rather for the security and independence provided through home ownership. There’s something to be said for the peace of mind in knowing that if you lose your job or fall ill that your family will maintain a roof over their head. I’m certainly not arguing your logic on which option provides a better return – in truth, I think you’re far over-estimating the return on a home (for instance, most first-time buyers don’t pay enough interest to warrant itemizing, so even the tax advantage is moot). Rather, my point is that home ownership evokes more than return – there’s an emotional attachment, a personal committment, and a sense of pride and accomplishment in owning your home outright that you just don’t get from investments. If return was the primary motivator, one could make a strong argument that renting and investing is a much better deal than buying a home.
I would keep the money for your child’s education. Rates for education loans are around 7.9% and they are deductible if your income is not too high. A mortgage at 4.75% is better. However, if you default on your mortgage your house is at risk. If you have difficulty paying your federal student loans they will give you a forbearance for a year to get back in financial shape, interest accruing of course. As far as resetting your payment schedule, make sure it doesn’t take you into when you plan to retire. Also, don’t forget that refinancing your mortgage cost some dough. Bottom line is you have to decide if you want to pay lower interest or want the security of being able to postpone payments if you never need to. I hope this helps.
So here’s our deal. We are about to sell our business. After paying off debt, fees, taxes, tithe, we will have about $180,000 left. Our house has a mortgage of $300,000 at 4.75% We’ve been told about recasting and plan to talk with our mortgage company to see about paying a portion of the mortgage of reset our payment schedule to more affordable monthly payments. We have a child going to college next year and have no college fund. What to do????
I have a house worth $670k and have a 185k mortgage at 5%. We have decided to do an addition worth about 300k. We have no other debt and would like to enjoy life more. We spend most of our time at home so it seems right to put the money there. Plus, we are in a very strong housing are of Arlington VA, so we probably will get the money back when we sell. We could pay for it in cash but it would leave us a bit cash strapped so will initially use a HELOC with variable rate – right now 5% – to fund most of it. We may convert it to a fixed rate loan but want the option to pay it off.
Here’s my two cents: Paying off your mortgage is like getting a return of your interest rate (minus the tax deduction savings) risk free. A similar risk free investment in todays environment pays from 0-1%. On a risk-adjusted basis the mortgage interest rate savings is the best return on your money.
Here’s an example: 5% mortgage interest – tax deduction savings in the 28% tax bracket = 3.6% net return on paying off your mortgage. However, don’t forget that you don’t start seeing the advantages of the tax deduction until you have accumulated enough deductions to get over the standard deduction on your taxes. Therefore, the amount you save is a bit north of 3.6%, without a lot of calculations lets just say it is conservatively 3.8%. Now I ask you, where can you get 3.8% in todays savings environment for a risk-free investment?
My wife and I are retired. We have a home in another state we are renting and purchased a home here in Georgia. We have a mortgage of $172,000. My wife is inheriting $200,000. Should we pay off the mortgage as our retirement funds are almost depleted and we live solely on Social Security.
We had a 20yr frm at 7.5 and at about 10 yr’s decided to pay off the balance. PO was 79k and we took some liquid cash, 401K, savings,cd’s, and pd off. We are now debt free. all asset’s r pd off and the piece of mind is great, plus we continued making the mort payment only now it goes into a savings account, which adds up fast. recommend never try to keep up with Jones’s, never buy new vehicles, shop till u drop when buying house. Older houses and fixer uppers are cost efficient if you do your homework. make rules & stick to them. Sav 1st and then spend as best intentions don’t always come true. relax and forget about being the fatest dude in town. B as tight as superglue and remember you get older every day. If you make it to old age it’s better to be able to pay your way than to be worried.
Oh yes, I LOVE “The Millionaire Next Door.” I believe in it! I have been living below my means for years now. I gave up on having car payments after realizing that I was losing thousands every time I traded a car. I can’t begin to tell you how much better I sleep at night knowing that there will be no car payment bill to pay this month. It makes it worth driving an old Corolla with 150K miles. I paid $0 for this Corolla. A relative wanted to trade cars and donated it to me. 🙂
My $1,700 mortgage payment is way less than I can afford, which is why my next mortgage payment is due in 12 months. I am about to drop it to $1200 a month by refinancing it to 4%.
Thank you for the compliment, I guess :). I actually still have a almost full head of hair at 49.
I have practiced the concepts of “the millionaire next door”. It’s a great book, have you read it? I wish everyone else in this country would have lived within their means if possible…. No new Mercedes for me, driving the 10 year old paid off car….
Jcw
It’s a mute point to comment on your strategy, Mr. Trump. You are in a different category. 🙂 When I say an ARM mortgage would keep me awake, it’s because I’m from earth, where most of us can’t afford an ARM mortgage on a house which is still worth $800K after the huge drop in property prices. I cringe when I think what mine is worth these days.
You are in good shape, congratulations!!!!!!!!! 🙂
If I had to I can pay the loan off and still have plenty of liquid money for living expenses which is why I chose the arm. The emergency money is all liquid, does not include any equity, etc. Also, I drive a 2000 dodge intrepid (obviously paid for).
Did not list other substantial retirement assets (800k) and 2 other paid for rental properties.
JCW, the term “ARM” can keep me awake worried. I would rather get a fixed-rate mortgage. If you look at the history of mortgage rates, a variable rate is unsafe. What if something happens and you are unable to pay it off in 7 years? These are uncertain times. ARM mortgages are out of question for me, but it may be the right path for you, especially when you mention that you have 4 years liquid living expenses. I hope you are not including the house or equity on it when you say 4 years. Or the car you drive to the grocery store, etc. 🙂 To me the only emergency money I have is what is sitting in my savings account and CDs.
I agree CharlieBoy! Comments on my strategy please.
Thks
I’m going to refinance my current 15-year mortgage at 5%. I’m getting 3.8%, 15 years, ZERO fees. They’ll transfer my current balance. There has never been a better time to refinance!
Just finished reading all these posts after several days. Great information.
My situation
Just refinanced to a 7/1 arm at 3.375% 417,000 loan. Home value 850,000. Plan on paying about an extra 3,700 month from monthly income not savings to pay off the loan in 7 years to eliminate risk of rising interest rates. Also have 4 years liquid living expenses.
If rates on cd’s go up over 3.375% than I will stop adding the extra principle payment, save the money instead to pay off the mortgage at the end of seven years anyway.
Comments please on this strategy.
@Dean – You are SO right! This is the strategy and philosophy we are using. While it certainly makes sense, depending on your situation, to invest as opposed to paying off your mortgage, particularly in this economic climate, I’m utterly amazed that more financial analysts aren’t promoting the early pay-off.
Investments are paying NIL right now, in many cases and paying off the mortgage is a guaranteed return on investment.
After reading through this mash-up of information, there appears that there is no clear stategy. Those that are lucky enough to fully understand how to invest in the market and have time to do so or the capital, are likely not in the class as the rest. Also those that were furtunate during the 90’s with high incomes or earn high incomes at an early age or high investment returns, are not in the boat with the rest. For the average person in the bottom 90%, there is no 10% investment return or having 401k’s with 400k in it at age 35 or start a business when most fail, the biggest losing investment of all.
Personally our savings rate is about 48% and both my wife and I earn 100k per year which oddly puts us something like in the top 7% of the country but for our area we certainly are not. Our original mortgate was $225k and have paid it down to $110 through extra continious fixed payments and a couple of one time payments totally $35k over a ten year period. With a 5.375% fixed interest, there is no “safe” stock market investment that would beat that rate. Speculating that 1,2,3,4 or 5 years from now you could take x amount and earned more by investing is futile. It’s equivelent to saying that if I only invested in Microsoft or Apple years ago. I don’t personaly have a crystal ball.
If I can reduce my interest payments and pay myself instead, why is that a bad strategy? As opposed to a fictious investment returns of 10% or more people are advising others to make?
In our early 40’s, we only have $200k in 401k/b, $45k stocks, and $200k cash and $20 cds. I’m thinking to take $50k and dump it into the mortgage and pay it off by 2013 with continuing extra payments of $500, will net another $25k in reduced interest on top of the $75k we already saved from prior one time payments.
So why is paying down this debt and avoiding future interest a bad thing? So what, I don’t get a tax credit? Why wouldn’t I just up my 401k savings rate to help make up the difference? Either way, we would NEVER put 100% of our money in any investments anyway so whether its sitting in the bank or went to pay off the mortgage and the intest yeild in the bank is lower than the interest we have to pay to the bank, sounds better to me to pay it off. I just went to my taxes and removed my mortgate interest and I owe $2500 compared to previous. Ok so keep paying $8k to the bank versus $2500 to the government????
Found this article: http://www.thesimpledollar.com/2010/05/11/the-myth-of-the-tax-deduction/
Here is something I’m thinking for a while, and will need your opinion in regard.
I would really to get over with my mortgage once for all and paid it off now. The remaining balance of 48k.
The reason for doing so now is mostly phsycological, as well I don’t want to pay $5800 yearly in interest this mortgage is costing me (at 6.5%).
We do have 50k in an Emergency fund, and thinking to use it to pay the mortgage now.
Both myself and my wife have full time jobs (appear to be safe) and no other debts.
After paying off the mortgage we’ll concentrate in building up the emergency fund again, this time we’ll have extra money to add to it as we won’t have a mortgage.
Do you think I’m jumping the gun here, what do you recommend?
Thanks to All,
Fausto
This is a very interesting conversation and I was hoping I could get some advice as well.
My husband and I just bought our home Nov 2009 in the DC/Maryland area. We are from the Midwest and would like to move back in 5-10 years time. Does it still make sense to pay off as much principal as we can if we plan on moving back before we could possibly have it completely paid off? It’s a 30 year loan but it’s an FHA with required PMI. I really want to get out from under the PMI as fast as possible. We have a modest emergency fund and are putting in the full matched 401K contribution, but we are in our 20s. Any advice on if the strategy would change when we are planning on moving in 5 years and most likely buying another home after the move?
Hi Erik! The person who gave you that advice is not your friend. They are just another person who wants you in the same crummy boat that they are in. Keep paying off your mortgage. Perhaps lower your retirement contributions, don’t eliminate them for 6 years. Get a cheap refinance on the 5.6% mortgage to closer to 4%, lower the years to be paid (you can choose the number, perhaps 8?), and then work like hell to pay it off earlier. Your kids are young and won’t cost much for a few years. They get incrementally more expensive as they get older until the grand finale of college, where they crush you financially. So, take advantage of this time you have to pay off your mortgage. Then, when they do go to college, you can afford to pay cash! Good luck and take care!
JFP —
You are on the money…I am shocked that people who say not to pay off the mortgage have not considered the risks in their lives…especially in 30 years, the biggest risk is health and then job loss. Peace of mind is the best policy, and in this market there is no way you’re getting a 8%-10% return. Personally, had we not taken the money out of our acct. to pay off the house we would have lost $40,000.00.
PAY OFF YOUR HOUSE. Read No. 43.
What should we do… Husband lost job, 2000 savings, and 3000 in checking account. I have a 401k 2000, I bring in 45,000 annually, he was making 70K, Has a company retirement plan that can be rolled over. I am 50, he is 52. Have two mortgages, 1 owe 45K other 63K, pay 2000 a month. been paying extra on the first and is set to be paid off in 2015, Have 10k in credit card bills. He plans on looking for employment… but we do not know how long that will take. We do not want to loose our home. We live in Fl. He wants to pay off the house, for peace of mind or just pay off the second 5% mortgage, and pay offf the credit cards by cashing out his retirement funds. I plan on working 10 more years. We do not want to be on the streets and do not plan to move. What are our options?
This was a no brainer for me and my husband (both 32). We’ve been diligently making extra principal payments for 4.5 years and have now officially paid off our mortgage! It’s an awesome feeling, although I suspect I’ll really feel it next month when I make no mortgage payment for the first time. To me, the peace of mind of being 100% debt free was worth more than anything.
When weighing the difference between the savings of paying a mortgage off early compared to the potential of investment savings, you have to take into account the characteristics of the mortgage amortization schedule.
Example: Principal $200,000 (30)YR.Mortgage at 5.5%
Interest $208,808 Over 30 Years
Total $408,808 True Cost
You have to consider that the interest charges are Front-End loaded heavily to the first years.
Example:
Monthly Mortgage Payment Amount $1135.58
1st Monthly Payment Principal Proportion $219
1st Monthly Payment Interest Proportion $917
2nd Monthly Payment Principal Proportion $220
2nd Monthly Payment Interest Proportiom $916 etc.
(Moves very slow in first years)
As you can see, any concept of paying 5.5% interest does not make much sense when you take into account how much front-end loaded interest will actulally be paid for the first 15 to 20 years of the amortization.
Also, what is freqently not understood by mortgage holders is that when extra dollars are added to the monthly payment for the purpose of principal reduction, it advances the set amortization schedule to a more favorable proportional level each time extra payments are made. Not only do you immediately add to equity position but you cancel interest payments at the highest levels of the amortization schedule. Subsequent monthly payments are made at a more favorable proportions of interest to principal.
That is why even by using a half-payment bi-weekly method, which is a conservative approach to paying off a mortgage early, you would still save over $41,000 of interest charges and over 5 years of payments.
Having the 5 years of payments or $68,000 to invest 5 years earlier makes pre-paying a mortgage a very worthwhile approach to saving and investing.
Another myth: You still get the lions share of the interest tax deduction each year during the pay off of the mortgage. When the mortgage is paid off, would you rather have the tax deduction or the full mortgage payment amount to do what you want with? No brainer there.
Also, looking for an investor to go halves on a great location to build 6 townhomes, taxes in area are very low(750 a year) 30k a year potential profit and guaranteed to sell (near military base). Since the military pays base housing pay of at least 900$ people are looking for a place to rent.. Ex- 6 townhomes x 900$= 5,400 a month now x 12= 64,000 a year total income if all are rented out. Taxes and are 750 a year in the area. 750×6= 4500$. Now subtract 64,000- 4500= 59,500$ total income and divide by two = profit is 29,750 per investor.
I have a house in lakewildwood in Varna,Il that I want to sell
it’s up for 189,000 4 bedroom 2 bathroom newly built with wrap around deck also all stone chimney.. A block away from the beach. Anyone interested? It’s rented out for 900 a month, pretty good investment property. I just bought a house in Colorado springs @ a 4.875 fixed rate.. Also have another property close to Chicago which is also rented out that one is also for sale for more info contact me 🙂 p.s. I’m 22 and in the military
Okay so i just went to HSBC to apply/inquire about a Refi-
Heres the story… I paid 710k for the house in 2005 and the original Loan was for 510k at 5.625 Intrest rate. So i got about 25yrs left and owe about 467k
The New Refi rate is 4.875 on a 30yr with closing cost at aroudn 13k. Its 13k because its a 3 family house and i have to pay 1 Point.
Which would bring my new refi loan to 480k for 30yrs
Still debating on wether to do it or not.. 13k is alot..not to mention it will add another 5 yrs to my morgage..
We have about $180,000 dollars invested in one piece of stock. I know that is a major risk factor if something went wrong and we could lose it all. We are thinking about selling the stock to pay off our newly acquired home loan of $140,000. We would be saving the $130,000 on interest and would have the money going toward the house payment to invest. We currently do not have a lot of money to invest with the house payment. Would it be better to pay off the house and basically start over with investing or redistribute the stock into mutual funds and continue paying off the house. Security of owning our home means a lot with current global and domestic economic conditions. We are both 40 years old.
I know this is a little off topic, But what are the new (law) Loan Modification programs out there?
My neighbor keeps telling me if you prove hardship, or in danger of losing your house, or your house loses signifigant equity You can get your loan Modified.
I only know about HARP and HAMP and not much.
Are there any other programs out there.
Personally i think if they do do this they should offer it to everyone regardless of hard ship or not..
In my case the mortgage interest tax deduction was relatively small compared to the money I saved in interest payments by paying off the mortgage early.
Patrick, you have 190k in savings man, thats a miracle for your age, just take the plunge and be debt free.
Definitely thinking about it. I just want to grow my savings fund a bit more and then may take the plunge!
Hi Patrick,
With your current savings, which is really good for your age, my advice would be to pay off your mortgage. The reason I suggest this is because your wife works part time and you are engaged in contract-type work. This type of work can have it’s ups and downs. For people with mortgages and rent to pay (which is most people) this can add greatly to your stress when business is slow. This will then put a strain on your marriage and affect your quality of life. Just think of paying off your mortgage as a very conservative investment that pays about 4.5% a year. It is the conservative part of a nice rounded out investment portfolio. But, the added benefit for you is that you will have the freedom to do the work that you like to do and your wife will have the freedom to work part time. Additionally, the minute you pay off your mortgage, all your hard work will come right back to you in a large increase in cash flow every week. I’ve done it and that increase in working capitol makes it easier to invest, pay bills, do home improvements and take vacations. And, you can do it all with cash. It really makes living life a whole lot better. Think about it and good luck to you on whatever you decide!
Wow. So much information here. As everyone else, my wife and I have been discussing paying off our mortgage as well. Since December 30, 2010, we’ve been sitting completely on cash. I thought the market was gonna pull back after it hit 10k, but it has kept on going. Anyhow, that’s neither here nor there.
We are both 32 yrs.
Have one child, with on on the way.
No 529 (since I feel like you can always get a loan for school, but not for retirement).
190k cash in ING Savings
200k in 401k / IRA sitting in cash reserves (no Roth)
140k mortgage debt @ 5.625%
No car payments
No other debt
Currently, my wife works a few days a week. I’m currently a contractor that is starting up a company with some partners. The business takes zero capital, so no investment required there. Obviously, it’s risky though. Although, we are confident.
Thoughts on paying off a mortgage?
All! Thanks for the the congratulations. I haven’t quite worked out how best to celeberate.
I’m planning on having the payoff notice printed as an edible image on a large sheet cake. I’ve got a few volunteers to make a pinata using copies of it (sounds fun and kid friendly). I think we will stuff a couple pages into a charcoal starter to get the BBQ going as well(smile). I like the suggestion of a wrapping it around a firecraker and if I do it, I’ll get some good highspeed video of it so I can watch it in slow motion.
It’s not everyday this happens and I’m not coming up with many good ideas so keep the the suggestions coming on how I can add some fun and flare to the event.
Hi, it sounds like you are doing a good job with a bad situation. I had to settle things for my mother recently, so I know that it is not easy.
You mentioned that you cannot afford your mortgage, so I thought I would add another way that you don’t have to make a completely black or white decision. Say your mortgage is $100k and you can’t afford it, but you don’t have enough emergency funds (e.g. 6 months of living expenses). You can refinance for only $50k or $25k and pay down the rest of your mortgage, so that your mortgage payment is affordable but you still have some cash for the unexpected. If things are going great in a year, you can put the money that you set aside to pay off your mortgage then.
Ken, Michael, Rita
I have many things to consider, and appreciate your input. Rita, you hit the nail – we had a friend who lost her husband right after we moved to a high cost area and we thought ‘if that happened to us, we need to look out for each other’ so we each insured ourselves to cover the mortgage… and then the unspeakable happened.
Michael- I cannot afford our mortgage and need to deal with it, apart from grieving I cannot bankrupt my family. Fortunately things (title, accounts, etc) were remarkably easy to deal with because everything was in both names and we were in agreement on everything. I have dealt with it all my self and may only have an issue with a single $45 check. Unbelievable, really.
Dear Sad, I too am very sorry for your loss. What an extremely difficult time in life. There are no good words I could say to comfort you. But, I will try to answer your question because you asked. Maybe you have a cash payout from your spouse’s life insurance and you are asking about paying off the mortgage with it. Or, you have some other source of cash to pay off the mortgage. The only reason we (my spouse and I) had life insurance policies was so that if one of us died, we could utilize that money to pay off our mortgage, which would immediately simplify the survivor’s financial life going forward. The survivor would have financial security, less stress, and more cash flow (that previously went to the mortgage) because the deceased cash flow would not be part of the financial equation anymore. Basically having the same mortgage with less income was not going to be a good combination. This would be true even if one spouse did not work and then dies. That is because a non-working spouse who takes care of the kids and does a hundred other things provided services that would cost a lot for the surviving spouse to obtain. That is why I would advise you to pay off the mortgage. You have enough problems with being widowed and raising those kids on your own. Simplify your life by getting rid of this one big burden so you can have the time, energy and cash flow to handle your other more important responsibilities. Good luck on whatever you decide. Take good care. Sincerely, Rita
SoConflicted, I also love the idea of your having a mortgage burning party! My parents and their friends used to have mortgage burning parties in their day. It was a huge deal as everyone worked to pay off their mortgages as soon as they could. I could not have a celebration when I payed off my mortgage because it was right in the middle of the real estate crash here in Michigan. Not a great time to brag about that kind of good news. Oh, well. I can live vicariously through you. Please take video and post it for us all to celebrate with you!
Congratulations SoConflicted! It seems like you are are a mortgage-paying off convert! I agree, it is amazing how the money just piles up so fast into those investment (and grows like a banshee in this market), and, there is even cash left over for fun when one doesn’t have a mortgage payment. There is nothing better than getting that load off your back and moving into the low stress, high cash environment of life without a mortgage payment. Welcome to the club, SoConflicted! And, E-N-J-O-Y!!!
@sad – I am sorry for your loss.
In difficult times like this, I generally believe that which Dave Ramsey consistently tells his listeners in similar situations – put your financial life on hold, get through the grieving process, and only when your head is clear, start making financial decisions.
If you want to take this approach, stick the money in a high yield FDIC insured bank account until you’re ready to start dealing with money again. Nickel has a ‘Savings Rates’ tab above where you can find a suitable account.
However, if you’re ready to start working through your finances now, you need to re-assess where you are now and how you want to proceed going forward. I would strongly suggest using a third party advisor to help you through settling the estate, finalizing tax returns, re-titling assets, applying for Social Security benefits, putting together a new budget, and putting together a new financial plan. A Certified Financial Planning Professional that charges an hourly fee is likely your best bet. To find a planner, here’s a link to the CFP Board of Standards that credentials these professionals: http://www.cfp.net/search/
As Ken said, more information would be needed before any suggestions could be made.
Sorry for your loss.
It really depends on other money available to you for emergency, retirement, college savings, and investment (if you want to share). A big factor is how much liquid cash you will need.
You can always choose a middle road, short-term mortgage (10/15 years) and pay some extra each month if things are going ok to further reduce the term.
here’s the sad situation
in middle of trying to refinance our mortgage I was widowed. 3 kids, 2 in high school.
I can either use life insurance to refinance low enough to afford comfortably on my salary, or pay off entirely, with still some to invest.
thoughts?
@SoConflicted – CONGRATULATIONS!!! I’m interested in your mortgage burning party. Will you use fireworks to burn the mortgage, perhaps a wrap the paper around a few mortars, or maybe a page at a time wrapped around a firecracker? You could make some great video of this milestone event. Either way, be sure to post an update of how your mortgage burning goes. I’m sure it’ll be quite memorable.
@CharlieBoy – seriously???
Yes, the stock market has been great for the average investor. My 401(K) has gone up; however, you can’t consider the short term. If you have a 401(K), you need to look at the long-term performance for each fund. When I look at the 10-year performance is when I realize that the stock market has lost to inflation in the past decade. Chart the S&P500 for 10 years and you will see.
Now, I have said before I that I believe in doing both, paying down my mortgage and investing for my future. The way I see it, doubling the principal each month is a decent way of diversifying.
The same tool that I used to do my simulation is NOW ready for real trading. It has taken me about 3 years to develop it, and I expect it to be WILDLY successfully with exponential growth when compared to ALL TOP FUNDS. The start date was Friday, 04/09/2010, the starting balance was $5,000. It has purchased 4 stocks for me this morning. The goal is to turn $5,000 into $2,000,000 in the next 5 years. I will post the url here in the near future so you guys can follow my progress. I have named my trading tool KARP. Too bad I can’t turn it into a real fund because I don’t have the huge funds needed to open my own fund. First I need to walk the talk, and I am starting now. $5,000 to $2,000,000 is my goal. 5 years is my goal.
Way to go SoConflicted…
It has been approximately 8 months since my last posting. I thought it might be good time to post a follow-up now that I finally got off the fence and paid off my mortgage (on my 40th birthday as a gift to myself).
Even before the payoff, I was working on an aggressive strategy to continue growing my “emergency” fund until it develops into a respectable “bridge” fund. I call it a bridge fund because it ultimately will be used to bridge the years between the date I am able to retire and the date I am eligible to draw down on my tax deferred investments and with any luck even social security.
The first three months of the 2010 stock market have been good to me. My non tax deferred investments have grown by approximately 15% YTD. My tax deferred have grown almost 70% over the last 12 months which for me means I have recaptured all of my prior losses from the 2008 through 2009 Q1 market downturn.
Now that my mortgage is paid off and I am no longer looking at that monthly expense, my emergency/bridge fund has been transformed from 9 months worth of current expenses to almost 3 years worth. It’s hard to articulate the liberating feeling of not having a mortgage and my amazement at how much the additional capital investment each month affects my overall portfolio. With any luck, by years end, I hope to extend my bridge to 5 years (give or take).
Oh! My mortgage burning party will be taking place on July 4th. I figured having it on Independence Day would be fairly symbolic and most of my friends would already be looking for an excuse to get together anyway. I think it will be a perfect opportunity for a proper celebration.
For anyone else who is on the fence…..
Take it from me, you won’t regret paying off your mortgage one bit.
A bird in hand is worth two in the bush? Old saying… Anyways, talking the other day with someone that lived through the great depression, and some folks weren’t fortunate enough to have money or own their homes due to the economic conditions. So folks were homeless and starving to death in some of the cities. Other folks who owned their homes and grew their own food in gardens didn’t seem to suffer as much. No one can predict where the economy is heading or where the stock market is heading. There have been long stretches in the stock market where it hasn’t provided very good returns. So beware of folks touting 8-10% returns during your time frame of investing. More then likely it may not fit into such an ideal scenario… With gas prices and different forms of taxes on investments & income going up in the near/long term that would also need to be added to the equation. Personally I’ll pay off my house in a couple of years and then invest as needed or have the freedom (freedom – what price is that worth?)in life. Probably banks and other financial organizations (credit cards) want you to pay on your debts (slave to debt?) as long as possible for their profits. Some folks still save up to buy things… During this last down turn in 2008 I believe some folks lost everything (investments) and committed suicide? It would be interesting to hear their thoughts on this topic?
I had about $508K left on my mortgage and I paid it off completely. Now, each month for the mortgage I would have paid, I am getting $1000 of S&P 500 fund (SPY) and $1000 worth of Wisdom Tree India fund (EPI). Since each month, I buy the same amount of dollars worth, the overall dollar-cost averaging reduces my risk of stock market tanking. Some of the purchases was when SPY was at $85 and EPI was at $13, so I’ve made out much better than just paying the mortgage at 5% interest rate.
The banks/Gov gets the bailouts (using our money) and if we don’t own our own homes the banks/Gov will get that too when the stock market crashes. I would at least payoff my mortgage so the banks can’t get my home where me and my family will be on the street asking the gov for a hand out. This gives them control over me, I don’t want to be a slave and jump through hoops to get want I want in life. I would rather work for what I want in life. It’s all about the Gov controling us and our lifesytles. Investments means they have control over our money because if the market crashes it will not matter if I have an investment or not, No money to pay me will not help me when I really need it to live. There’s a free informational ebook and video that explains how to payoff your mortgage in 90 days so you can get out of debt to have more control of your life. It’s great information and a helpful tool.
I would first get the details from the bank, such as closing costs and exactly how much the points would cost me, interest rate, and then I would run the numbers to decide. I would be willing to pay extra upfront in order to reduce my monthly payment in order to increase my Net Operating Income.
To me it’s about the net, which is something I wish I knew a few years ago when I rented a house with a zero NOI. I was one rent check away from panic, which eventually happened.
Now, I might consider paying it off too, but it would depend on the numbers. It would be interesting to look at your numbers here just to see what I think I would do if I were you. Increasing the NOI is a wise decision regardless.
Correct. You’d have to pay points (and points are tax deductible). Personally, I have not experienced any issue when I contacted few banks and brokers and told them that I wanted to refinance an investment property. Even Wells Fargo who’s my current lender on all of my properties offered me a lower rate (I think, it was about 5.75 while I’m currently paying 6.5). The best I have received from a broker (I have done business with them before so I know them) have offered me 4.75 with closing costs of 3.7K on 30 YR fixed. This definitely increases my NOI/Cash Flow so now I’m thinking instead of paying off the entire mortgage in a single shot, I may be better off refinancing and then pay it off in about 5 years.
You live there, huh. Now you got me. I suspect the finance company would be happier about that, but it’s still a rental property. Give them a quick call, them come back here and let us know. I am wondering. 🙂
@CharlieBoy
I actually live in one of the units.
Would i still qualify for owner- occupied refi?
That’s what I was thinking. There is NOW WAY that my credit union will refinance a rental property at anywhere near the current rate. You would have to ask your tenants to move out, if the contract has expired, and do an owner-occupied refinance. To get the currently-low rate of less than 5% on a rental property, you would have to buy points.
What bank/credit union is offering a refi on “investment property?” I am considered a “preferred” bank customer and they won’t even touch financing for a rental property – even if you live in it half the year. If they see any $ declared as rental income on that property, even if it was just a few summer rentals, Citizens Bank’s new tightfisted policies won’t allow lending. Period. — So I’d love to know where you can get a 4% fixed rate on a property with income, with lowest possible closing costs.
@CharlieBoy
Yup thats exactly what i am going to do. Refi, Increase my NOI and then pay it off ASAP.
Thanks
Cotopaxi:
Everything that I read regarding real estate investment highlights the importance of having a decent NOI (Net Operating Income). Yours is negative when you subtract maintenance, vacancy and other expenses. The extra costs have not created a burden for you because you have been able to pay out of your own pocket. The property is not self sustainable. This is a good time to take care of that problem. My top priority would be to refinance it in order to increase the NOI. My second option would be to pay it off.
If you have paid your mortgage on time, it is NOT likely at all that they will lower your interest rate just because it’s high. They want you to refinance if you can and, if you can’t, they don’t care if you move the earth to keep up with the payments.
Great article — but wouldn’t it make for you the finance you loan balance into a new, 30-year, or even 15-year loan? Not to expand the balance, just roll the balance you have into a lower-interest loan?
@Cotopaxi
You just have to run the #s to see if its worth it to refi..
But in your case i would just pay it off if you have the money.. and then invest the cash flow some where else. its easier that way and one less thing to worry about.
I dont have the money to pay mine off.. so if i refi it will increase my cash flow as well as lower the total cost in the long run.
P.S. Im 26 live in NYC
Rshen11:
Your interest rate is better than mine. I’m paying 6.5%. I can get 4.75% on 30 year fixed with $3.7K in closing costs. Considering, it’s an investment property, I think, the rate is quite good and the closing costs are low but then I’m thinking why not just pay off the mortgage…why even spend $3.7K, which would be an expense for me. So, I’m kind of torn between the 2 options.
I’m not hearing any comments from anyone on loan modification so I’m assuming it’s a bad idea given my situation. My credit rating is over 750 and I have never been late on any of my bills and I’m debt free (with the exception of 3 mortgages) and I’m in my 30s so I guess, loan modification is not for me. I do, however, wonder what Wells Fargo would offer if I just threaten them that I’m giving up on the property…curious if they would lower the interest rate!
For the refinance question: Join a credit union and refinance your mortgage. You can get a “no-cost” mortgage (no closing costs, etc.) for the cost of a slight increase in the interest rate. If you plan to pre-pay, like I did, then that slight interest increase will not matter, particularly if you sign up for less years on the mortgage as well. And, keep in mind, you can create a mortgage with any number of years you would like. There are nice interest breakpoint discounts usually at 15 years and sometimes 10 years, but, you can still determine whether you want a 20, 15, 12 or 7 year loan. Good luck!!!
@Cotopaxi
Hey im actually in the same poistion as you.
Not sure wether to refi or just to pay off..
I got a 30 loan at 5.625 and about 25 years left on the mortgage with $200 Cash flow a month.
Im pretty sure im going to refi depending on the closing cost and the rate i get. Im sure i still can get it at 5. and if i used the same bank i hear the closing cost will be cheaper..
Im thinking if i refi at 30yrs and 5% i can use that extra cash flow if i choose too and re apply it to the mortgage.. and i would finish paying it off faster..
I do get security deposit from all of my tenants. Also, I have a real estate agency maintaining the property on my behalf (I pay them 9% of the rental). I do have maintenance costs and irregular vacancies however, fortunately, so far the extra costs have not created a burden for me. My question is should I pay off the mortgage or refinance or go for loan modification?
lilchores, yes, the total including principal, interest and escrow was $1,100. Nothing extra for me to pay other than dealing with maintenance and the unexpected vacancy. They paid utilities, water, etc. I had no security deposit. I made a mistake and I have learned, and the first mistake was to have no positive cashflow at all on a rental.
CharlieBoy, when you say your mortgage was $1100/mo and your rental income was $1100/mo, are you including taxes and insurance in your mortgage costs? Was water included, or did the tenant pay all the utilities including water. Did you have a security deposit to apply toward any of the damage or missing rental income? Was it difficult to find a replacement renter? Were you able to regularly raise your rent?
Both mortgage and rent were $1,100 a month. I did not have a buffer to cover maintenance and VACANCY. One day, when I realized that the rent check was a few days late and my mortgage was due, I decided to call the tenants. Nobody answered the phone, so I decided to pay them a quick visit to make sure everything was ok. Well, nothing was ok. The next door neighbor told me they picked up their stuff and left. Bottom line, I was left with beyond-normal damage to fix and a mortgage to pay and no money for either. A rental property needs to be self sustaining to be worth it.
CharlieBoy,
please expand on your comment “From my personal experience, I can tell you that a rental property whose rent income is about the same as the mortgage payment is a bad idea. At least it was for me. I was a time bomb that ended up exploding.”
Cotopaxi:
From my personal experience, I can tell you that a rental property whose rent income is about the same as the mortgage payment is a bad idea. At least it was for me. I was a time bomb that ended up exploding.
Sharon:
If I were in my 60’s and had money to pay off my mortgage, I would do it faster than one can say ‘do it.’ At the age of 60, the ship of risk taking has already sailed. If I had to pay $6,000 on taxes and insurance in my 60’s, I would move.
We’re a couple in our early 60s, still working and debating about saving more for retirement or paying off an $80K mortgage. We’ve decided to pay if off. If one of us becomes disabled, the other will be able to manage the taxes and insurance of over $6000 a year here in VT. The sense of security in owning that roof over our heads is worth what we might lose to questionable market investments.
I took to heart the argument about investing in the market for higher returns instead of paying the mortage off, and finally came around to realizing that I’m not good at stock investments and paying the mortgage early will atleast guarantee a fixed return. So, we refi-ed to a 15year fixed and sending in extra payments as and when possible.
This is a great thread….
My wife and I are in our thirties and are debt free with 3 properties, all from saving and living like monks. Most people look at the monthly payment and fail to look at the TOTAL cost at the end of 30 years.(typically 2X + the cost of property)
They also fail to figure that the average person moves every 5-7 years or so and gets a new 30 year mortgage everytime they do. People don’t just buy a home and stay forever. It causes me great concern that people would apply leverage principles or risk arbitrage on the very place that their family calls home.
I think that is why our economy is in the state it’s in.
The Monk
Does it make sense to pay off mortgage on an investment property? I have tenants living in the property and the rental income is pretty much what my monthly mortgage amount is. If the interest rate was decent then I wouldn’t try to pay off the mortgage. I’m paying 6.5% interest. I understand that it’s tax deductible but I don’t know if the 6.5% interest rate is worth the tax deduction (I’m in 28% tax bracket). I have the money to pay it off and I have tenants so why shouldn’t I pay off the mortgage to get “guaranteed investment return”?
Next option is refinancing. Refinancing to a lower interest rate will cost me closing costs which will be recouped in about couple of years. I may or may not be able to sell the property in couple of years as it all depends on market conditions. If I refinance and then sell the property in couple of years then I lose the money on closing costs. If I refinance and don’t sell the property then it’s still an expense to do the refinancing. It’s an expense that I can avoid by paying off the mortgage and keep the rental income to myself.
Also, any thoughts from anyone on loan modification? I have excellent credit, high income and no debt (other than 3 mortgages). Will Wells Fargo lower my interest rate simply based on the fact that the interest rate is high? I doubt it but it doesn’t hurt to ask especially if Wells Fargo feels threatened that I would give up on the property just because of the high interest rate? My only concern with loan modification is that I don’t know what kind of options they will come back with and in case, if I don’t like any of the options and want to go back to the way things were then I have still screwed up my credit because of the loan modification proceedings.
Appreciate the comments/thoughts.
I purchased my last house in Dec. 1998. I sold it 9 years later in the fall of 2007. I had a profit of $125,000. I paid no income taxes. A rental property would be different, but it was my primary residence.
The bottom line to me is that I won’t invest every extra penny in the stock market. The bulk of it goes to pay down my mortgage, but some extra money will be invested elsewhere. I double my principal, that has been sacred.
The US tax code is deliberately slanted in favor of home ownership. However, as with ALL investments there is a “cross over point” where that becomes less true. IF you are at the beginning of a RE mortgage, the tax benefits/deductions are in your favor; after 7-9 years they are not. IF you extract your equity with a 2nd mortgage you can re-establish your benefits. Doing that while you HAVE income to use the deductions against makes perfect economic sense. However, if you lose your job OR when you are about to retire, the opposite is in your economic best interests. Paying down a home loan in the early years is foolish; doing so just before you retire is wisdom. In between you need to run the numbers.
>>”Us missing another Great Depression wasn’t an accident. Our policymakers have learned over time how to handle these situations and THAT is why we’re not seeing massive tent cities across the U.S.”
Do you mean to tell me you believe that the Obama administration knows how to handle the economy? Wow, you are faithful, good for you.
I trust the Obama administration like I trust Hugo Chavez or the leader of North Korea.
Second, you are simply taking a good fund and comparing it with mortgage rates in the past 20 years, as opposed to see how the stock market in general, and the AVERAGE fund, have performed in comparison with mortgage rates.
Plus, you are only comparing with mortgage rates, I am looking at the big picture. I am looking at the possibilities that I believe will open for me once I no longer have to spend a large amount of my pay on a mortgage, and the priceless peace of mind that I have knowing that INVESTING IN MY MORTGAGE IS AN INVESTMENT WITHOUT RISK.
I am not only looking at my primary home, I am thinking of purchasing a rental property and see how housing prices have appreciated in the past 20 years versus the stock market in the same period of time. There is no question who wins!
AN EXCERPT FROM AN ARTICLE BY EILEEN AMBROSE:
“The past 10 years have been dubbed the “lost decade” because investors have little or nothing to show for it.
The stock market, whether measured by the blue chip Dow Jones industrial average or the broader Standard & Poor’s 500 index, was at a lower level on the last day of the year than it was a decade ago. That hasn’t happened since the 1930s, the era of the Great Depression.”The Zeros is such a good name for it. Good-bye to the Zeros and zero return on the S&P,” says James Angel, an associate professor of finance at Georgetown University.”
AND, LIKE I SAID, I BELIEVE IN INVESTING IN THE STOCK MARKET, BUT I PAY DOWN MY HOUSE WITH EXTRA MONEY AS A MEANS OF DIVERSIFICATION.
Michael, you found a fund that performed well (10.09%) over the past 20 years. I do NOT trust their numbers. I was reading about the obscure way that funds use to show their performance, but I don’t even care.
The fact that that fund did better than the S&P 500 does not convince me that I should pay minimum on my house and invest in the stock market.
I didn’t run a simulation against that fund. I ran a simulation with the S&P 500, which I can find you links discussing that investors have nothing to show for in the past decade, like Aaron’s wife as he mentions above. That’s what the numbers and charts clearly show, and my own 401(K) account confirms.
I am NOT against investing in the stock market, and I do so in my 401(K) religiously. I have been contributing 5% to get my company’s match, but I used to invest 15% for a while, until I realized that the mutual funds in my 401(K) have performed poorly after expenses in the past 10 years. I do not have their 20-year return to compare.
If I had the chance, however, I would cash it all out (if they didn’t charge me a painful penalty) and I would pay off my mortgage faster than you can say hello. In fact, I would either pay my house off now or just buy an investment property because the historic house prices over the past 20 years are far more attractive than the stock market performance.
But I believe in diversification, and paying down my mortgage with my extra money, after I contribute money to my 401(K), is what I do for diversification. That’s so I don’t put all my eggs in one basket. But everybody can make their own decision, and we are here to express our opinions on the matter.
Now, besides my 401(K) and paying extra towards my mortgage, I will be setting aside some “mad” money to invest in company stocks, not funds. I am planning in opening a trading account in the near future. Why? Because I firmly believe I can beat the market and the top funds. At least my back-testing using 10 years of historic data tells me that I can do better. Having said that, paying my mortgage down will continue to be of utmost importance.
Like I’ve said before, only in the culture of DEBT people seem to think it’s ok to spend 30 years slaving away for a mortgage company. Well, good for them. I want to be free ASAP.
Aaron, it is a wise decision to refinance now when we have this record-low rates.
And, yes, I believe that your wife’s account is about the same over the last decade because I ran my simulation software, which makes monthly deposits into a hypothetical account and on the S&P 500. After 10 years, inflation outpaced the gains even after I added dividends.
Since you already fund your retirement, my vote is for you to apply the $25K towards your mortgage. It’s anybody’s guess how long this bull market will last since the Obama administration, like the Bush administration, remains on the path of economic destruction by overspending. But the new administration is taking the mission a step further by trying to turn the United States into a socialist hell where the middle class is nothing but a class of overworked, overtaxed peasants.
I believe in diversification, and in investing in the stock market, but I refuse to pay minimum on my mortgage just so I can risk losing everything when the stock market crashes AGAIN. The next crash, if we don’t find a way to elect more fiscally responsible leaders (the only name that comes to mind at this time is Ron Paul, sorry), could finish us.
I am considering a 15 yr refi at 4.375% with no closing costs and no fees and using $25k to pay down my mtg balance to a conforming loan to get to this rate. My current rate is 30 yr fixed at 4.75%, with 24 yrs left to pay off. This will cost me about $600 more per month in mtg payment- but if I live in the house for the next 15 yrs will save me about $180k in interest.
But, should I invest the $25k and $600 monthly instead in a balanced set of mutual funds? The return is not guaranteed, but could be higher- even after taxes. However, money invested over the last decade has not seen an increase in investment (my wife stopped working over 10 yrs ago and her retirement account is worth today about the same as when she retired).
I fully fund my retirement account (or I would not even consider paying off my mortgage early). I also have somewhat of an emergency fund (a few months worth).
What is the best approach (ignoring the emotional aspect)?
Arthur, the IRS site has a QA page on the homebuyer credit that you may want to read:
http://www.irs.gov/newsroom/article/0,,id=206291,00.html
And I would get a roommate to help with my mortgage if I were you.
Also, anyone know the last day to ammend taxes for the first time home buyers program if i close on the house april 30th, 2010??
thanks
-Art
i just bought a townhouse yesterday finally after the offer got accepted.
i got it for 145k, it was just finished being built. My mortgage payment including taxes and HOA will be 960$ @ 5% interest rate. i used the VA so i had no money down. My question is should i get a roommate so they can pay half my mortgage since its a 2 bed,3 bath, 2 car garage? P.S. im in the military so it wont be hard finding a roommate since apartments in the area are 600 average. If i charge 500$ plus utilities that should be more then half my mortgage payment.
let me know what you guys think.
– Art
Rshen11, since it’s an income property, even though the cash flow is not good for now, I would refinance it in order to lower my monthly payments and increase the cash flow. I would struggle to save every penny from the cash flow to cover future maintenance and vacancy problems.
Should I refinance?
I am 26 and live in NYC
I got a 3 unit house 5 years ago at a Rate of 5.625 on 510k Loan (25yrs left) and 450k lef on the loan.
The mortgage inssurance utilities and taxes averages about $3600 a month for whe whole year.
I rent out all 3 units for 3800 a month.
I get a cash flow of $200 which isnt much at all barley covers the maintenance..
Should i refi at a lower rate and for another 30 yrs?
to increase my cash flow?
lil chores:
I refinanced from 6.5 to 5% last month and paid 2,800 in closing costs – about 1.5% of the total loan amount. Unless you are paying points to buy down the interest rates our closing costs should not exceed 1.5% of the loan amount. I got that and didn’t really shop around. I am sure I could have got down to 1% or even less if I really tried. So unless your total loan amount is 750k or more, 10k is a total ripoff.
Lil, I refinanced mine to 5% BEFORE the credit meltdown, so my refinance costs were very low! From what I hear, it is substantially higher today. You have to calculate the numbers and use a decent mortgage calculator to determine whether or not it’s worth refinancing it. I wouldn’t bother unless it’s at least 1% lower, but I would have to know what the closing costs are to even consider. You need to shop around for lower closing costs. Also, it cost me a lot less because I used the same mortgage company that had my original mortgage.
Appreciate all the interesting comments. For those who are refinancing their mortgages from (as one example stated) from 6% down to 5% to save money on interest, I would really like to know what the total closing costs were for that refinance. Aren’t closing costs quite hefty? Don’t want to sound repetitive, but a couple of years ago, when my GMAC arm seemed like it was about to adjust from 5.5% to 7.5%, I looked into refinancing, and the broker wanted to lock me in at 6.75 or 7% (that was then, this is now) for 30 years AND charge me around $10k in closing costs. I realize that might have been an isolated incident and you may feel it has no merit today. But imagine how I’d feel if (two years ago) I’d traded my a.r.m. which is now at 3.5%, for a fixed at 7% and having to pay all those closing costs for the pleasure. I know that rate sounds high today, but it was the going rate at the time. Aren’t closing costs on reFIs going to diminish the purpose of the reFI?
Early payments do NOT reduce interest costs whatsoever. You simply pay in advance and build a buffer. So, first I want to build a decent buffer, like 14 months or so, then I will focus on paying down the principal ASAP.
Emergency and buffer are safe. Does early payment reduce interest cost or just make it where you have already paid for future months? If I follow my current scenario, my 10 year mortgage will be paid for in 57 months. Interest will go from 35K to 17K. Not exactly sure the last months since when my buffer = principal = Payoff. Sounds like the early payments takes care of future but maynot reduce interest.
Steve, but you didn’t mention where you are saving your emergency money and, since you mentioned dividends, I fear that you may be investing it in the stock market. Emergency funds should not stay at the mercy of the vicious stock market. It could get gobbled up faster than you can make a withdrawal.
Refinancing it was a wise move, no doubt! I too refinanced mine a couple of years ago from 6% to 5%, and down from 30 to 15 years.
>>”If I lose my job, and i’ve sent in all my buffer I have to hit my emergency”
When I mentioned that I send early payments, I don’t mean that I am just paying down the principal. I actually make the next payment ahead of schedule. At the moment, my next mortgage payment is not due for 13 months. So, if I lose my job, I have to worry about my other monthly expenses, such as food and groceries, but my biggest expense (mortgage) would be covered for 13 months. So, there is a difference between paying down the principal and sending early payments. I actually do a little of both, but my main focus has been to send early payments to build this big buffer during these uncertain times of a shaky economy and a president who has contempt for the middle class and the country.
I send in a weekly payment of 1/4 of my original payment. I went from 2000/mo to 1500/mo but still send in 2000 at 500/wk. That give me an extra each year. But I still have the buffer. If I lose my job, and i’ve sent in all my buffer I have to hit my emergency fund instead of my buffer. by refinancing I’ve saved interest and increased my buffer length by 25% if I lose my job. At the end of the year, 1/2 of my buffer goes to principal.
Steve Willis,
I like your mortgage buffer approach. 🙂
Now, you need to be VERY CAREFUL where you are saving your emergency fund/mortgage buffer. I hope it’s not in the stock market at all as we KNOW it will crash. I would look into a savings account or maybe CDs. I realize both lose money to inflation, but you do NOT want to risk your emergency fund in the stock market.
My approach has a similar idea, but I build my mortgage buffer by sending early payments to my mortgage company. For instance, my next mortgage payment is due on May 1st, 2011, and I will be sending that payment next Friday. That way, I don’t care what happens to the stock market (or banks in general) and I will always stay at least 1 year ahead. Besides that, I have $2,000 in a savings account for short-term emergency and $10,000 for other emergencies in CDs. But, when it comes to my mortgage buffer, nothing beats sending in early payments ASAP.
For the vast majority of us, our homes are our biggest investments. People too often fail to protect their biggest investment. We all need to have a detailed emergency plan.
I just refinanced my 10 year to another 10 year after 7 years. If I keep the same payment I save 6 months of payments. I will keep doing that. Now to get it down faster, I’m putting all my extra money (excluding: I’ve maxed my 401(k) and have a couple $100 more a month to add to my emergency fund) into an investment that pays a small but reasonable dividend. Now this could go down but most likely won’t. Have to keep an eye on it. At the end of the year, I take 1/2 of that out and apply to mortgage. I call this my mortgage buffer. Don’t know what the market will do so If i get laid off, I use my mortgage buffer to pay mortgage. This is the only thing my buffer does is paydown my mortgage or make mayments if I get laid off. When I make it through the year, I take 1/2 of my buffer and apply to my mortgage. As of now, I have 6 months worth of payments in my buffer and I keep making mortgage payments and buffer payments. At the end of 2010, 1/2 goes to mortgage buydown. By calculating 3% gain on my buffer, and making those end of year payments, I save 15K in interest and cut the loan time in half. In summary: I have my emergency fund and a mortgage emergency fund. The biggest fear is that you get laid off and lose your home. By having a separate mortgage emergency fund and using that to buydown the loan, you reduce a lot of the stress at the same time you save, and buydown your mortgage. With any plan, if you don’t adhere to it, it’s not a plan.
The current inflation rate, which was released on February 19 for January 2010 is 2.63%:
http://inflationdata.com/Inflation/Inflation_Calculators/Inflation_Rate_Calculator.asp
Also, take a look at this chart:
http://inflationdata.com/inflation/Inflation_Rate/CurrentInflation.asp
THE FED DOUBLED THE SUPPLY OF MONEY LAST YEAR. WHEN THAT CATCHES UP WITH US…
I just wanted to thank all of the posters that contributed here. I read each and every single post and am amazed (in a really good way!) at the responses and debate. Great, intelligent responses on all sides and so much food for thought.
Again, thank you all.
A little of both is ok. I contribute 5% to my 401(K) because all the mutual funds in my 401(K) have performed horribly in the past 10 years. It doesn’t matter to me how well a fund has performed in recent history.
So, as means of diversification, and for greater peace of mind, I invest most of my extra money on my mortgage. I still have 5 years to go IF, and that’s a big IF, I can keep this uncertain job.
I do invest a little on commodities each month, up to $400 because I think they might be a better protection against inflation int he LONG run.
Other than that, I do plan on opening a trading account.
(Along with my simulation tool, I have spent the past 4 years developing a trading tool which, when I go back 10 years, gets 1,000% return. During the horrible year of 2001, it got 35% return. How would it perform in the real world, with a real account and with real money? That I have not had the guts to find out. 😉 )
Charlieboy – your talking alot about PAST inflation. Where are you getting statistics such as (“inflation was up 1% in January”)? Not only where are you getting it but you imply that inflation will rise 1 percent each month, for which there is no real substance to back that prediction up. Inflation has not been at the historical 3% over the past 10 years, but lower. I just bought a new refrigerator for LESS than it cost me when I bought the previous one 15 years ago. Now, as a matter of fact, I agree inflation is coming; therefore, you want your money to be in assets that will appreciate when we have inflation. Fixed return assets such as CDs will destroy your cash. Will your house value rise in an inflationary environment. History is mixed on that one. But if you are going to put all you cash into paying off the house, it better go up if we get inflation.
CharlieBoy,
Thanks for the reply. I feel that my husbands job is secure, of course one never knows anymore. He just received a promotion about 6 months ago so I don’t think there are any layoff plans but again, you never know. We do have a 12 month emergency fund as well. Sorry, forgot to mention that. I think my job is secure but the good thing is we live off of my husbands salary and use my salary towards savings, and extras. If I did lose my job then we would still be okay. I personally would feel better having no mortgage in a few years and use the extra money to invest in real estate and mutual funds and or savings. It is a hard decision though. I guess you just have to do what’s right for you individually, that’s why I think we will probably do a little of each since we have differing opinions. We shall see.
Good luck with your 4 year plan to get your mortgage paid off!
Catgirl,
First what we KNOW:
1) The stock market will crash.
2) Investing in your mortgage has zero risk.
How secure are your jobs? I mean, I thought my job was 100% until yesterday when I learned my boss was laid off, which means anybody where I work could go next. I’m still employed, but seeing him getting laid off when he was a huge contribution to the company just opened my eyes. Having said that, make sure you have enough emergency funds to last 12 months.
After that, I say assess your risk tolerance. There are almost no funds that would have outpaced inflation in the past decade. Imagine when higher inflation rates hit us, or do we really think that what they are doing to our money supply will never catch up with us?
Also, I’ve learned today that they play with the numbers big time when they report their performance to us. So, what they say the return is in the past decade is most likely not real when you throw it in an actual simulation tool like mine.
I have really enjoyed reading the discussion of paying down the mortgage vs investing. It’s nice to see I am not the only one struggling with this decision. I was wondering if I could get an opinion for our situation. My husband and I are both 45 and we have a 220K mortgage at 4.75%. We have no debt other than the house. We paid cash for both our cars, one is a 2007 the other 2002 so we should be good to go for awhile. We each put 15% of our pay into our 401K’s. We have about $300K combined and add about $38K each year into the 401K’s. Not eligible for Roth. 🙁 We also have a college fund for our 2 year old daughter. We have $160K in the bank that needs to be put into something instead of sitting in the bank. Not sure if we should pay off the mortgage,invest in mutual funds or buy land. (If we put it towards the morgage I think we could pay it off in 2-3 years total time.) I am thinking that maybe we should do a mixture. My husband really thinks inflation will hit in the next year or so and is convinced that paying down the mortgage is a bad idea, where I am more in line with getting it paid off. Maybe a compromise??? Thanks in advance for any comments.
>>”Charlie, the crummy stock market for the last 10 years is only one way it could have turned out.”
Yes, welcome to Vegas.
Now, we need to remember that there is NOTHING more important than building a decent emergency fund. Nothing. And, yes, there are a FEW people who can beat the market, but most of them are not professionals.
Charlie, the crummy stock market for the last 10 years is only one way it could have turned out. There is no way of knowing if real estate or financial assets will appreciate more in the next ten years. That is why, diversification is such an important idea. The least risky course is to save until it hurts but have some skin in diverse assets at a comfortable risk level.
Paying off the mortgage doesn’t always do much for security or create that much of a hedge against unemployment or whatever. My mortgage is only a few hundred dollars…the rest of my house payment, almost 50% of my house payment, are the taxes and the insurance which I would need to continue to pay anyway. So I’m looking at getting ride of about $320/month. Even on my current, low salary, that’s not enough of a motivator for me to put extra resources towards my mortgage. As my salary/career increases I’ll eventually be able to pay it off and still afford the things I want & need. The house payment will always be there…until it’s not. No matter how much money I make in the future, I’ll never be able to go back and invest in my 401k or ROTH, or any other time-dependent investment vehicles. I take solace in knowing that my entire house payment is cheaper than the rent of a decent one bedroom apartment, in the same area, 5 years ago–and it will continue to “cost” less as inflation increases.
Payments don’t change the property appreciation, but an extra penny towards the principal means that the equity I have in my house is instantly increased by a penny.
Besides, it means that investing in real estate is something one may consider more seriously for diversification purposes. Had I purchased a house 17 years ago, I would be MUCH better off today if I invested in paying it off instead of throwing money into the stock market drain.
“When you look at how much a property will appreciate in 20 years (I am not talking about short term), versus how much a balance grows in any fund, it makes sense to invest more in one’s mortgage and not just make the minimum payments.”
Payments have no effect on property appreciation.
In fact, depending on your risk tolerance, if you can afford double payments on your house, you could buy a house twice as expensive, and get twice the appreciation.
Big risk, big reward.
@CharlieBoy – Please take this for what it’s worth, but your many comments are riddled with erroneous information and flawed analyses. This is not meant to slam you, as you’re a guy trying to put across a point that has validity, but your support for your view needs some work and I am concerned that some readers might be misled by your commentary.
To start off, your investment analysis could use some help. Let’s do a really simple thing in assuming a stock portfolio. Let’s find a stock mutual fund that was started 20 years ago. Let’s look at the average annual return over that period and then compare it to mortgage rates at the time. Finally, let’s see what this tells us.
On April 2, 1990, the Franklin Balance Sheet Fund began operations. The average annual return over the life of the fund as displayed today on the company’s website (http://bit.ly/9UzFQG) is 10.09% after paying the sales load for class A shares. Looking at mortgage rates from the same month and year, we find that mortgage rates were 10.37% (http://bit.ly/dkeUpk) according to the Federal Reserve. An individual in 1990 would have taken out a mortgage at the then high rate, and refinanced a number of times as rates continued to move lower. They would have come out WELL ahead over the last 20 years by paying their monthly minimum on the mortgage and investing the rest – even while facing a pair of nasty bear markets in the last decade.
So what? This is one 20 year period and it doesn’t exactly constitute a fully developed analysis. It’s more like anecdotal evidence. It’s kind of neat, but it’s far from proof.
However, you can test as many 20 year periods as you want, and what you will find will be the same – stock investments outperform mortgage rates over the overwhelming majority of those periods (going back to 1934 anyway). The way that you can find this out is by doing a rolling 20 year historical return analysis. The tools for this aren’t readily available to the public, but any investment professional can get this information for you if they have access to fund company data (and most do).
An even better analysis uses Monte Carlo simulations to determine possible outcomes and you can buy the software at http://www.moneytree.com
The fact of the matter is that EVEN WITH CRASHES, if you’re investing over a long period of time, the average annual return on stocks will be higher than mortgage interest rates AND will fall in a narrower range. In any one year period, returns can be 30% up or 30% down. In any 25 year period, it’s more between 8% and 11%. The range of the former is 60% and the range of the latter is 3%. Your continued insistence on the market crashing over and over again is true and dead wrong. Between the crashes, there are rallies and over the long-term, the net result is a return between 8% and 11%.
The argument to payoff a mortgage early is not one that is based on pure returns, but on all of the other things that are difficult to quantify. These things like job losses, major casualties, health problems, caring for aging parents, unexpected pregnancies, etc. are all events that have financial ramifications. Even with adequate insurance coverages, one can still be bitten by an unusual event. These events that spillover and necessitate a withdrawal of capital from investments or equity from a home are the reasons many would rather not carry a mortgage.
For the overwhelming majority of people, they would prefer to not pay on a mortgage and own their homes outright. How to pay off that mortgage is the major question of Nickel’s post and comment thread.
In answering the question, you continue to hammer investments and not being consistent enough, but the evidence tells a very different story as outlined above.
NEXT, in your blasting of VPINX, you failed to present good information. You ask the question, “How exactly are they they protecting you against inflation?” This is the Vanguard Inflation Protected Securities Fund and it invests in Treasury Inflation Protected Securities (TIPS). These government bonds are not like other bonds. The price of the bond adjusts for inflation based on the Consumer Price Index (CPI). To answer your question, the fund protects its investors against inflation because it buys securities that are designed to track inflation.
As an aside, should inflation pick up as many expect to happen in the coming years, TIPS will be a far, far, far better investment than intermediate and long-term Treasurys because they don’t carry the same kind of interest rate risk. In fact, if you chart 3-month T-bills and overlay expected inflation rates, you will see that they move in similar patterns. This works FOR TIPS and AGAINST longer maturity bonds.
NEXT, you said, “to the fact that housing prices will go up much faster than inflation in the long run” This is a crazy notion. Housing prices (nationally, not locally) are a function of wages and interest rates. In other words, the appreciation in housing prices is LIMITED to the rise in wages and the cost of borrowing. During our housing boom, we had increasing wages and very low interest rates. The results we’ve already seen.
Now that we’re in a deleveraging phase (which you are a chief proponent of), housing prices will likely stagnate for a long period of time in real terms. Inflation will have the effect of raising nominal wages (not adjusted for inflation) and the central bank (the Fed) will raise interest rates to choke off inflation. The effect will be that housing prices will rise, but they will rise only in nominal terms because increased interest rates will reduce demand (the way we choke off inflation).
This belief that housing prices will rise at a rate “much” faster than inflation isn’t supported by the data or the demand function. The only time that housing prices rise more rapidly than inflation is in a hot local market (real estate is still largely a local phenomenon) or during times when inflation is low and interest rates allow greater leverage in borrowing. What you can afford in the price of a home is not a 1-for-1 exchange when interest rates rise.
NEXT, your horribly oversimplified argument against the Vanguard Total Market Index is poor. The stock market (which this fund is a proxy of) has beaten inflation over any long-term period. I don’t think many people are considering paying off their house in one year, so don’t use a one year period to made any kind of judgment. If you’re able to pay off a house in five years, look at rolling five year period. At that point, you’ll find that it’s closer to a coin flip to invest or pay off the mortgage…except that the variance in returns (the risk) is far greater in the markets. While they may ON AVERAGE offer a return equal to the mortgage rate, the degree of risk doesn’t justify the investment in stocks.
FINALLY, you said, “When our debt finally destroys our economy and the stock market does what it did in 1929, I suspect the couch potato portfolio will sink to the drain” If we didn’t go down in September of 2008, it’s not happening…at least not for a while.
Any ideas as to why the Great Depression went so badly and the Great Recession wasn’t named the Great Depression II? It’s because we had a very active central bank and government. The Fed and Treasury took extremely active roles in staving off another Great Depression and while no one likes the money that was spent now, it was the difference between us being where we are now versus where our ancestors were in the 1930s.
Us missing another Great Depression wasn’t an accident. Our policymakers have learned over time how to handle these situations and THAT is why we’re not seeing massive tent cities across the U.S. (Granted, the financial industry and naive consumers created quite a pickle, but we will weather the storm)
If you’re referring to the very long run when our debts continue to pile up, I wouldn’t worry about that too much either. As long as we continue to make gains in productivity, we’ll be fine. Short of that, we have a long history of doing what has to be done (cutting social welfare programs will at some point become necessary). Our nation is a reflection of ourselves. Most of us don’t do what needs to be done until we get close to the deadline.
It’s political suicide to cut Medicare or Social Security benefits, but something needs to be done…eventually. I’m certain that we’ll be up to the task when the day arrives.
That’s all I have time for today, but again, don’t take it personally as this is a learning opportunity. I like that you’re getting engaged with your money and the community, but it’s important to take a little time to understand the topics on which you comment.
@Ned Mills – these portfolios are variations of asset allocation funds. I like the fact that they offer diversification, but they are not customized to what’s going on in your life. If you can spend just 15 minutes or so using some asset allocation tools on Morningstar or an investment provider’s website, you’ll likely get a better ‘fit’ portfolio.
The only gripe I have with these tools on the web are that they don’t account for a lot of other issues in your finances like whether or not you have an adequate emergency fund. Also, most are overweighted towards stocks (not surprising since fund companies earn higher fees on stocks than bonds or cash).
I pay down my mortgage principal as my highest priority because being mortgage free would expose new possibilities for me; however, I BELIEVE IN DOING BOTH. But paying minimum on a mortgage while investing in dead end funds is what makes zero sense. I have demonstrated in my simulation (url above) that the stock market has not been a better option in general when compared to making extra principal payments to one’s mortgage. When you look at how much a property will appreciate in 20 years (I am not talking about short term), versus how much a balance grows in any fund, it makes sense to invest more in one’s mortgage and not just make the minimum payments.
Ned,
Thank you for the links!!!
I’ve looked at the couch potato portfolio, which has VIPSX and VTSMX in it. I see other portfolios there, but I’m looking at the couch potato that you mentioned.
VIPSX: Flat prices, about $12 a share. It is expected to remain kind of flat because it is a row-risk (and low return) investment. It yields 1.68%. With a total expense ratio of 0.25%, you get what, 1.43% return? How exactly are they they protecting you against inflation? The inflation in January alone was over 1%. This is a sure way NOT TO GET RICH SLOWLY, OR EVER. It invests in bonds issued by the U.S. government. In other words, it invests in DEBT. Ouch! Let’s see, would I rather get 5% (about 4% net after tax deduction) by investing in my mortgage or get about 1.5% from a fund that invests in bonds/debt? I’ll stick with investing in my mortgage due to the ZERO RISK, and to the fact that it provides shelter for my family AND to the fact that housing prices will go up much faster than inflation in the long run.
The other fund in the portfolio is VTSMX. Yields 1.94% with an expense ratio of 0.18%. Net = 1.76%? That’s outpaced by inflation faster than you can say, ‘where’s my money?’ I am nicknaming the long-term chart on this thing… Friday The 13th.
When our debt finally destroys our economy and the stock market does what it did in 1929, I suspect the couch potato portfolio will sink to the drain.
Ned, where are the links?
Hey Charleyboy,
I checked out your simulation link. It was comparing paying off your mortgage early vs. investing in stocks only. The portfolios I was referring to were balanced between stocks, bonds, gold, and money market funds, with different variations depending on how aggressive you wanted to be. From what I’ve seen, these portfolios would average a better return over the long term than paying off a 5% mortgage. Check out the links I posted and let me know what you think.
Thanks!
re: “Couch Potato” portfolios
OK, Charlieboy- here’s the info regarding the “Couch potato” portfolios, designed for easy management and diversification:
Permanent Portfolios:
http://crawlingroad.com/blog/2008/12/22/permanent-portfolio-historical-returns/
http://www.permanentportfolio.com
“Couch Potato” Portfolios:
http://assetbuilder.com/couch_potato/couch_potato_cookbook.aspx
http://assetbuilder.com/couch_potato/couch_potato_results.aspx
Please tell me what you think of this strategy.
Thanks to everyone for their advice!
Look, even if my mortgage rate were 0%. If you look at the chart of historic housing prices that I added to my simulation page, you would realize that the stock market has lost to inflation while houses have appreciated a lot in the past 17 years of the simulation.
EXAMPLE: The house I actually purchased almost 12 years ago for $184,000 (back then we paid way too much. We didn’t even offer less. The sellers asked too much expecting negotiation, but we wanted THAT house, that day, and didn’t bother to offer at least $5K less) would be sold today for $270,000 today. Two years ago, we actually sold it for $310.000. We were shocked.
So, it doesn’t even matter that I am only getting about 4% return by investing my extra money on my mortgage because I am taking no risk and I am very interested in the long-term appreciation. I still have over 20 years till retirement. I am anxious to finish paying off my house so I can purchase a second one for investment purposes. I don’t care what happens to the stock market because my house will appreciate. What a peace of mind.
Sure, housing prices are down now from about 2 years ago, but I am only interested in long-term results.
These remain critical FACTS:
1) Investing in your mortgage has no risk.
2) In the 17 years of the simulation, the property appreciated substantially while the gains in the stock market were outpaced by inflation.
3) The stock market will crash. Houses will continue to appreciate because our species is addicted to shelter. Population continues to increase. (When I was a child, I heard the number 4 billion. Today I hear 6. When will it stop? We have multiplied, and then some, but…)
Ned – congrats on your first home. I am guessing you are getting a great deal with the depressed prices in Las Vegas. Wish I lived out there – would probably buy an investment property there.
Since you have no other debt, I would not concern yourself with paying off your house. Surely you got a great rate (probably around 5% I assume). After your tax deduction you are actually only paying about 4% interest. With 15-20 years until retirement, if you are disciplined you will likely at least get equal return in the market. You should outdo 4%. Just don’t assume 9.9% per year. You have to be able to stick it out those years when the market/investments is down 20% so you are around when it is up 30%. On top of that, while housing prices in Vegas may drop further, I think 10 years from now you will have seen appreciation of at least 4% on average in your home. If you bought today at 250k and can sell it in 10 years at 325k, you will have made 5% return on average per year. While that exceeds the historical norm for real estate for yearly return, I think we will see some significant bump-ups in coming years as the masses get more comfortable that the economy has stabilized. So that investment should pay off nicely on its own. Look at it this way, would you rather make 75k on your downpayment or 75k on a 250k investment (by paying it off now/early).
I added dividends but did not added interest deduction into the simulation. My point is that the appreciation of the property in 17 years surpasses the below-inflation gains of the stock market in the same period of time BY FAR.
Charlieboy:
Again, you seem to be taking liberty with the numbers in your simulations. If you pay off your 5.5% mortgage it isn’t a gaurenteed 5.5% return on your investment. YOu have to shave off at least 1% and more like 1.5% return due to the homeowners interest deduction you get. The real interest you are paying on your mortgage is less than the stated loan interest amount. So if you add in dividends to the market returns and you “take out” the interest deduction you can see that it is about a wash for a 17-year market period, even what that market period included two market crashes.
Ned, couch potato portfolios? Can you give me a link of the portfolio you are considering? I would like to look at it. Thanks!
NedMills,
If you go back to my trading simulation page, which I created after purchasing historic data and running my simulation engine, I updated it yesterday (again, and I’ll keep researching the issue) with a chart showing historical house prices. I think you *might* find the answer to your question if you read that page again:
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
My first issue is that I believe that only by luck one can achieve a LONG-TERM return of 9.9%. My simulation shows that the odds are against us. The so-called experts have failed us.
I invest in the stock market too. I contribute 5% to my 401(K), and I too am at the mercy of a fiscally-irresponsible government and the stock market. The only people making money in the long run in my retirement account are the over-paid fund managers.
We keep forgetting this fact: THE STOCK MARKET WILL CRASH AGAIN. Back in 1929, it took the US economy 15 years to fully recover and thousands of families were homeless after losing so much in the stock market.
We are in the process of getting Obaminized…
Ned, 1) you can’t count on a 10% return going forward. It is pretty easy to put together a portfolio with an impressive return looking back but it doesn’t tell you much about the future. I would be highly suspicious of any advice that implies you can replicate past returns in the future. It is an argument that has intuitive appeal but no basis in reality. 2) 25% in precious metals and 25% in cash are much higher allocations than is recommended. The cash will sit and lose value to inflation over time. Precious metals are high now and likely to decline when the world economy improves. 3) you should look at your investments, your mortgage and your house as a portfolio and decide how much risk you want to assume. Higher expected returns are associated with higher risk except for the risk of non-diversification which yields more risk without higher expected returns. You won’t get the chance of 10% returns without a lot of risk but you want the chance to participate in some possible appreciation of financial assets and precious metals. My opinion is that it is good to be putting money into both your mortgage and financial assets with the allocation dependent on your comfort with risk. If you are looking for solid, conservative general investment advice, besides this site, I suggest Bogleheads.org.
What a lively discussion! I am a self-employed entertainer in Las Vegas, and with the sagging economy here, i haven’t found anyone here who has the financial position of being able to pay off their mortgage early.
I am buying my first home (late starter- I’m 45 and happily divorced), and have no other debts.
What I haven’t heard from this blog after reading most of the posts is regarding “couch potato” portfolios– those with built-in diversification. The “Permanent Portfolio” is one of these types that invests 1/4 stocks, 1/4 bonds, 1/4 precious metals, and 1/4 cash/money market. They boast a long-term yield of 9.9%, and claim they even had a 2% yield when the market crashed last year. There are other variations of thus type of portfolio, and economist Harry Browne (God rest his soul) wrote a book on how to create your own “couch potato” portfolio.
Here’s my question to everyone: if my mortgage is 5% and I can put together a portfolio averaging 9-10%, wouldn’t it be more prudent in my case to just make the minimum mortgage payments and maximize my 401k into this type of portfolio?
Thanks, everyone for a great discussion!
Here’s my question to everyone: if mortgage
CORRECT, dividends make a huge difference, so here’s my updated post with dividends paid every 12 months into the account at 2.5% of the market value:
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
Also, I didn’t choose a time period. I used all the historic data available for SPY, which happens to be the last 17 years.
you have to factor in dividends. Most of us invest with dividends in mind. If not, you are more of a speculator than an investor. The SPY has yielded an average of 2.5% over that time period. Add that alone to the and compounded to your total principal by reinvesting dividends and your annual return would be very close to 5.5%. So you end up matching your mortgage “investment rate” during a very poor 15-year time for the market two crashes)- probably the worst 15-year period in history outside of 1939. So not such a good argument for mortgage payoff versus invest. Actually it bolsters the invest perspective. The NASD was once 5,200 and the Dow was 14,500. Look where they are now and you still would have eeked out 5+% per year on average. The next 15 years are likely to be slightly better or maybe much better – back toward the historical norm of 8% annual return for stocks. As you like to say “The market will crash”. Well we have had two crashes the last 15 years and overall the market has still returned positive returns.
And I am not even considering if you invested in a “boring” low-risk stock like VZ. It is about where it traded in 1995 – but with a whopping 6.6% dividend. Granted it wasn’t paying that in 1995, but it has always paid a healthy dividend. Average around 5% over that period. PLUS, if you bought in 1995, you could have sold in the 60s. But even if you didn’t you would still have slight appreciation today in the stock price (it was about 25 in early 1995) and have taken in major returns in dividends.
Without a doubt, investing extra money on your current mortgage seems to be the best path. I’ve run the numbers again:
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
I think the numbers speak for themselves!
OK, TIME TO GO FROM SUBJECTIVE VIEWS TO NUMBER CRUNCHING:
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
Hi Art! I’m 22 years old as well! Just kidding! But, I think you said it all when you asked if you should “take a chance”. I know that the housing prices are low, but, they will be plenty low for a long time, so, you don’t really need to jump on it right now. Think about getting in when, and if, this current economy gets some legs. Just as CharlieBoy indicates, you could be better off building your financial buffer. Lay-offs are still happening (albeit quietly) based on the current data. This week alone, 1/3 of one of our divisions was let go. The stock market may not be diving, but, it sure is not going up. It is just putting down railroad tracks. It’s going to go, but, you might want to want to wait and find out which way. Be patient, get that cash reserve, then wait in the weeds for your opportunity. It’s win win for you. Try to resist the urge to do something that ties up all your money (and gives it to the banks) when you may need it the most. Take care.
Art, do you have enough emergency money to cover maintenance and vacancy problems? If you don’t, you should build a substantial buffer to protect yourself against those issues before considering what your next step should be. One bad tenant can leave thousands of damages behind as we well know by now. After that, I would probably NOT rent. I would save enough for a decent down payment and buy something that I can comfortably pay.
And I’m also 22 years old 🙂
I have a question.. I dont know what I should do.
I currently own a condo in chicago that is being rented out
I owe 69,000 left originally got it for 100,000 in 2008
it was foreclosed so I fixed it up and rented it out. Now my question is I currently live onbase in the airforce and will be getting bah (base housing pay), which is 825. Most people go on rent but I rather take advantage of that extra money to pay into mortgage on a new place instead of paying someone else. I was wondering if I should just go on rent and hold a current mortgage or take the chance and go ahead and get another place. Also will be using a va loan which is zero down payment currently approved for 5%
mortgage on condo in Chicago is 492 and association is 170, also taxes are 2200 a year currently rented out for 725 a month.
CharlieBoy: I too pay at least 20% down on each property. Lucky for you that you have a credit union that gives mortages – not many do. That 7% rate (plus 9000+ closing costs) from GMAC was two years ago. Since then, I wiped out a Wells Fargo 30 year at 7.625 preferring the 2.5% equity line from Citizens. Before the rates get too shocking, I hope to find some water-loving retirees looking for the perfect retirement home, and that sale (inshallah) would be my ideal answer to rising rates. Need a place with a mooring, CharlieBoy? I can give you owner financing at 6.8% No points, no closing costs to speak of! and Thanks for the comment re: investing so much personal cash in the rental property that they never have a chance to be breakeven or profitable. That is sage advice. I am too prone add value each year so I feel justified in raising rates.– it is only fair, I am giving them more each year. But maybe I shouldn’t — I will think about that.
After calculating some historic averages, I have decided that the normal mortgage interest rate is 9.1%. So, what we are experiencing now is totally temporary.
http://www.freddiemac.com/pmms/pmms30.htm
lil chores,
Some broker wanted to lock you in at 7%? Shop around! When I was looking at buying a rental property, I realized that my interest rate was going to be just a little higher with a great FICO score and with 20% down through my credit union. (I wouldn’t want to buy anything with less than 20% down anyway.)
Without 20% down, my credit union wouldn’t even consider it though.
You already own the properties, so they are going to look at how much equity you have to determine your terms. I would shop online! If they are currently rented, that should help too.
I believe in planning for the worst. And we can have an idea of what the worst is by looking at historical mortgage rates:
* In the early 70’s, mortgage rate annual averages ranged from about 7% to 11%.
* In the 80’s, from about 10% to almost 14%. The lowest annual average for the entire DECADE was 10.19% in 1986.
As inflation becomes a greater threat under the out-of-control government, we could see mortgage rates go back to their normal high rates for many years to come. Who knows, but I would NOT take the risk with ANY kind of variable rate. I wouldn’t even care if it’s 0%. The risk is too high.
It wasn’t until the 90’s that mortgage rates ranged from about 7% to about 10%.
On my mortgage company’s home page, they are showing today’s rate for a 15-year fixed at 4.375%.
@lilchores – what is the published rate that is used to calculate your ARM rates and what is the rate you pay above/below the published rate? Just curious…LIBOR???
Also, didn’t mean that you should leave your properties in poor condition, but to avoid expensive, unnecessary renovations. For the the highest end vacation properties, furniture can be changed out annually, flooring can change every few years, and appliances and electronics need to be updated continuously. A multi-million dollar home certainly needs a lot of upkeep to continue to draw an affluent crowd.
However, for most people that have vacation properties in good but not great locations, a very close eye on costs is necessary. Otherwise, they simply become cash flow pits and leaves all of the return potential to capital appreciation.
@cbc – the estate tax issue you mention can largely be mitigated or eliminated by doing the right estate planning up front. I forget the stats on Sam Walton’s estate, but the net tax rate was only a fraction of what lawmakers and the IRS wanted. When the Walton estate won in court, they did so because they followed the law. Any decent estate planning attorney can seriously reduce or eliminate estate taxes.
Some of the common tools are (1) A/B or Credit Shelter Trusts, (2) Family Limited Partnerships and LLCs, (3) Charitable Trusts, (4) Gifting, (5) Generation Skipping Trusts, (6) Irrevocable Life Insurance Trusts, (7) Private Foundations, and the list goes on and on.
By the way, is that whole life you speak of owned by an ILIT? If your primary goal is creating a legacy, might be something worth looking into sooner than later.
I don’t know all the answers, Rita, and I only got ONE repsonse. As you well know, there is not just ONE opinion on this board. Some good folks think they will die in their current (possibly paid off) home, but others may think that — like most americans– they might move every seven years…
First, there is not better rate of return than paying off your mortgage. Period. You can slice and dice numbers and rates of returns, talk about opportunity cost (term borrowed from economics 101), investments in IRAs and all the rest but none, repeat none has a better rate of return than paying off your mortgage just as soon as possible. Rates of returns on all investments will eventually be taxed. Perhaps some munis are not taxed at the Federal Level, but most, if not all, are taxed at the State level. In one way or another. Then let us talk about all that wealth that you have accumulated and pass on to your heirs and they get whacked with estate taxes. No, I am not a financial salesman making my living off of creating false hope and dreams. I am an advocate of living debt free. Period. Get Whole life when you can afford it, and create your own bank. Borrow from yourself when you must and pay yourself back. With a little bit of financial planning you can rid yourself of the parasites that would rob you of your and your descendants of a debt free life. I know my words will create a hodgepodge of erudite responses and that is fine, I believe in free speech. I do know what I am talking about. I am living debt free, building a legacy for generations to come without the burden of paying someone else to penetrate the fog and smokescreen that has been created over the past 75+ years to the benefit of the few to the detriment of the many.
If you already knew all the answers, why did you ask for everyone’s opinion?
Michael Harr, thanks for the thoughts. I will start sweating when rates get back up to 8%, and when that happens, the rates will threaten to croak the economy AGAIN, right? A refi costs truckloads in points, fees, and is often a false value. I could tell you about the absurd GMAC refi a broker tried to sell me — locking me in at 7% with re fees of $9000 or more. Then the rates dropped to zero. A 30 year note when you intend to own less than 5, are you sure? And really what vacation home would YOU want to stay in if the penny-pinching owner did not fix it up every year? A crummy, rundown home has almost no value in the vacation market. These are not being fixes up for personal use, they are a business, and they have to be great and beautiful to win the business against other homes. I am not talking about ‘niceities’ for selling the home, I am talking about ‘niceities’ for making the home so good, they pay their own mortgage and bills because people love to stay there. —But you did say something I thought was good and that was “don’t get bogged down with just the properties you have on hand. By the time you’re ready to retire, you might decide you want a different property. Every day, there are millions of properties for sale…no need to get fixated on any one of them today.” The best 1% of those millions of properties are always going to be out of my price range, and the lower 99% aren’t that hot and need lots of work.
From everything that I read, I agree with Michael completely. Interest rates are low now, but an article form last week advised that this is about to become history. Anybody dealing with variable interest rates should lock a fixed rate today.
@lilchores – your rentals are a very risky proposition as they are financed with variable rate mortgages. We have historically low interest rates and you can expect mortgage rates to climb once the economy is on solid footing (one to two years out). You should try to refi to a fixed mortgage sooner than later.
As for fixing them up into potential vacation homes for your personal use, you should work on getting the financing squared away first, and any money that you put into the properties should come from your cash flow. Ultimately, I’m not a big fan of putting big bucks into renovations or updates unless they become necessary. The reason for this is that investments into ‘niceties’ usually don’t pay well.
Think of it this way: if you manage your properties well and have them paid off by the time you retire, you’ll have enough money to do all of the upgrading you want to the property you want. Also, don’t get bogged down with just the properties you have on hand. By the time you’re ready to retire, you might decide you want a different property. Every day, there are millions of properties for sale…no need to get fixated on any one of them today.
Seriously…get the mortgages worked out. You’ve got a ticking time bomb on your hands.
Mike,
I like your plan. Remember these 3 facts:
1) Paying off your mortgage is an investment WITH ZERO RISK.
2) The stock market WILL CRASH.
3) It took us 15 years to fully recover from the Great Depression.
Jiffipop,
Unfortunately, I am behind with my retirement schedule. I contribute 5% to my 401(K) at work and my employer matches it at 100%, which means 10%. Otherwise, I have almost nothing else.
See, I finally made the final decision that paying off my house by the age of 50 (5 years) is my highest priority after I studied what happened in the Great Depression when the US economy totally collapsed and it took us 15 years to fully recover. I have already read some articles suggesting that we will face the same crisis again, and this time it will be even worse due to our unpayable debt. The federal government is 100% irresponsible.
Goggle the word “Hooverville” to see what happened to people who lost their homes during the Great Depression.
Once my house is paid off, I will invest that money into my retirement, 100%. For now, my 401(K) is all I can afford.
I also save some money into my long-term emergency funds each month.
I have a $2,000 short-term emergency fund in savings. Then I have $10,000 in CDs for long-term emergencies, such as job loss.
Now I am saving a little each month (up to $400) into a trading account where I invest in commodities. That could be used for an extended emergency situation, if (or when) a second great depression hits us or if it takes me longer than usual to find a new job if I lose mine.
Once my house is paid off, what I now spend on it will be totally invested into my retirement.
What is your opinion about paying down mtg on a rental home? Over the last decade, instead of selling, I spent $$ transitioning my old home into quality vacation rental with rental income covering most costs. (Did this a few times.) For now, have very low mortgage rates arms (at 2.8-4%) and equity lines, (2.5% -4%) When rates were 8% on the equity lines, it was a bit scary / taxes are very high. My current home is very large, (need space for office, storage) but may be too big to be the “keeper.” Might scale down and choose a smaller waterfront home, but keeping options open in case the RE market ever comes back. See, not clear which is “home” that i’d be paying off…
What is your opinion about paying down mtg on a rental home? Over the last decade, instead of selling my own home(s), I spent $$ to make it/ them into beautiful vacation rentals with rental income covering most costs. I’d be doing ok were it not for the fact I continue upgrading them, which is expensive. These homes have very low mortgage rates FOR NOW (3 arms: 2.8%, 4%,3.5%) and 5 equity lines, (2.5% to 4%) When rates were 8% on the equity lines, it was a bit scary. Since I do not know, at this time, which will be my forever home in retirement 10 or so years from now, (for now I need a really large space for office, storage, home) so do you think I should try to pay them all down? Should I just pay down the ‘keepers.’ Can’t bring myself to sell a special place in this depressed market if the situation isn’t desperate…
@Mike – that was a really nice comment and a very well thought out decision. As a piece of trivia, what you’re doing is essentially following Dave Ramsey’s advice on debt and investing. He advocates everyone be 100% debt free and then to invest 100% into stocks.
If you ask someone if a 55 year old should be invested in all stocks, you’ll generally get a reaction of ‘are you nucking futs?’.
The fact is that if you have zero debt and your home is paid in full, you can afford to take more risk. For you it’s through your investment portfolio. For others, it’s starting a new career. It’s different for each person, but being without a mortgage carries a great number of benefits.
Last note, while I appreciate anyone that takes the time to work with their investments, it’s still a good idea to try to reduce the risk in your portfolio. When you begin retirement, you will be systematically withdrawing money (at least annually) to live off of. Just as dollar cost averaging INTO the market is good, systematically withdrawing FROM it is a bad thing when it comes to managing volatility.
The piece that I put together for a retiree using monte carlo analysis is case in point for managing risk.
As you get older, returns take a back seat to risks and the longevity of your nest egg will depend more on managing risks than returns.
Regardless, good decision, and I’m glad to hear your bets paid off since the bottom.
Charlieboy:
You talk fanatically about paying off your mortgage, being a slave to the banks, etc. etc. You say you will pay off your mortgage in 5 years when you are 50.
I am also 45. But what overwhelms me is not my mortgage payment but how much money in assets you need to retire. So What I don’t get it this: Say I need 75k in income per year to retire in a decent manner. IF I pay off my mortgage (1k per month), I still have to generate 63k per year. The mortgage is really a very minor part of the total expenses I will need to cover. You seem like the type of person that if you had the cash available you would have paid off your mortage by now. So the question is, how do you expect to retire so early? Where will the income come from? You must already have several million saved up, but why then don’t you just pay off your mortgage now? And if you don’t, how the heck will you retire so early?
Lately I have been contemplating paying off my mortgage. Over the past few months I have been flip flopping on this idea. I finally decided to do some reading on the web and found this thread. After reading all 251 posts today that were done over the past year I can say this has been a great resource with some very intelligent posts. I must thank those who have contributed as it has allowed me to make my decision and be confident in doing so. While reading all the posts it certainly brought up many points I never thought about.
I will be turning 40 this year, have 10 years left on my 15 year mortgage and have a goal of retiring at 50. Eliminating the mortgage tomorrow will require just under 30% of my non-retirement cash/investments. After paying it off I will still have enough money to cover more than 5 years of living expenses. (more than enough to keep investing). My investing style has always been rather aggressive and as I get older I know I should get a little more conservative. I currently don’t own CD’s, bonds or anything a normal person would consider conservative, its mostly stocks, ETF’s, commodities and a few international mutual funds. Therefore my rationale in paying of the mortgage is that this will be considered the conservative part of my portfolio similar to buying a bond paying 5.5% but with even less risk. This allows me to keep my aggressive approach to investing since the paid-off house will balance it to be a little more conservative overall.
Based on previous comments I think most would agree this is the prudent decision in my situation. However, many others talk about paying down a mortgage with only 6 months of an emergency fund. In my opinion I think this situation is one that is much more on the fence, at least for anyone comfortable with risk in their portfolio. Having the majority of your net worth in a house may make it more difficult to fund your retirement. However, having a small portion of your net worth (about 25% in my case, including retirement assets) in a fully paid off home I feel is smart diversification. But then again I am an aggressive investor where huge swings in my portfolio don’t bother me. I was down huge in 2008 but due to a little research and lot of luck, my net worth is currently at an all-time high. Someone who is much more conservative and would be putting their money in a CD or bond may be making the correct decision by paying off the mortgage with little additional money left over.
In the end as many have said, I agree that there is no correct answer for everyone. It think it’s a combination of where you are financially as well as your risk level that needs to determine what each person should do.
Thanks again for everyone’s insightful posts.
I agree with CharlieBoy on all these basics and have attempted to practice them throughout my life (I am old, 51). I also agree in trying to stay in shape so that one can enjoy the fruits of one’s labors. I also agree that one has to enjoy things as they go along. There are cheap ways to do lots of things and have fun, too. I think what I have found out, though, despite of my trips and boating adventures is, that it’s really your friends and your family (if you are lucky) that are where most of the fun comes from. Whether you travel to visit them, or they go with you on your adventures, it comes down to the fun of being with my people. One more thing to add to Charlieboy’s 3)….don’t ever lease a car, either. Another giant rip-off. I usually own a car for at least 10 years, sometimes more. I take whatever value I can wring out of them before they start to cost me more money than they are worth. Also, used car insurance is much cheaper, too. And, not to pick on Charlieboy again, but, nice fake picture! HAHAHAHA!
Fausto, that’s what I’ve been preaching here but the crowd that believes in spending yesterday what you earn today doesn’t seem to get it. Perhaps the same happened back in 1929. We do NOT learn from history.
>>1) Leave within you means (I said it before)
That’s a religion for me. I call it leaving below my means. I pay myself first, which means saving, not burning it on a car payment.
>>2) Stay out of Debts at ANY cost.
Unfortunately, our culture has been conditioned to believe that it is ok to live in debt. People actually believe that there is good debt. lol.
>>3) Don’t buy new cars as they are a huge drain of money.
http://articles.moneycentral.msn.com/SavingandDebt/SaveonaCar/TheRealReasonYoureBroke.aspx
Just some points that could make a difference between surviving (make a living) or increase your peace of mind and wealth. They are based on my personal experience.
Warning: Some of the points below will requires courage, patience and alot of COMMOM SENSE.
1) Leave within you means (I said it before)
I only buy what I can pay for now.
2) Stay out of Debts at ANY cost. (if you follow tip 1 that will be possible).
Our system is set-up for us to fail and be in debts.
It is NOT OK.
3) Don’t buy new cars as they are a huge drain of money.
I take good care of two cars a 1998 and a 2002 both paid off long time ago.
4) Don’t be greedy.
When I sold my Townhome in Florida in 2006, everybody told me I was stupid not the sell for more money. I paid 125k and sold for 300K, for me was an awesome profit and didn’s see the need to be too greedy. Withing 4 months after the sale of the house, that property went down and is now selling for 128k.
5) With the profit from the sale of my Townhouse in Florida, I moved to NC and purchased a large family home for 305K. At closing the lawyers/ RE Agent asked me how much I was going to put down on the new house, I said 230 CASH!! (They tought I was crazy) so I got 75k loan and a plan to pay it off within 4 year. Now I’m in year 4 and the balance will be paid off on shedule by Christmas (no more mortgage).
6) Buy in the Mutual funds and Index funds expecially in a Roth IRA.Or in an investment you REALLY understand.
When everybody was running away from stocks in 2008 I decide to get in and buy as much as i can. It was hard and i was called stupid again…..well now I made some money on that.
Final toughts ……..
Use you brain and your common sense, do the opposite of what everybody does, do the MATH and be realistic.
I heard people saying that is perfect to keep a 300k mortgage because they can get a tax deduction at the end of the year…..or other absurdity like getting loans interest only so they can invest the rest and get a better return….and many more.
Do you want move forward in life and give a shot to be one of those 3% of American having a good financial life or do like anybody else wasting money left and right?
This is just my opinion, but hope it could help.
John, yes, we either buy or rent. The option is to buy less house than they let you buy so you can pay it off quickly. That’s what I did. I spent $200,000 less than the bank was willing to let me buy, and I have abstained from trading cars and eating out since I bought this house so I can focus on my mortgage. The average American spends $8,000 on car payments each year. Get on a mortgage calculator and see what that would mean if they kept the same car and put those $8,000 towards their mortgage principal. It’s crazy!!!
Gosh, I guess I’m a slave to reality.
Since I don’t want to be homeless and getting a free ride in terms of housing is not realistic, I have to rent a place to live or buy a place to live, i.e. either way I have no choice but to earn and spend money.
Is there another option to get out this slavery?
I don’t have a silver spoon and don’t play the lottery or gamble, except small poker games at times and sports pools like MARCH MADNESS BASKETBALL POOLS on occasion, such as the tournamet coming up OH YEAH–sorry getting off point again from the topic of invest or paying off mortgage– but please give me the secret to avoid being trapped in reality or do I still have to keep enjoying all aspects of my life like I am.
Yes, life started almost 46 years ago in my case, but I in the battle to survive each day at work, praying we won’t all be obamanized (taxed) to death.
I can’t go all out and start splurging too much while keeping a substantial mortgage payment. Everything in moderation. There is no true freedom while one is in debt.
But I do a little of both. I mean, you probably picture me sending every penny to my mortgage company while living a miserable existence waiting for that sacred day when I send my last payment. No, that’s why I have a serious budget. I actually have a vacation savings. So I would not go into debt or pay minimum on my mortgage to go on vacation. As a matter of fact, I have just submitted a $192.50 to my vacation savings account. My next destination is Brazil next year, where I will be spending 3 incredible weeks. Incredible, doing nothing but visiting places and having those exotic Caipirinha drinks.
The celebration cruise, which may include me taking up to 3 months off from work doing nothing, will be after I pay off my house.
I am a willing slave to my mortgage company because it is my BIGGEST expense. I can just imagine how much money I could be investing if I didn’t have to send them a big check every month. 🙁 They are not stealing my money with a gun, I realize that, and it is a tool for home ownership, but it feels like slavery. Mortgage is a debt, and debt is slavery. I’ve just paid over $600 in interest to them minutes ago. That is sad, and that must end AS SOON AS POSSIBLE AND NOT A DAY LATER.
Oh, ACE, you are so hilarious and RIGHT. I agree that a mortgage is a tool. It’s taxes and our stupid medical system that is ripping us off. Why isn’t everybody complaining about this? My handyman (no health insurance) popped into a hospital because he was feeling a little funny. Gee, he smokes 2 packs of cigarettes a day and at 57 feels a little funny? So South Shore Hospital hooked him up for a stress test, an ultra sound and get this TWO MRIs, stuck him in a hospital bed for a day or two, refilled his blood pressure prescription (which they overdosed him by accident that same visit) and released him with nothing wrong with him. TEN THOUSAND DOLLARS was the bill. I pay this guy $20/hour and I know he doesn’t pay any income tax. Talk about ripoffs!
You look much much younger than you are, you dumbbell-swinging fox.
I however still vehemently disagree with you. Especially when you say “I will be booking a celebration cruise with my wife and two kids. Life will then begin.”
Life’s already begun a long time ago. It’s use it or lose it. There are no rollover minutes. Do you have any dreams? Start living them now.
Also, you’re not a slave to anybody. A mortgage is simply an optional tool that allows you to buy a house you otherwise would never be able to afford. There is no invisible enemy out there trying to steal your lunch.
>>CharlieBoy: You’re young
Ah, I forgot to say thanks. I am 45 and 46 is just around the corner. I have not allowed this desk job to take control of my well being. After spending some 27 years or so behind desks all day, I could be dragging my feet, looking and feeling like something else; however, paying my mortgage off is not my only passion. I take care of myself with decent nutrition and exercises. And that’s the reason I expect to spend years fishing. 🙂
I will be turning 46 this April. Here’s a photo of this middle-aged man (me) taken last summer in my basement:
http://www.flickr.com/photos/[email protected]/4369794063/
>>CharlieBoy: You’re young, but what if you die on the day you send your last mortgage payment?
My dream is to die debt free. Regardless, I am hoping to finish my mortgage in 5 years, when I turn 50. So you are asking “WHAT IF” I die at 50? Well, look at statistics and tell me what the odds are. I mean, accidents can happen, but statistics tell me I will likely to live to be 80. Look at the explosive world population and consider that the average person lives to be old and spend years in retirement. In my specific case, considering my health level (10% body fat at 45, fanatical nutrition, exercising 5 days a week for the past 23 years), I am thinking I will live to be 80. But I don’t spend my life worrying about when I am going to die and WHAT IF this, WHAT IF that. Well, IF my uncle had paddles and a handlebar he would be a bike?. Wait… I forgot how the saying goes…
If I die on the day I pay off my mortgage, I will leave a nice (it’s almost brand new) house for my kids.
I don’t dream about the day I never have to work again. I simply dream of the day I no longer have to be a slave to a mortgage company. The CEO of my mortgage company makes $900,000 a year BEFORE bonuses. It’s sickening, and I am part of the problem. I get up at 4 AM to come to work for him. Something is wrong with that picture, I am sorry so many people who have been conditioned to accept a life of debt fail to see it.
Also, Ace, this may sound like a surprise to you; however, I have been to Japan, Peru, Ecuador, Guatemala, Brazil, Argentina and England. Peru was the most exotic with the best food to me. In Ecuador, I visited the middle of the world spot with a line showing where the middle of the world is. The average temperature in Ecuador is always something like 72 F. Ah, I also went to Russia. My job sent me to some great places. Like I said above, it’s a great job but I feel the stress of not knowing what will happen to this company or industry tomorrow, so retirement would be a dream in that sense. Retirement is about doing what you want and when you want it, as opposed to sitting around doing nothing.
The day I pay off my mortgage, I will be booking a celebration cruise with my wife and two kids. Life will then begin.
Today I will be submitting a mortgage payment that has a little over two times the principal. Next month, I will be submitting two separate payments so I can also have a buffer if something happens to my job. So today I will actually be paying my mortgage payment that is due on MARCH 01, 2011. So, if I lose my job in this economy, I would have that much time before having to spend a penny on mortgage. The average person would fail.
Well, Ace. Surprise. I must have been to Europe twenty-five times since I was 23. It was just as good at 55, in many ways better, than in my 20’s. Lots of things, mental and physical, are actually better now. You should take that into consideration.
CharlieBoy: You’re young, but what if you die on the day you send your last mortgage payment? Would you look back on your deathbed and say that paying off your mortgage furiously was the best thing you did in your life?
If not, delay paying off your house until you’re 60, and have fun with the extra cash.
People dream about that elusive finish line, where they never have to work again, and then fulfill all their dreams. THERE IS NO FINISH LINE. And if there is, once people get there, their “loved ones” put them in a home and salivate over the gold pot. Of course, no one thinks they are “that guy.”
Live everyday as if it were your last.
What amazes me is to see people with comments like, “I love my job, I never want to retire.”
Well, I love my job too; however, as I look out the window and see the beautiful mountains out in the distance while I am here working to make somebody else rich, I realize that I would retire TODAY if I could and then truly live life. For me, retirement will be like being born again. It’s the fact that one can do whatever one wants. Every day will be a weekend for me, wow. I think Monday morning would be a good day to go fishing instead of coming to work EVEN THOUGH I LOVE MY JOB. But it’s just that, a great job, and there is no FREEDOM in the corporate world!
Ace, no, I won’t be on MTV’s spring break. lol. But every day will be like spring break after I retire.
And I am NOT even ahead of schedule for my retirement. I am already 45, and my house should be paid off when I am 50. It’s not like I am 30 with a house paid off.
CharlieBoy:
– What I am suggesting is: live richly and savor.
– Those dreams can be funded by the extra money people send in to pay off mortgage faster. They save on interest but leave a lot on the table: life.
– I assume you will also enjoy spring break at 70. I’ll see you on MTV.
Charlie Boy:
I was addressing Fausto’s comment and your response to Fausto.
>>”You may have a million or three, you may have retired 8-10 years ealier than most, but you’ve missed out on life.”
I don’t know what you are suggesting. Misses out how? By having a giant mortgage for 30 years?
>>Remember those grand dreams about sailing and traveling to Europe?
Those dreams become a NIGHTMARE when they are funded by debt.
And you are wrong, I would enjoy it at 70 the same way I would enjoy it at 20. No doubt!!! My dad is 70, I know.
I’ll have a little, as long as I can pay for it without debt.
I shake my head in amazement at the penny-pinching crowd who condemn consumerism and motgages and debt and brag about how little they spend, how their home is paid for and how they are going to retire a few years earlier, and with more money than most.
This would be pure genius if you can meet one condition: you will be young forever.
Otherwise, there is little fun in accumulating wealth so you can retire at 55. Because guess what? You may have a million or three, you may have retired 8-10 years ealier than most, but you’ve missed out on life.
Remember those grand dreams about sailing and traveling to Europe? You cannot in good conscience say you’ll enjoy them like you would at 25-30.
Stop killing yourself just to pay off a 30 year mortgage in 15.
Last I checked, you still can’t take it with you. So hey, live a little. Life is a journey, not a destination.
>>What percentage of people in the US really have the financial capability to buy a pre-built building or home for cash? Very few!
That’s fine!! The issue is whether we should use our extra money to paid it off as quickly as possible or risk the extra money in the stock market. Yes, RISK.
The only thing we know without a shadow of doubt is this,
THE STOCK MARKET WILL CRASH.
In many countries, people build their office structures and homes over time as they have the money to work on the project so when the structure is finished and capable of being worked out of/lived in, it is also paid for. As a result, in those countries, you often find many structures/houses in varying stages of completion.
In the United States, I would estimate that at least 95% of building structures/homes being purchased are already built. Thus, to make that purchase, the buyers have to pay the seller/builder for the cost to build plus appreciation/profit/ that has built into the price over time since the building started and was completed including the real value of the structure, i.e, the land/location.
What percentage of people in the US really have the financial capability to buy a pre-built building or home for cash? Very few!
Therefore, borrowing to buy in the US is a necessity, and not a method that should either be condemned or patted on the back for either.
Also, in the US, do we want to be in an enviroment of partially constructed structures? I doubt it, its not our culture. We value the appearance of a neighborhood, we value curb appeal.
Its all simply a difference in culture that needs to be acknowledged, there’s no reason to be so negative about the US culture or, alternatively, to overrate another country’s culture.
Fausto, you are correct!
My parents in South America are retired. My dad had only 3rd grade and was a bus driver for most of his hard, poor life. We were always poor; HOWEVER, he has NEVER had a mortgage. The house he lives is paid for, and so is his rental house and another house they built by saving for years. 3 houses, never a mortgage and little income.
BUT, IN THE CULTURE OF DEBT, WE STILL WONDER IF THAT’S A GOOD IDEA.
Let me bring a different prospective on this topic.
The way we debate and questioning if we should pay off the mortgage or invest is viewed with such clarity in other parts of the world that is not even a question.
I can tell you from data showing and personal experience that the wast majority of people in countries like Italy, France and other parts of Europe their priamry goal is to have;
1) Live withing their means
2) Stash away cash in safer ways (Emergency funds, etc.)
3) PAY OFF THE MORTGAGE.
Yes, In Italy for example 56% of home owner actually OWN the house and don’t have a mortgage, in spite of the lousy Italian economy and high unemployment.
We in the USA are high risk takers, we all want get rich and take big chances to increase our profits all the time. We think we are all (most of) experts traders and like the excitements of the game.
A little risk is fine…but why don’t We get what we know is FOR SURE which is to Get ready of Debts FIRST?
One more stats, the average Italian family of 4 leave with a monthly income which is almost $2000 x month….but somehow they manage to be in very little debt.
>>I understand you want to be prepared for every possible scenario.
I want to be prepared for the next crash. One of the things we know is that the market WILL crash. One needs to be prepared for an extended recession, like the one that started in 1929 and ended in 1935. Having debt is a big risk. I can add water to my beans, but paying a big mortgage during a big recession is, as we know well, a huge problem. Look at how many people have lost their homes in this recession.
>>for you, that means no debt and no use of banks
I use it normally, keeping my savings and checking account. In fact, I currently have 4 savings accounts for different purposes. And I don’t carry cash, I use my debit card. I don’t use credit cards.
>>I guess you have just gold bars and money in mattresses?
Gold has a history of volatility and it is overpriced. I have about $1,600 in GLD, but no actual gold in my house. I don’t want to take the risk of being robbed, so no gold coins or bars. I will invest in gold with caution, and not get carried away. Where to invest long-term emergency money is an issue at the moment for me. Perhaps some energy, we’ll see…
It’s pathetic that we can think that any debt is “good” debt. That is insane.
Well I hope you have more than a few guns. Seriously, the scenarios you paint are so dire financial planning has little meaning. And also seriously, the level of civil unrest it will create will make it likely that only the richest (bankers? – haha) will be able to protect their land. A piece of paper showing “title” will be laughed at.
@Charlieboy
haha if that happens..and im sure it will. i will excersise the 2nd amendment to defend my land.
Charlieboy:
I understand you want to be prepared for every possible scenario. for you, that means no debt and no use of banks (for savings) I guess. I guess you have just gold bars and money in mattresses? If the banks start calling my mortgage invalid and hike the rate significantly overnight AND the banks fail and my money is not backstopped by the fed, well I am not sure it will even matter to own one’s home. It will likely be confiscated by the mob of mobs of homeless.
So happy my question has given so much opportunity for comment besides getting feedback about my situation.
Well, if you lose your job, wouldn’t it be easier to survice without a mortgage payment? Unless your mortgage payment is very, very low. In my case, and for the average homeowner, my mortgage payment is by far my biggest expense! I could survive on water, rice and beans, but my house payment would kill me.
Have you heard of Hoovervilles? They were slums where thousands of Americans were forced to live in during the great depression because they lost their homes when they could no longer make their monthly payments once the economy collapsed and they lost their jobs. The great depression lasted 5 years.
We are assuming that hyper inflation would benefit our mortgages with fixed rates; however, do we trust legislators? Are we underestimating the level of corruption in our government? Wouldn’t they side with the bankers and enable them to make adjustments for inflation accordingly? That’s what happened in Brazil in the 80’s when inflation reached triple digits. As long as we keep a mortgage, we are at the mercy of law makers and their supporters (bankers), which is a very scary thought. Having a mortgage is slavery, and that is what keeps me awake these days.
So you may have enough money in your savings to pay off your house. What would happened to that money if the banks failed overnight?
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
Michael: I plan on living in the area for 10 more years until the kids go to college, then seek a lower cost of living area to retire, buying the house outright with the gains I have in this house. If things go well with other investments I may keep this house and rent it out for retirement income. Even with the mortgage payment I would clear over 1k per month in rental income. I will not be buying a larger house.
Although I have the savings to pay of the mortgage right now I will not for two main reasons. First, if the economy continue to deteriorate, which I think it will, the current value of my house is more likely to decrease than increase. Progressively there will be less and less people willing to be able to pay that amount and demand will erode. Therefore, at very best I get a 5% return on that lump (185k) of money assuming the house value stays flat and I am getting a negative investment on that lump of money if the value slides, which I expect it yo somewhat. Second, inflation is soon to come upon us. My loan interest rate, however, is fixed at 5%. It will not go up. that is good. When inflation kicks in I believe I can get a better return investing in such things as commodities. But moreso, I don’t want to be house-poor when inflation kicks in. When it is 5-7 dollars for a loaf of bread, it doesn’t do you much good to have 600k locked into your house and your savings significantly reduced. Houses can’t pay bills and buy food. If I pay off my mortgage right now I am left with 50k in savings, only about 8 months of living expenses for a family of 4 where I live (Arlington VA). Granted I can build it up the cash quicker with no payment, but for all the doomsayes out there, what if the economy gets real bad and I lose my job. Then I am stuck. Then I am possibly forced to sell my house since I would bet approved to take equity out of it when I am out of work. So clearly the best route I think in my circumstance is to pay additional monthly payments and work to pay off the mortgage early (15 years is our target, I will be 60) and continue to put other money into IRAs and savings accounts. The duel approach. I am not choosing to not pay if off for the tax benefit. I agree than it makes no sense to spend a dollar to save a quarter. Hope that helps
Rita from Michigan, thanks for the reality check. I mean, even though I have enough emergency money to last months, the fact is that the Great Depression lasted YEARS.
We currently have people all over the country living in tent cities and the mobile home parks are overflowing. The foreclosures are monumental and the number of people who possess underwater mortgages is wild. I think the reason it is not so real is that it is one of those “quiet” activities. People don’t tell everyone that they are getting foreclosed on, they just quietly pack their bags and leave (these houses are easily spotted at night when the lights of the inhabited houses are on and the lights of the repos are off). People don’t tell people that they are underwater on their mortgage because they would have to admit they made a bad investment. Here is a true life example: I have a neighbor who makes a lot of money and we live in a nice area. They are underwater on their house, their boat, their cottage and their condo in Florida. They just sold the condo in Florida and are now taking a loan on their 401K (because they cannot get another loan with their current assets since they are all over-leveraged) to pay the difference between the sale price and the original loan. Basically, their net worth is in the negative range. No-one knows, of course, since they look wealthy with all their assets and have an gross income in the $400K range. It is very quiet out there folks. Too quiet. I think, in the very near future, we are going to see people who can afford to pay their underwater mortgages, but, decide they don’t want to, walk away, which will cause another wave of foreclosures. This is happening in commercial real estate right now. I am not trying to be doom and gloom here, but, their is a stark reality out there that those of us with some cash saved and a roof over our heads may not be aware of because it is not happening to us, though, It’s happening to many others right in front of us.
Consider the Great Depression. All industries got crushed, the stock market crashed, all financial systems failed. Think about what happened to families who had emergency money to last them several months and, after they ran out of emergency money, realized they still didn’t have a job, no food and no way to keep their homes. Consider how they had to live:
http://progressives.typepad.com/photos/uncategorized/seattle_hooverville.jpg
@jiffypop – when do you plan on cashing in on your gains? Would you be willing to move to a lower cost of living area in order to realize your profits? I’m curious because many in your situation are unwilling to downsize and I’d like to collect at least some anecdotal evidence that downsizing never really happens unless it’s the last resort.
Also, I think what Ken was trying to forward was the analogy of a home mortgage pay down being similar to investing in a bond in that a 5% mortgage rate could be equated to investing in a bond with a coupon rate of 5%. It’s not perfectly analogous as you point out, but I think that was the gist.
At any rate, I’ve enjoyed this discussion a great deal, and it’s interesting to hear various views and experiences on this subject.
@ALL – What will be even better is creating a software solution that can put together these many viewpoints. I think most of us agree that prior to paying off a mortgage, one would need to at least have other debts paid in full, have sufficient cash reserves, and be on track for retirement (either before or after the mortgage payoff), among other things.
My question to readers is what other possible criteria would you want to base this decision on? Is there a minimum/maximum payoff date – e.g. it must be paid off within 10 years or it’s not worth it. I firmly believe that a decision engine can be built to answer this question if the right inputs are created and the calculations are built around risk preferences and within the context of one’s overall financial situation.
I figure, why talk when we can build, right?
there has been alot of discussion on houses as investments in recent posts and being slaves to lenders. I bought my house in 1997 for 222k and it is assessed now for 620k with no significant improvements over that period. Thanks to the “masters” I was able to take 10k initial downpayment which has been transformed into nearly 400k in profit. This was also an investment that I never had to loose sleep over or watch day to day fluctuations of the markets, read quarterly reports, etc. I still think the interest I have paid is well worth the return on a very low-maintenance investment. I see no reason to rush to pay off my mortgage and the system worked very well for me and the lender.
That’s why I pointed out the risks that may exist and the virtues of diversification. The “expected” risk of housing was low for decades, but you never know. Even “risk free” assets can tank, given the right circumstances, such as many bonds did for periods. If you don’t diversify, you are much more likely to suffer devastating effects if the long shot circumstances occur. You are taking on “uncompensated” risk if you don’t diversify — that is, additional risk just because you have too many eggs in one basket, even it is a brick and mortar basket.
So, even if you do a thorough analysis (as you should), you still can’t analyze the risk of non-diversification away. You have the additional risk of a faulty analysis if you only have one investment analysis in you portfolio — you want to minimize that risk by having a “spot on” analysis of other investments which comes with diversification.
In regards to comment 211, I disagree that a house is a low-risk invetment by nature. Tell that to those who bought in 2005-2007. In 3-5 years their low-risk investment may be down 30% or more and in 10-years MAY be back even. The person who posed the question did not say how much equity, how stable the housing is in his area, etc. It needs to be evaluated like every other invetment. If he is underwater on the house then it may or may not make sense to throw good money after bad.
@Robin Jareaux – it is annoying that property taxes exist, but I’m happy to pay them as they generally go towards paying for social goods like education, parks, etc.
Along these lines, a good next step after paying off your mortgage would be to set aside enough funds to endow your tax and insurance payments. This amount is usually between 25 and 33 times your annual total of payments for taxes and insurance. This equates to a 3% or 4% withdrawal rate that has been shown to be in the ballpark of never reducing principle and adjusting for inflation.
As an example, if your taxes and insurance are $1,000 annually, between $25,000 and $33,000 should be enough to pay for these expenses in perpetuity while continuing to account for inflation.
@CharlieBoy – on the much quoted line from the Bible about the borrower being slave to the lender, while I am generally in favor of paying off a mortgage early, this particular quote doesn’t sit well with me. In our financial system, we are all borrowers, lenders, or both. Based on this passage, that would make us slaves, masters, or both. Capitalism’s success is in large part attributable to the system of money flowing from lender-savers to borrower-spenders and vice versa.
It wasn’t until a group of merchants in Venice went to the early bankers in the ghetto that credit really started to flow. This is where the market for debt began and subsequent to that, capital markets were born with issuance of shares of stock in companies (think Dutch East India Company as an early example).
When we deposit money in a bank, we are effectively giving the bank the ability to lend it out at a rate of interest. When we purchase a bond, we are financing the debt of a company or government. When we buy newly issued stock, we are financing the operations of a business.
What this means is that if you condemn the use of credit, you are also condemning the ownership of these assets which make owners the ‘masters’ of the ‘slaves’ (borrowers).
While it can be a superior position to be a lender-saver compared to a borrower-spender, if debt is being used to create more economic opportunities that have a greater return than the cost of financing, I have no qualms. The problem in the area of mortgages is that residential housing has limited growth potential and is better considered an expense rather than an investment.
To more clearly answer your original question that popped in my CrackBerry, the reason people would be willing to be slave to the lender is if the expected returns were greater than the cost of financing.
Where we got into a lot of trouble is that many were financing ventures (housing) that offered no real chance of outpacing the cost of financing (particularly on adjustable rate mortgages). Generally speaking, housing prices can only appreciate as quickly as the cost of financing and the rise in real wages allows.
Granted, housing markets are generally a local as opposed to national phenomenon, but on average, it’s difficult to expect housing prices to rise at rates equivalent to equities as housing is constrained by interest rates and wages and stocks are not.
By the way, from what I’ve read on your blog, I like the plan. For anyone that can payoff their mortgage inside of 5 years, it’s a virtual no brainer barring any strange circumstances.
Well, I started commenting here (again) but decided that I was just rewriting what I wrote here:
http://solidpersonalfinance.wordpress.com/2010/02/10/pay-off-mortgage-or-invest/
Having no mortgage payment might feel a little better than having one, but so much of my mortgage payment is escrowed real estate taxes and escrowed insurance. Even after you pay off the balance, you have these really hefty, mortgage-sized payments that used to be attached to your mortgage. Seems like getting rid of your phone bill and instead having a big cable bill.
@JR5280 – You should take the windfall and payoff the mortgage. There are many reasons for this, and while Ken makes some good points, the fact that you will be investing your monthly principal and interest payments adds a wrinkle to the analysis.
Here are some facts:
1. Stocks are expensive right now (p/e10 is north of 20 and 16 is long-term average)
2. Bonds have ended a bull run that started in the 1980s (interest rates are near rock bottom and bonds will get crushed when rates go up)
3. Real estate is just nearing fair value (sales are still soft and a great deal of inventory is available which means we haven’t reach equilibrium yet)
4. Commodities markets are too volatile to represent a large share of your long portfolio (some people love gold, some love oil, but only a fool invests heavily in either)
In short, the financial markets don’t have a lot of great values available (unlike 2009 where values were easy to find). As a result, if you invest in a lump sum today, you’ll be buying stocks high, bonds high, real estate a little high, and commodities should be limited.
The other option allows you to be debt free which reduces overall risk exposure (I would wager that for all but the wealthy few, the risk of holding a lot of bonds – i.e. paying off a mortgage – is offset by the reduction in risk by being house payment free).
Given your circumstances, it would be just as well to payoff the mortgage today and invest systematically into choppy markets. A large lump sum investment makes little to no sense at this point.
Of course, there is the third option which is to do a little of both – accelerate the pay down of your mortgage and invest the rest over time. As Ken said, it will depend on your risk preferences.
Bottom Line: Do NOT invest it all today. Payoff the mortgage today OR accelerate your mortgage pay down and invest the rest over time.
Paying off your mortgage is part of the asset allocation that you have to make for your investments. It is similar to a bond with the return being the interest that you don’t pay. Probably one of the first things that any good financial adviser will try to determine is your risk tolerance. Those with a lower risk tolerance are usually directed into more bonds.
How good you will feel if you pay off your mortgage is like how good you will feel with low risk investments. However, you should be diversified to some extent no matter what.
So, the decision has to be made in the context of your entire portfolio of investments. If you have a ton of risky investments, then it is clearer that you should have some low risk investments of a different sort and paying off your mortgage is one of them. If you have nothing else or only low risk investments, you should put some of your money into riskier investments that differ from your house.
This is because, without diversification, you assume some risks that you shouldn’t, for example:
1. real estate completely tanks
2. the tax breaks for home ownership change
3. something happens to your house, neighborhood, or region (e.g. flood or very high unemployment)
4. Your title is bad
5. you miss out completely if riskier investments do great.
You want to balance your risk with trying to get a better return. If you want zero risk, then pay off your mortgage and you can compute your return. If you want some chance for a higher return, put some money into other things as well.
I have read most of the comments but I think my situation is a little different. I recently received an unexpected cash windfall. It is enough to pay off my mortgage and have some left over. I believe my financial situation is in excellent condition-no long term debt, adequate savings and retirement plans and a 6-9 month emergency fund.
I am seeking advice and viewpoints on (1)paying off the mortgage now and investing an equivalent of the monthly P&I or (2)investing the payoff amount now. What is the best choice for maximizing my returns in 5 years-the time when my mortgage is due to be paid off?
I didn’t read each and every comment due to time constraints, but one comment I did see over and over essentially was “why give up the interest deduction?”. Everybody’s circumstances are different, but in my case, my itemized deductions (including mortgage interest) are only slightly higher than the standard deduction. So in my case the argument for the mortgage interest deduction isn’t really valid.
I like the freedom that having very little debt affords me. Several of you have commented regarding the peace of mind which owning your house outright brings – that is very valuable to me. I have played with all the numbers and scenarios, and in the end I prefer to pay off mortgages early. I still contribute to my retirement plan according to how the market is doing – I’m a contrarian, so when the market is up I do not invest as much, but when it is down I maximize my contributions. But I also throw extra money at my mortgage each month.
I also believe that God designed us to be happiest when we are productive and contributing to the greater good, so I don’t really ever plan to “retire”. I plan to always do something to generate some level of income, whether that be working for someone else or being self-employed.
Thanks for the feedback.
Paying down your mortgage principal faster requires delayed gratification, which is something that is beyond the average person. To the person who lives for today, he or she typically wants to feel that high today, so an extra dollar earned means he/she can spend that much more in order to get a high today. Paying down your mortgage, is basically delaying gratification by several years. In my case, I won’t see the real benefit until I either sell my house OR finish paying it off and, suddenly, find that I have an extra $1,640 each month to do what I want. That is gratification worth waiting for.
Also, paying off your mortgage is investment that has ZERO RISK, unlike any other type of investment that MIGHT yield higher returns. Headlines suggested that investors lost a decade of investments in the stock market. So, even though you can get higher returns, compare the risks. If you send an extra $100 towards your principal this month, you are that richer by $100. You are not wasting $100.
John, Michael and CharlieBoy are right. Run the numbers and make your decision with data. Data rules. Just make sure you weigh the price of freedom vs. slavery. Good luck and let us know what you decide so we can either congratulate you or berate you endlessly! 🙂
Take care,
Rita
@John – the easiest way to see what the actual impact is on your taxes is to do them online using TurboTax, FreeTaxUSA, or something similar. On these sites, you can create your returns for free and don’t have to pay until you go to file them. I would suggest going through what your taxes look like without a mortgage first (don’t forget to enter the real estate taxes). After that, write down your ‘taxes due’.
Next, add the mortgage interest at 5.5% and write down your ‘taxes due’. Run it a third time using the 4.5% and record the ‘taxes due’.
Finally, compare the tax difference to the amount you’re paying in interest. This is a good exercise and it will tell you exactly how much tax benefit/pain exists. Plus, once you calculate your net, you can better see what your life looks like under each scenario: debt free, current, and refi.
Last note. Going from a 30 year to a 15 year note is well and good, but you must take greater care to have sufficient cash reserves. The difference in cost between the 15 and 30 year must compensate for the risk added to your cash flow. This is a decision that you’ll have to work out for yourself, but knowing exactly how much each course of action will cost will help.
Thanks for the analysis Rita and I’ll look at the taxes CharlieBoy.
I agree with Rita from Michigan. You need to know how much actual money your interest deduction translates to. To do that, do your taxes without including your mortgage interest and see what the total is. Then add your mortgage interest and see what the actual difference is. Most people don’t realize that they are getting pennies on the dollar, and that is why interest is slavery.
The bottom line is, INTEREST is SLAVERY.
John, don’t worry about losing the tax deduction. Check out how much you really get back on that deduction in cold hard cash. You will never get back that $20K savings. Go for the new mortgage. And, by the way, you don’t have to get a 15-year mortgage. You can re-mortgage for 14, 13, 12 years, whatever fits your current payment or situation. It is only the interest breakpoint that occurs at 15 years.
CharlieBoy: Do you have any further thoughts with my clarification?
Let me clarify, over time I believe I would save about 20K in interest with a 4.25% interest rather than keeping 5.5% and paying an extra $500 each month towards principal, but by refinancing to 4.25, I will not have paid the additional 20k in interest and therefore, cannot deduct what I don’t pay from my taxes over that period of time.
So my question is paying the $20K over time and getting to deduct it over time the better or worse choice?
>>”I would pay about $20K more in interest that can be written off”
WRONG. It can not be written off. Your mortgage interest is a deduction. By written off, you make it sound like it’s free. No such thing.
I owe 231k on my house on a 5.5% 30 year fixed, I’m paying principal and interst plus $500 more each month towards principal so I’m effectively paying 4.5% on a 15 year fixed.
I think I can get a 15 year fixed for 4.25% with no points, fees, costs or other out of pocket expenses–straight refinance. This would be about $1750 a month, where with my extra monthly payment I pay about $1964 a month. Over 15 years, presently, I would pay about $20K more in interest that can be written off, but i would lose that annual write off by refinancing to the 15 years. I could even add $200 to the 15 year payment as well to reduce the length of th loan further.
Any thoughts on if its better to keep the higher interest rate for tax write off purposes or take a lower write-off by reducing the interest being paid?
@C – CharlieBoy’s reaction is correct. However, your job security is something that you have to take care in assessing. Since you’re contributing to a SIMPLE IRA, it would appear that you work for a small employer. If this is the case, it’s important to try to understand your employer’s business (diversified revenue streams or not, how well has management done in growing the business, etc.). If it looks like your employer is on solid footing AND your particular job function is going to be an important part of the plans going forward, by all means, pay off your mortgage.
Beyond paying off the mortgage, you may want to consider putting a retirement plan together using Fidelity’s MyPlan or something similar. If you’re retiring after age 59 1/2, you may want to start supplementing your retirement savings by using a tax-deferred variable annuity (the low cost variety with M&E less than 0.75%). If you’re going to retire before 59 1/2, would like to keep your additional savings liquid, or simply hate the idea of paying added expenses to an annuity provider, start dollar cost averaging into a balanced portfolio of ETFs or index mutual funds (lower turnover = less taxation).
One note for those following this discussion, there aren’t many values in the traditional market (cash, stocks, bonds) this year. Stocks are above their average historical valuations, bonds are at the end of a multi-decade run going back to the days of stagflation, and cash equivalents continue to be less than appealing. A balanced portfolio using shorter maturity bonds along with a healthy dose of foreign (bonds and stocks) is probably the most prudent approach. Last year was a helluvalot easier to find value whereas this year is something of a crapshoot.
Oh, one last note for C. You should toss $5k into I Savings Bonds as soon as you can. They’re yielding better than savings or money market accounts and of course, have the highest credit quality. They’re illiquid for one year (barring a natural disaster) and carry a penalty for redemption within 5 years (last 3 months of interest), but they’re very well suited for someone with your stout emergency fund….even after paying off the mortgage. Current yield is 3.36% through the end of April.
Without a shadow of a doubt, PAY IT OFF.
Have really learned a lot reading some of your replies. I think I know the answer to my question but I’m looking for a little verification. About 4 years ago my job situation became a little iffy and I began saving as much cash as I could in case something happened. In short, I know it’s stupid but I now have about $110,000 sitting in a savings account earning only about 1.5%.. Yeah, real stupid. I have about $45,000 left on my mortgage at 5.9% and paying it off would save me about $14,000 in interest over the next 7 years. I don’t have a whole lot of other deductions so I only realized about $200 in tax savings because of the interest I paid last year. I am 45 years old and have just recently started maxing out my Roth & Simple IRA contributions and my employment outlook has gotten better the last year or so. It’s a no brainer right, pay it off?
Good for you! The tough part is finding a place to park it where it is liquid but won’t burn away. I am not wondering whether I should pay off my mortgage now because I seek financial freedom or peace of mind. I feel I have those.
But I am uncomfortable having 235k sitting at ING direct making only 1.15%. I know that isn’t good long term. The question is how do I make that work best when not sold on the stock market? I really do think we are heading into a double-dip recession. I get the gaurenteed 5% idea if I pay off the mortgage, but that feels like less financial freedom to me because I am tying so much money up in an illiquid asset and then I could actually be more dependent on the bank (e.g., if I soon lose my job, medical catastrophe, etc.).
So that is why I came here and I thank all the board for their input. I think It is best FOR ME to not totally pay off my mortgage but take a dual approach of extra payments. If I just add 300 dollars in principle to my monthly payment it reduces my 30 years term to about 18 years. Not too shabby. Then I will continue with 401k and monthy additions to taxable savings accounts, looking for places I can find higher returns for the large savings I have.
Well, I agree completely that some people shouldn’t have bought houses. It’s more than just some people; it’s more like millions of people. People who live from paycheck to paycheck, being always one month away from catastrophe, are playing with fire. But, then, I am not surprised when our government teaches only horrible lessons to the people and caters to the financially irresponsible. Six months of living expenses is not enough. I am aiming for two years.
Again, paying off one’s mortgage is laudable. I am not against it. But my house is worth 600k, I live in the most stable housing market in America (arlington VA) and I owe less than 200k. There is really NO chance my mortgage will be called in under any scenario. And I feel bad for the person who lost their house in May and is now going to lose their house. However, nobody should lose their house after 8 months of unemployment. that is poor finacial planning. The problem is people buy houses who shouldn’t. You shouldn’t buy your house unless you can put at least 20% down AND still have 6-12 months worth of savings left over AND your mortgage payment is no more than 30% of your net income. At 5%, my P&I each month ($1,000) is 13% of my household net income. If everyone would start there – then there would be little to fear and one’s mortgage would not feel like an albatross around the neck. I am tired of all the blame going to predatory lenders. Take control of your financial like. Live within your means!
>>”they will attempt to save themselves first even if it requires feeding off of your rotting carcass”
Amen! In times of economic uncertainty, who wants to gamble.
The banks can call in the loans under circumstances that are spelled out in your mortgage contract. One of them is the acceleration clause. For instance, if the value of the collateral (your house) falls below a certain ratio, the acceleration clause makes the loan immediately payable. There are many different conditions in the acceleration clause. The best way to understand your risk is to read your mortgage contract. It’s all about the money, so, work real hard to save yourself by paying off your mortgage. Don’t bank on the bank somehow needing you. That is not in the contract. If they start going down or your housing value goes too far down, they will attempt to save themselves first even if it requires feeding off of your rotting carcass.
I’ve just finished reading a book called ‘How I Became A Millionaire Bushman.’ The author defines financial freedom as one’s ability to survive a couple of years without a penny in employment income. I tend to agree with him. If you know that you can get laid off tomorrow and survive an unusually long unemployment period, you are financially independent. Others define financial independence as the ability to survive without employment, living off one’s own business or investments. But would a business owner survive a couple of years without his business for some reason?
Like I said before (many posts ago), I know a person who lost her job in May and is about to lose her house, which is only 6 years away from getting paid off. She never thought she would someday be unemployment for so many months. She did not have enough emergency funds to cover her mortgage for so many months.
Really, you don’t want me to say what I really think in regards to the way the conversation is going here. So instead, I was being nice and helping the guy out (so he doesn’t look like an idiot in future conversations – at least, grammatically anyways). 😉
Nickel is right!!!!! Let’s stick to the subject at hand, should we pay down our mortgages or invest? I like to think that I do both by contributing 5% to my 401(K) with 100% match from my employer. The extra money is used to double on my mortgage payment for over a year now. 5 years of slavery to go! The next 5 years will feel like an eternity.
>>a lot is two words, not one.
Correct, and you should have started that sentence with an uppercase A.
>>There is alot of fear of banks on this board and what they could do to you or me.
Just keep us as their slaves, no big deal.
Seriously? Correcting the grammar of people who’ve taken the time to share their insights here?
a lot is two words, not one.
“There is no word in our language that is spelled ALOT. If you cannot remember whether to use A LOT or ALOT, just remember that you would never use this spelling ALITTLE to mean a small quantity. So, if that seemed complicated, what I’m trying to say is that you should NOT use ALOT, spelled without a space; always use A LOT, spelled with a space.”
One more thing. There is alot of fear of banks on this board and what they could do to you or me. But remember, they NEED you and me. The don’t produce a widget or sell a tangible item. They only exist to make money – and that occurs by chargin you more to borrom money than they get from the fed. When they charge me 5% they are making 4% for just being a middle man. The LAST thing they want to do it call in mortgages. Taking back principal is a loser for them. The interest is their life-blood. When I recently refinanced, I took the attitude that THEY NEED me, which is the truth. If they call in all mortgages, they would effectively destroy themselves. It is no different that people not being about to afford their payments. I have a great track record of paying my bills, great credit score, lots of assets and my guess is alot of you on this board are responsible as well. Remember, they need people like you and me.
CharlieBoy: I think you are oversimplifying. If we are to the point where banks are “calling in mortgages” on even those who have substantially more equity in their house than they owe – well such is a scenario that would be unprecedented in history and these discussions are pretty mute. Civily, all heck would be breaking loose.
What people seem to forget is I can never owe more that 185k on my house. So if I have 200+k in low interested bearing vehicles it doesn’t really matter what inflation does in that regard. I have a 5% fixed rate so at any time in the future I could pay it off. It doesn’t matter if inflation goes up to 15% (alhtough won’t the CDs and other yields also rise and the value of my house also go up?). Right now if I lose my job I have 4-5 years of living expenses set aside, without tapping retirement funds, for a family of 4 AND then if I had to I could sell the house, realize a 400k profit, and then live another 6-8 years on that in a rental. And my guess is my wife or I could get some supplemental incomes as well if needed to extend that money. These are absolutely worse cases (out of work for 8-10 years?). That should be peace of mind! What the cash also gives me is IF I lose my job I don’t need to, say for instance, take out a loan to go back to school and retool. If all my cash is in my house, where am I gonna get a loan for school when I am unemployed? The bank won’t give it to me. That flexibility to me is priceless. I respect paying off the mortgage and will slowly work in that direction, but I value the flexibility moreso I guess. Remember, I am continuing to put money in savings each month, so in several years that 235k should be 300k. Maybe then I will pay it off – or branch out into more risky assets. But I would never advise someone to basically empty their bank accounts to pay off their house unless they were absolutely sure they would be saving a bunch month to month.
It amazes me that some people trust that their liquid assets will retain their value in case they need to pay off their mortgages if they are faces with an overextended job loss. If you had been investing in the S&P 500 in the past decades, as opposed to paying down your mortgage, you would have nothing to show for today.
I agree, the peace of mind is priceless. I put $’s into my 401K to save while paying off the mortgage, too. If you work toward paying off your mortgage in advance, your housing risk reduces year over year. This buffers you against job loss, etc. I became so caught up with paying off my mortgage that in the final couple of years, I did drop all savings and threw money at the problem to kill it off. But, that was temporary and I was at risk of losing my job in the automotive business and wanted to make sure we wouldn’t lose our house if that happened. However, I think there is another wave of recession coming in before the grand finale. During this portion of the program, I believe more people are going to be walking away from these up-side-down mortgages (even people who could afford them). And, I think the banks will react (and may already be quietly doing this) by calling in loans on the people who have money available. This is a risk of a mortgage that no-one talks about. That the loan can be called at any time. A mortgage against a property of someone who has a good amount of savings could be at risk these days, particularly if their savings is not protected in a 401K.
Poster # 177. You may have peace of mind having more liquid assets than the mortgage of your balance, but you are the exception. The average mortgage holder is in the opposite situation. Look at the record-breaking number of foreclosures and the problem is clear. A mortgage is a debt, and that mortgage payment will be due if something happens to our jobs tomorrow. What will happen to your conservative assets IF the dollar truly collapses. What investment will survive a mega inflation similar to the inflation rates in Brazil in the 80’s? We are talking up to 900%. Nobody knows what will happen to our debt our investments, but I assure you that it is probably better NOT to have a mortgage. The Federal Reserve doubled the supply of money last year. That bill will come due at some point. Will your conservative funds survive the collapse of the US dollar? That is uncertain, and we can only speculate. Meanwhile, I want to get rid of my mortgage ASAP.
Peace of mind is knowing that no mortgage company can take your home from you.
I have peace of mind. Anyone who has more liquid assets in very conservative vehicles than they owe on their mortgage should have peace of mind. What is their to fear? My interest rate will never go up on the mortgage. My cash will not evaporate in bad investments. It will take a hit with inflation, but the house payment will not rise with inflation either.
I see the issue of whether to pay down the mortage or invest/save as more for someone who just bought a house and have maybe saved about 3 months for an emergency fund. It gets much more complicated when you have hundreds of thousands in cash. Do I really want 600k tied up in my house?
PEACE OF MIND HAS NO PRICE!
I agree with the idea that you can’t assume your investments will outpace your mortgage interest. The 225k I have in investments/cash was once 350k not too long ago. That still doesn’t want to make me through the majority into paying off my mortgage though. I like the freedom of having it in CD’s. I have my IRAs and new 401k contributions in stock and bond mutual fund. So here is my “potfolio”:
1. 185k mortgage on an assessed 627k house. Mortgage is at 5%, recently refinanced.
2. No other debt
3. 200k in retirement ports invested in mutual funds.
4. Continue to max out retirment contributions.
5. 225k in fixed income (ING direct savings/CDs).
So I feel relatively finacial freedom. I also have a 250k HELOC out on my house for any major emergency. It currently has no balance on it.
One way of looking at it also is I have owned the house for 13 years. I bought at 222k, so it has pretty much tripled in value in that time. It has returned about 15% each year. Granted, those days are over – that is why I am now considering paying down the mortgage.
I think I agree with Vinjay in the duel approach. I do feel alot of financial freedom having 225k in cash/investments, even with a 185k mortgage. Besides, my house is worth over 600k so I already have over 400k in equity. To pay off the rest of it leaves me with alot of my networth in the house and little “freedon” until I restock my other assets.
A simple way to look at this is if you are paying 5% on your mortgage, you will need to earn 5% in investments to break even (all things being equal wrt to taxes). Now you have to weigh additional risks/rewards with investments vs a secure rate of return of 5% on your mortgage savings. To counter the secure rate of return, you have ready access to cash if invested in stocks/bonds. My approach is to max out savings, emergency, college funds and then split the remaining amount between extra payment s to mortgage and investment.
I have struggled with this issue mightily. I am 45 with 2 kids and married. I max on 401k and have 225k in cash and a 185k mortgage. Very tempted to just pay off the hourse. What I struggle with is you can’t live off equity in your house. If we wanted to retire here we will still need to build non-house assets in a big way. Our mortgage is at 5% so seems like the smart thing is to invest the 225k in market index type medium to low risk assets. I don’t want to be forced to take a 10% interest homeloan down the road because an emergency forces me to tap into that home equity.
Well, let me see. Let’s look at the past 10 years and the S&P 500. Forget the, “well, if I had invested in gold, blah, blah” scenario because I am leaving luck out of real life. If you had stopped paying down your mortgage 10 years ago, and invested every extra cent in the S&P 500, today you would have next to NOTHING to show and would have paid a FORTUNE on interest in your mortgage.
OK – ACE, you DO have some sense to ya (more so than most 30 year olds!)…sorry I doubted ya, but that article you posted had some of the worst financial advice I’ve ever seen! (Was more like a pro-consumerism ad disguised as really bad “advice”) I agree with your most recent post – in fact, I’ve also opted for debt when I was earning more in investments (like taking a city loan for the new AC system b/c I was earning more on investments at the time. like you said, Why not take advantage of a situation like that?)
But I seriously doubt most people’s ability to make competent decisions when it comes to money – and I certainly would not advise anyone to borrow against their house (or even prepay the mortgage) if they have any have CC debt, car loans, or do not have an ample emergency fund. Very few adults are truly in a situation where they can make the prepay vs invest decision. And for those of us who are…well like Ken says, everyone’s situation is different, and everyone has a different tolerance for risk. And some people’s risk tolerance varies across different aspects of their lives (my retirement accounts are 90% equities and got a great return in the last year). I personally would not borrow a $100 or $200 grand (“take out a big, long mortgage”) against my house and risk losing the house my husband, kids, and I live in if something were to happen. Maybe if I were a single gal, I would take on more risk outside of my retirement accounts – but I’ve got too many people depending on me (oh the burdens of being the breadwinner…).
oh – and when taking advantage of the “zero percent interest” deals – make sure to ask if there is a discount for paying cash up front. Many times there is (which they won’t advertise) – which means that “zero percent” is not really zero because you are foregoing the discount you’d get if you paid cash. I’ve only had one instance where the discount was not large enough to offset the earnings I could get – so I took the zero percent loan and let the cash earn a little extra until the loan was due. All other times, we were better off paying cash for the discount.
sorry for the long posts! Thanks for the “chat” and Have a great New Year!
Paying off your mortgage is like buying a risk-free asset. One way to evaluate its imputed return is against another type of risk-free asset, such as a Treasury bill. That is pretty straightforward. Owning a lot of risk-free assets fits some people. A paid off mortgage also provides a lot savings discipline an undeniable psychological benefit.
However, if you are willing to take on some additional risk, you can expect to get additional returns. You can also get some additional diversification if you do this, so that, if your house depreciates, for instance, maybe your oil stocks will be appreciating. This diversification actually reduces the risk of a home (actually it is your entire portfolio of assets that will be less risky). People may think that the value of their house is unimportant since they are only living in it, but there are risks such as a toxic chemical site being found near it, the neighborhood becoming undesirable, or having to move to be near a hospital or family member that might make the dollar value of the house important. If all of your eggs are in one basket, these would be catastrophic events.
The bottom line is that everybody has different risk tolerances, but some amount of diversification is healthy. It is possible to be very frugal and responsible, but to own a variety of assets. Personally, I would like to pay off my house as soon as I can, but I would also like to participate through securities when the global economy starts growing again.
I see you’re adamant about paying off the mortgage and consider debt a necessary evil. I view debt merely as a tool which, if used correctly, can yield good things.
If I invest my money instead of putting it toward my mortgage, why would I end up a Walmart greeter?
That’s the logic this Floridian fails to understand (yes, I’m from FL too).
And I agree with you on almost everything else. I bought my car cash 10 years ago and still drive it today. I was 20 back then.
I bought furniture recently using a line of credit that was extended to me, zero interest if paid off within 12 months. I did that and incurred zero interest instead of plunking down the cash upfront because, why not?
You’re more qualified than I am to speak in financial matters so I respect your opinion. But theoretically the only time people are better off paying off their mortgage instead of investing the money is if they aren’t disciplined and end up spending the money on guns, needles, and 11-year old hookers.
wow – that’s scary. This article appeals to the typical American’s need for immediate gratifaction – ignoring all logic and sacrificing long-term goals for immediate satisfaction. Which in the end – is why those people will still be working well past normal retirement age (I, on the other hand, am on track to retire a millionaire at 55).
I believe I’ll rely on my own credentials, thank you – degrees in Finance and Accounting (master’s) and a CPA. My own education and analysis has led me to the conclusion that the best way to build long term wealth is to not rely on debt unless you absolutely have to (and in no way, should you take out a loan for a flat screen!). Sure there is some debt that is necessary as you go through life, but you have to have a goal of paying it off. Those who pay off debt faster (or do not incur it in the first place) keep more of their money over the course of their lives.
And even though you probably won’t read it, I’m going to pick apart each “reason”….
#1 – I didn’t buy b/c I thought the home would rise in value. I bought b/c, in the long term, it was much cheaper to buy than to rent my whole life (if I had bought after 2005, I might have come to a different conclusion!) I couldn’t care less about the home’s current value!
#2 – I’m not prepaying to “build equity,” so there goes #2.
#3 – While a mortgage may be the cheapest way to borrow (which is why I advise others to pay off CC, cars, or other high interest debt before prepaying a mortgage), the claim that there is no way to avoid debt in today’s society is a bunch of hooey! It IS possible to live without car loans and student loans – and I am living proof it is possible! I paid for my own college education all by myself – a bachelor’s in Finance, a Master’s in Accounting, AND CPA testing and credential with NO student loans. And borrowing for a flat screen or furniture – that’s just ridiculous!
#4 – makes no sense to pay $10,000 just to claim a $3,500 reduction in your tax bill now does it? Besides, there are other (smarter) ways to reduce your tax liablility to zero. I can show you…
#5 – this is the issue Nickel presented us with – an dthe one I argued earlier.
#6 – fun? are you freakin’ kidding me? you know what will be more fun? NOT having a mortgage at the age of 42 (how old I will be if I keep paying at my current rate, but hey, since my income is still rising, I could very well pay it before I’m 40!)!
#7 – is exactly what I was saying is wrong with people earlier – your house is NOT a bank account!
#8 & 9 – this appeals to Americans’ need for immediate gratification, even though it makes more sense in the long term to make the larger down payment. Calculate the investor’s NET wealth, to include his mortgage liability (which ultimately WILL have to be paid, whether by him or by his estate upon death), and the results are different after 15 years.
#10 – I repeat what I said earlier about the need for an emergency fund before you even contemplate paying off your mortgage.
this article was a joke – but you rely on it if it makes you feel better about your choices. See you when you’re a walmart greeter at 65 😉
I understand that the idea is counter-intuitive, and will generate fierce opposition in the mind of the average person.
Go here to read a well presented argument on this by someone whose credentials – unlike mine – are verifiable.
http://www.ricedelman.com/cs/education/article?articleId=232&titleParam=10+Great+Reasons+to+Carry+a+Big%2C+Long+Mortgage
If you still prefer to pay off your mortgage because of the peace of mind and other intangible benefits, or because you don’t trust yourself to make the right decision, then you definitely should, because you can’t put a price on that.
It is however incorrect to tell _everyone_ that they _should_ pay off their mortgage.
“it’s not a good idea to put your cash where you need someone’s permission to get it out”
See, here is where the notion of ‘financial miseducation’ shines through. People should not view their house as a bank account that they can ‘withdraw’ from. Equity in a house does not equate to spending money OR savings. I broke my brother of this way of thinking several years ago – had I not, he would have been in just as much trouble as many others are now who viewed their house as source of cash.
“Another danger of throwing cash at your house is that when the going gets tough and god forbid you lose your job – like millions of Americans did recently – you can’t get it out.”
Hence the reason we have a sizeable emergency fund (more than the “3 to 6 months” that many recommend).
I assumed that those contemplating a prepayment decision already had the emergency fund set up AND all other debt, including auto, paid off. If not, then prepaying the mortgage isn’t really an option now, is it?
I’ve been following this thread also since I get updates by email everytime someone posts.
One amusing aspect about paying off the mortgage that keeps coming up is the “intangible benefit” of knowing it’s yours.
As if, by not paying off your $300k or $400k mortgage and having that money in the bank – or invested – you’d be oh so poor.
Another danger of throwing cash at your house is that when the going gets tough and god forbid you lose your job – like millions of Americans did recently – you can’t get it out.
An equity loan is a loan against your income, not your house. the bank doesn’t care that you’re a “good person” who sent double payments for 10 years and that you have 75% equity, they only care if you can pay it back.
In most cases today, it’s not a good idea to put your cash where you need someone’s permission to get it out. Hanging on to the notion of “owning your house free and clear” shows financial miseducation.
I like the statement of “security of knowing its 100% yours”.See what happens if you don’t pay your taxes.
I read this many months ago when it was first posted. Coming back to read recent comments is interesting.
Here’s my take on it…I agree Cash is King! The reason this country is in so much trouble is because people have taken on too much debt. I don’t think we should be encouraging anyone to do anything other than pay off debt b/c most people are too stupid to handle debt appropriately (hence Dave Ramsey’s ‘bad math’ approach – he knows most people operate on emotions, rather than brains, and are likely too dumb to understand anything else than his “debt snowball” method).
and to invest rather than prepay a mortgage would also assume that people in general know more than a little something about investing. I can tell you, most people are darn near clueless when it comes to investing! One only has to see what near retirees lost on their retirement portfolios in 2007-2008 for proof of that.
I do know a bit about investing, and I bet most readers here do as well, or they are willing to learn (otherwise they wouldn’t be here!). But even so, we have kind of taken nickel’s stance (the cop out – ha!), but with more weight towards prepaying the mortgage. It’s the stance we’ve taken since we bought the house, and now we owe less than $60K on it – and have oh so much equity that we STILL receive loan offers when others have been complaining they can’t get credit! But we refuse to borrow against the equity in our house. (And as another poster mentioned, home equity is protected here in Florida.)
We have NO debt other than the mortgage. All student loans (each of us has a master’s degree, and additional certifications in our areas of expertise) were paid off within two years of graduation (neither of us had parents with enough money to help pay for our educations – we did it all ourselves), and both cars are paid for. We also max out our retirement plans. We’ll also pay for each of our 3 kids’ college education with cash (although it looks like at least 1 of them will get a full paid scholarship – fingers crossed b/c that would be a nice bonus for us! The other’s too young to tell, but we do our best to teach ’em!). We are also on track to retire as millionaires at 55 – with NO mortgage. (We are in our early 30’s now.) And don’t think we’ve deprived ourselves of all fun in an effort to pay off debt – We eat out, go to movies with family, and take vacations each year (last year was two weeks in Italy – at a 4 star hotel) – all paid for with cash!
And the kicker for most….we’ve done all this on less than $80K combined income/year (oh birdieman what I could do on incomes like you & your fiance! Listen to Michael, he’s pretty smart!) We just started saving when we were in our early 20’s. And we have used our brains (rather than emotions) for all financial decisions (like when the bank told us we could afford a half million $$ house, we didn’t listen to them, we didn’t need a house THAT big!).
Bottom line, yeah there are some who may come out better investing than prepaying a mortgage, but it’s still a gamble. With so many uncertainties in life (especially with kids!), most people would be wiser to free themselves of the burden of debt…and a mortgage, although considered “good debt” by most, is STILL debt!
Birdie man,
I agree with Michael. Max the 401K since you can afford to (particularly if you get a company match, which is free money, at least put in enough to get that) and put every dime you have into that mortgage and do it as fast as you can. You will have so much cash flow after that, you will be able to do the pay-as-you-go option for the kid’s college. If your economic situation collapses for some unforeseen, unpredictable reason, you will be safe and sound. The only other action I would suggest is, if you can do it for free, is refinance the mortgage to something lower than 30 years, like 25, 15 or 10 even. That forces the payment issue. You can pay extra after that, but, overall your interest will be lower, your regular required payments will soon become almost entirely paying against the principal instead of interest, which is much more fun in the beginning. But, that will happen soon enough, even if you don’t refinance. And, remember, even if though it takes time to pay off the mortgage, every extra payment lowers your overall risk and increases your net worth. Calculate your net worth again and again and watch it grow! Most people, which includes many who appear very wealthy, have very little or a negative net worth.
@Birdie man – there is much to consider, but the solution is an easy one. Since the kids are 12 and 5, you have 6 and 13 year time horizons for college, respectively. This isn’t much time to depend on market returns and because of this, putting money into the 529s will either be risky (if equity heavy) or provide little real return (if fixed income/cash heavy). The result is that a 529 plan will provide at best a return that keeps pace with inflation and at worst could blow up.
Retirement saving is different. You have a long time horizon of 15 to 20 years before distributions begin and another 25 to 30 years of withdrawals. Because of the tax preferences given to retirement savings vehicles either through your employers or through an IRA, these contributions should be maxed out. This is a MUST do.
In weighing the pros/cons of the mortgage payoff or adding to the 529s, the returns will be similar, but the risk profiles are considerably different. Paying off the mortgage has a superior risk adjusted return to college, so you should put every dime you have available after maxing out tax-favored retirement contributions towards paying off the mortgage.
With your income numbers, the house should be paid in full by the time the eldest child goes to college. At that point, between the 529 and your newly freed up income, college will be no problem and who knows, if you’re really disciplined, you might just see an early retirement.
Bottom line: Max out the contributions to tax-favored retirement vehicles and payoff the mortgage with every extra dollar available. This should be accomplished in six years or less.
NOTE: If your fiance uses a SEP, it might take closer to seven or eight years to payoff the mortgage because the max contribution is much higher than a 401k/403b/457…$43,750 versus $16,500
My question is whether to place money into prepaying mortgage in big chunks over the next 2 to 3 years or place it into an IRA and/or 529. At this point I’m not going to add another post on taxable income vs. mortgage prepayment. Here’s my situation:
My fiance is self employed and makes about $175,000 / yr. Two kids, 12 and 5. I will have an income of about $100,000 to add to the family income next year.
Her mortgage balance is $250,000 just refinanced last year at 4.75% fixed 30 yrs.
We are both in mid 40’s.
So the question is how best to allocate among Retirement/529/mortgage prepayment. My fiance wants to put about $60,000 to pay off mortgage this year and another $50,000 next year and about $20,000 a year additional towards principal reduction. She currently has about $50,000 in kids’ 529 plans.
We are not saying it has to be all or nothing for any one option. We can certainly redistribute, but how much in what is the question.
Thanks.
We concentrated for many years on paying off our mortgage. And, like a previous commenter, we are feeling secure and non-threatened during this economic crisis. There are other hidden costs to having a mortgage that are difficult to quantify. These include the stress of not owning the roof over your head, the financial stress on your marriage, the lack of financial security (e.g. net worth = assets – debt), to name a few. For me, the non-quantifiable costs are priceless. They are worth far more to me than all the calculated, non-guaranteed returns projected by all the financial analysts, brokers and bankers that want to utilize your money to stay in business. Look at the source of the advice you listen to. I asked a financial advisor at a party about paying off mortgages. She told me that her mortgage was paid off. That was the first thing she did. But, that is not what we hear from them. If you want to coast through life in a debt-free, care-free way, with a roof over you head pretty much guaranteed, get out of debt and build your net worth. I did it and I am loving it! Good luck!!!
you can reach me at [email protected]
It is great that you are thinking about this at such a young age. Time is on your side by starting so young. While having a paid off mortgage has tremendous psychological benefit and provides a saving discipline, diversification of your assets is important. Your very long time horizon allows you to take on the risk of stocks because the volatility of returns over a long term is reduced. Consider the extra amount paid on a mortgage as being similar to purchasing a bond (because you are saving 5-6% interest on whatever the mortgage extra payment). You will want to come up with an investment diversification that gives you an appropriate percentage, considering your age and risk tolerance, of your investments in stocks. You will need the upside potential returns that they offer, otherwise all your eggs will be in one basket, the house. It seems that you can accelerate your mortgage payoff and still have a good start on an investment portfolio that will have the longest term chance to grow, instead of starting from zero on that front.
I am 27 years old, building a new home in Florida. I have the opportunity to buy the home outright. I hear two sides of the debate, but I am curious how anyone considers the individual “age factor.”
I do not see anyone posting their age, though some post being near retirement. I have quite a few years before I retire and opportunites to contribute into an IRA, my employer matched 401k and employer Stock Purchase Program are around every corner.
I need some insight on ways I can smartly invest my earnings, this ‘inheritance’ AND be able to attend school and travel and live comfortably.
Regarding the “Debt is king” idea, this money would be a lump sum. While I would be able to afford my mortgage payments on my base salary I do not intend to ‘blow it’ all recklessly. I also do not see myself being able to afford a mortgage while investing a matching contribution to any LTI vehicle after this money has been disbursed. So I am kinda wary to pay into a mortgage AND additional securities now.
The “Cash is King” philosophy is what was instilled in me from birth. When I saw the opportunity to pay my car off 4 years early I took it, and reduced my insurance coverage to maximize my expendable income whereby allowing me to afford a mortgage. If I am able to pay off a mortgage and buy my home outright I would have a serious influx in expendable money that I could invest as I went, while living a comfortable lifestyle.
These are of course hypothetical scenario’s. I know a lot of this is in the attitudes and behaviors of the individual, but aside from the 38 years of working I have ahead of me, I want more from life than to work just to retire. Any suggestions there? How can I make this money work the best for me now? Pay off the mortgage or reinvest in the soon to be “Bull Market?”
http://bit.ly/6HPOI5 and click ’email me’
Hi, Trout,
If you post some contact info, I will contact you (email, Skype, etc).
Ken and/or Michael — is there a way to reach you one-on-one?
Trout, I agree with Michael — you must include tax on both sides of your calculation to get an accurate result. Otherwise, paying down a 5% mortgage and buying a 5% guaranteed bond should be equivalent.
Also, this decision (aside from the considerable psychological benefits of prepaying a mortgage) should be made in the context of your whole “portfolio” of assets. You want to have a suitable mixture of fixed income and variable income assets that suits your risk tolerance. Paying down a mortgage is like adding more fixed income assets. Right now, finding a risk-free, fixed income investment with 5% return (i.e. prepaying a mortgage) is pretty good, but you still need a diversified mix of investments. This can be missed if you analyze a mortgage in isolation from everything else.
@Trout – if you intend to take the proceeds from the sale of the rental and put it toward the mortgage you’re closing today AND if you also intend to pay off that mortgage in short order after applying the proceeds from the rental, then skip the extra points. The 0.25% you save versus the pre-payment of interest (points) may not be worth the hassle.
HOWEVER, if you plan to take the proceeds of the rental and 1036 (use a professional so you don’t have the IRS knocking at your door with their hand out) it into another property or equal or greater value, then you’ll want to go ahead with the extra points.
ALSO, you should construct a retirement plan to determine whether or not you’re on track. If you’re not, it might be a good idea to set aside some of the proceeds from the sale of the rental so you can max out tax favored retirement plan contributions.
Worst case, you should setup your home to be paid in full by the time you reach retirement, so you should run a few different scenarios to see how it impacts your retirement versus risk profile versus net investment return.
As to your analysis, you must include taxes to make it accurate. I did one for someone entering retirement, but if you run the numbers for someone that is 20 years from retirement, the scenario looks a little different. Ultimately, it comes down to risk preferences for each person. Risk preferring types will max out ‘good’ debt whereas risk neutral people will simply go for the biggest payoff and risk averse (80%+ of us) will prefer to payoff the debt only if the risk premium is deemed acceptable.
Ok..I’ve done some analysis. And outside of some special cases, I cannot see a time when investing instead of paying down a mortgage is beneficial. The special cases would be tax advantaged savings where the rate of return is 2% or better than the mortgage rate. Otherwise it seems that paying down a mortgage more rapidly always results in the best case. Now, I’m not taking itemized mortgage tax deductions into account. But even with mortgage rates at 4-5%, that takes a guaranteed investment return of 6 to 7% just to break even, and to make it worthwhile, one would need 8% or better. That seems fairly risky even over 20-30 years. Paying down a mortgage has NO risk. The key factors in my analysis are:
– investment ROR has to be 2% (after tax)better than the mortgage rate to break even, and therefore nearly 3% before tax
– once the mortgage is paid off, one has the full former mortgage payment to invest, so if you pay down a mortgage in 20 years vs 30, you then have 10 years to invest that extra amount, whereas if you invest a little each month while paying off the mortgage in 30 years, your invesment does grow quite nicely, but not enough to offset the larger amounts of interest paid
– if one could guarantee themselves 3% or better above the mortgage rate, than the investment alternative would look brighter. But even at today’s historically low mortgage rates, that means one’s invesment rate has to be about 8% over the life of the loan to make the invest vs paydown option financially viable. Again, the mortgage accelerated paydown option has no risk. Well.. the only risk is that one needs cash, and they have sunk all that into the mortgage accelerated paydown. But even then, assuming the property has not lost a lot of value, the principle would still be there.
So.. moral to the story..
— buy a properly valued property
— payoff the mortgage as rapidly as possibly while keeping a safety net in cash to sustain 6-12 months
— maximize employee match 401K type investments
I’d still like to hear back on the 2 Qs I posed earlier. I am suppose to close Monday PM. I have taken the 1.281 point buydown to a 4.5% mortgage vs a 0.281 buydown to a 4.75 mortgage. That is very marginal. And based on my own analysis, it sure seems like I’d be better off taking as much as I can spare of the proceeds of the sale of the other home and applying it to my new loan. I will probalby hold onto a bit for cash reserves and a few items I’d like to purchase, but for the most part, none of that will go towards long term investment. The best investment is to payoff that mortgage.
Know I got a better Idea that we should buy a smaller
house which is less then $50k in the same area and we can fix if nedded so we dont have to work so hard to pay off our $79k which we wanted. Since my husband and I got a job,and we will afford to do that so we dont have to warry about the payment or rent when we retire in 5 – 9 years from know.I will appericate to get your comments.
Thanks
I have 2 homes — one being rented, owe 185, value 320, the other value 380 (just appraised), and new loan of 304, 30yr at 4.5 (after 1.281 discount buydown). I’m still scratching my head if I should have paid (rolled the 3k into the loan) the 1 pt to go from 4.75 to 4.5 I have about 330 in stocks, 100 cash pension balance, 25 money market. Right now with the 2 houses I’m paying the actual payment, though when the new loan begins I’ll continue the old payment of 1750.
I plan to try to sell the rental in 1.5 years. 320 is a conservative value, it could sell at that now.
2 Qs…
1) if I could still take the 4.75 (.281 points) rate over the 4.5 (1.281) rate — should I ?
2) if I sell the rental in 1.5 years, should I take all the proceeds and apply it to the other mortgage? or invest some of it?
Age 44
@Eddie – I just posted it to my blog at http://bit.ly/5u3dqI
This isn’t anywhere near what pro-level analysis tools can provide, but it’ll give you some very good information. All you need to do is download it and fill in the highlighted sections on the inputs screen. In addition, you can change inflation rates on a year by year basis. For example, you might put zero growth in the property value for the first couple of years and then have it increase to 4% later. Bottom line is that you can slice and dice this thing from here, but these are the kinds of numbers that I would look at to begin a more detailed analysis.
If you have questions, feel free to contact me through the blog and we can discuss it offline.
Oh, and IF I was in your shoes, I’d move out tomorrow, find the rock bottom cheapest place to live in town, hunker down until I had at least six months’ worth of expenses in cash (preferably twelve), and then look into upgrading my personal digs. Once I had that kind of cash reserves, I’d start putting any extra cash flow into tax-favored retirement accounts and finally back into paying the property off early.
Have fun.
@ Michael Im also hoping it will get positive cash flow in a few years due to rent increase as well and other sources of revenue i am looking into.
Thanks so much never did a spread sheet before. This should be fun.
@Eddie – Okay, so you have at least $117,500 in equity in the property with $470k @ 5.625% for 25 years on the mortgage. Cash flow is slightly negative, but equity is high AND you assume the property will appreciate in the coming years. You also wish to move out of the property in about five years or so and rent all three units.
What you need is a spreadsheet where you can construct multiple scenarios to see what this will do for you. Let me see if I can dig one up because the number of data points you need to examine is too much for a reply comment. I’ll take a look tonight.
Michael Thanks so much for the prompt response.
We bought the property about 5 years ago with a big down payment well over 20%.
The Property is just about the same now as it was 5 years ago. Give or take. But who really knows.
I live in one of the Units but do not plan in living there for ever.
I do plan on renting out all 3 Units when i move out In like 5 years. And i hoping the rent will increase and i will get some cash flow.
I was only considering refi in the the future( 5-10yrs) to lower the monthly payment. which would result in much greater cashflow assuming the same interest rate. And with the cash flow i can do something else.
What are your thoughts?
Thanks
@Eddie – That is a scarrrrry big mortgage to carry with no free cash flow from the investment. In this instance, I would prefer to be your brother by taking a buy out and walking away. The reason for this is the property has a negative cash flow ($200 on $3800 is never enough to cover maintenance and repairs) and a large debt against it which creates a compound risk situation that isn’t justified unless there is (1) a great deal of equity in the property, (2) a high probability of the property increasing in value in the very near future, or (3) both.
The problem you have is common for young real estate investors, namely, how do you ensure that you meet the cash flow requirements to see the property through to growth? I am assuming that you’re not earning a sufficient income to carry the mortgage without the rental income (if you can do it without the renters, then your risk scenario is far different than I’m addressing here), and if you have periods where units go vacant for a period of time, it could be very hazardous to your long-term financial health – perhaps even setting you back by a decade or more.
If you absolutely must keep the property, it would be preferable to keep a partner on board (someone with a healthy amount of cash available or a high level of disposable income/free cash flow) to reduce the risk of having a cash flow implosion.
With all of that said, if you have six months’ worth of expenses sitting in cash AFTER the buy out of your brother, ignore everything I just said and hope that your local real estate market starts looking up.
I don’t want to discourage you from building wealth through real estate, but unless you have a really strong cash position, the risk/return metrics don’t look very good right now.
Also, you might want to examine what your money could be doing elsewhere. If you choose to hold this property, you are essentially saying that there is no better investment for your money than this one property.
As to the question of refinancing, if I’m your brother, I wouldn’t allow this partnership to dissolve without a new mortgage. He will have this mortgage on his credit report AND not show any rental income. When he goes to the bank to get a loan on his own, it’ll hurt him and that’s not a fair deal. That’s why partnerships (especially among family members) should be unwound properly and handled by attorneys (if affordable).
Last thing. If you pull up historical interest rates, you’ll see that we are near the bottom of the barrel. It is unlikely that money will continue to be this cheap for much longer. As a result, whatever your financing is when you buy out your brother and have a new mortgage, be sure it’s something you’re able to live with because you may not get a lower rate in five, ten, twenty, or even thirty years.
My brother and i own a 3 Family house together. 30yr fixed at 5.625 Interest.
We currently have about 470k left and 25 years to go.
The mortgage payment w/ Utilities,taxes come out to about $3600 a month.
We rent out the 2 units and i live in one of them.
The 3 units can be rent for about $3800 so we basically break even. Give or take a little. NO cash flow
I am buying my brother out next year.
My Question is should i continue paying of the mortgage regularly and finish it in 25 years.
Or Should i refinance Say in the future (5-10yrs)to lower the monthly payments which would result in greater cash flow?
I am 25 right now and my ulitimate goal is to rent out all 3 Units and move some where else.
Thanks
Wow! Lots of comments on this topic and I understand why. Today I am paying off my mortgage, in less than 15 years, and the advantages mentioned in the article are all the reasons why. The security and peace of mind in an economy like this, in and out of recession, unemployment still an issue as companies struggle to manage, is priceless! We planned ahead and were able to use cash savings, no IRA, 401K or long term investment money to do this. We paid a little extra principal as the time got closer to pay off. We have plenty of other write offs so taxes are not an issue, especially since we had a fixed rate loan with a little higher interest rate than the lower rates you’re seeing now. Now, we can put more towards my kids college and our retirement funds. We paid off our vehicles and pay off credit cards every month so my Christmas gift this year is being completely debt free.
Great topic…
One subject I have not read, is how long do you plan on staying in the home you purchased with your 401k money. This is perhaps more important than any other consideration. The home I live in now is the one I plan to die in. (not soon I hope) It’s a no-brainer for me to pay off early. If you don’t plan on staying though, get a 30 year mortgage (this will lower your monthly payment), add equity by doing improvements (this will add to the value of your home) and invest your remaining money. Hopefully the home values will be up when you sell down the road.
If all else fails you haven’t stuck a fortune in a money pit and your investments are liquid.
I am just curious if the total loan size of a mortgage makes any difference in peoples’ calculations. I live in DC in a 3 bedroom house with a mortgage of $592K. I put 20% down to get a single loan ($740K is value of the property).
If I pay an extra $1,000 a month (current mortgage is $3K a month), I will pay off the loan in 19 years instead of 30. But that result means a %33 increase in the amount I pay each month just to live (let’s exclude the other costs for now).
I am 35 now, so that does mean the house would be paid off before I retire 🙂 Will I stay in the house long enough, who knows? I can make all of the plans I want (I don’t have any reason to move currently), but life usually has its own plan – job, family, medical issues, etc.
It doesn’t seem to be in my favor to focus solely on trying to pay down the mortgage on such a big note. For example, after 10 years of my current loan I will still owe around $483K. if I put an additional $1K a month (a total of $120K extra over 10 years), I will still owe $325K!
Now, on the bright side, if I refinance in 10 years, I will have approx. $160K of extra equity built up, which would result in a smaller payment (let’s assume interest rates are equal).
Investing $1,000 a month also has its risks. I think it might be difficult to judge the value of putting extra money in the market just on the last 10 years.
In the long run the market makes money, but what if your horizon doesn’t exactly match up with “long run” ? What if during these last 10 years you were forced to take out money from the market?
It feels like doing a little bit of both (pay down mortgage and invest) would be a good hedge for those of us that don’t like to watch or study our finances as much as others 🙂
thanks for all of the good comments on this board!
My husband got laidoff from his job for 16 years he is 59years and I am 53yrs old both of us have full time job,We bought a house few years a go .Its $79,000.00 now , So we are thinking know we should do $2,000.00 a month so we can pay off faster.We have got few rental propertys,and that will help us to do this,
So I will appericate to get some suggestion on this.
I just bought a house 3 weeks ago. I borrowed 92% of the home’s value so I am paying PMI. I also have some consumer debt left over from some non-enlightened habits during college and a lost job in 2005. Due to the PMI payment the highest cost debt I have is the mortgage up to the 80% L/V mark. I plan to pay that down as quickly as possible with he help of the 8k tax credit. once that is paid off I will go back to the min payment on the mortgage and eliminate the consumer debt. With luck the consumer debt will be history by Q1 2011. Even if I pay minimum on the mortgage after eliminating the PMI I will have the 15 year note paid off when I turn 42.
When I get to that situation where I don’t have any debt more expensive than my mortgage I think I will invest first once I get emergency funds and whatnot established. I’m in the early stages of my financial plans right now so that may change as time progresses. My mortgage is at 4.25% so there’s a good chance that guaranteed investments will outperform the mortgage when I get to that point.
My wife and I paid our house off this past April and have no regrets. We had taken a 115K loan out on a 5-1-ARM (before they were popular). This was our first home and we did the variable interest rate loan thinking there was no way that we would live in the same house for more than 5 years. The 4.7% rate was also better than the 30 year 5.3% rate…so we went for it. In the first three years we never missed a double payment…meaning $750 was our minimum but we would always throw $1500 at it no matter what. When the principle got down to $67K I remember specifically looking at the statement and saying to myself “we could have this paid off within a few yearsâ€. As our earnings increased we just kept the same lifestyle and eventually started throwing $3K/month and in the last year we were doing $5K/month. I’ll also add that the entire time we were investing 6% into both of our 401K’s, and had at least $20K in cash at all times…but living as frugal as possible trying to achieve our goal.
Looking back on it, I think we did the right thing. Had we dabbled in the high risk stock market, we probably would have not seen the 4.7% that the loan gave us.
Now that we are completely debt free, we are finally making the purchases that all of our materialistic friends have been doing for years (it’s just were doing it guilt free). I suppose this spending spree should stop at some point and start thinking about retirement…but that’s 35 years from now!
I’ve read about half the blogs here and have been enlightened by the different opinions on non-mortgage investment options.
Cheers!
this is an interesting blog
I currently have a condo in Chicago land area that i’m renting out
700 a month for rent(renting to friends). I have a 30 year fixed 100K loan which i used to purchase a foreclosed property. It just needed lots of work but having construction backround i flipped it no problem.It got appraised for 125K after repairs. I currently pay 1000 extra a month for principle just to pay it off faster. Within 2 years the mortgage went down to 75k. My goal is to pay it off within the next 5-6 years.
After its paid off buy another one =]
I am 21 years old =]
Ken:
Yes, I’m coming to that conclusion: wait a while and use the IRA funds (conservatively invested amount) to pay some extra principle payments throughout the year to reduce the balance while allowing the remaining balance to grow. Also if taxes remain the same or increase only slightly, then there may be no rush – other than psychological. We live in IL and there is no tax on IRA distributions (yet); however I’m keeping an eye on that variable too.
Mike,
You could wait until late in 2010 (or April, 2011) to see what is happening with tax rates for 2011 and decide then whether you want to take the tax hit in tax year 2010 or 2011/2012. Remember, there is some time value of money in pushing out the tax payment even if the rates are higher. 2010 is an election year, too, and no telling what may happen.
You have to be careful about giving up forever the tax-advantaged treatment in an IRA or Roth IRA if the numbers don’t work out. I am all for the psychological benefit of a paid off mortgage, but want to make a reasonable numbers-based decision, too. One option, if the numbers don’t work out, is to establish a “mortgage account” within the IRA with the full payoff amount invested there in something fairly conservative and use it to payoff the mortgage over time. This could give you the psychological benefit of knowing the mortgage is “taken care of” and that you could pay it off at any time, while keeping the tax benefits of the IRA.
@Ace & Edelman Followers
I just read through #10 and it’s conveniently skewed to make it very attractive to keep a mortgage. I particularly like the part where the same person who is paying the mortgage off early keeps no cash. By the very nature ofthe early payoff strategy, it appeals to fiscally conservative people. This means that the odds of having someone work to payoff a mortgage early AND not have any cash set aside are about as good as being struck by lightning. I’m sure it happens, but not too often.
Also, if you take a look back at rolling 5-year periods for the major indices, you will find that the odds of having an 8% average annual return over that period is below 50%. (It’s only around 2/3rds for a positive return).
One thing that I really, really loved was the ‘opportunity cost’ reference because in the example, it assumes a ‘bubble’ fantasy where the only opportunities are extremes. Minimum down and invest everything versus everything down and invest nothing.
As listed in previous comments, an early mortgage payoff strategy should be employed only after sufficient cash reserves and insurance coverage is in place AND tax favored retirement vehicles have contributions that project out to a comfortable retirement. The ‘bubble’ that is listed on the Edelman website isn’t very close to reality.
Ken & Mike:
This all sounds very good. The only question I would ask is if the mortgage could potentially be paid off through income rather than dipping into the retirement accounts. Based on current tax rates and the high likelihood of tax rates increasing over the long-term, it would be preferrable to keep money in a Roth IRA intact and payoff through other means. Just a thought.
Ken:
Thanks for your comments. I know about splitting the conversion as income over two years (reporting as income on 2011 and 2012 returns), but your point of why convert to Roth if I plan to take it out and pay the mortgage makes sense. I guess I could pull enough to pay the mortgage and taxes, and be done with it. I’m just itching to have no mortgage payment – and concerned about the end of the Bush tax cuts eff 1/1/2011 if I wait to do it or split it over the 2 tax years.
Mike
Mike,
Be sure to check out some special Roth conversion provisions for 2010. I can’t check this right now but believe that, if you convert in 2010, you can split the taxes between 2010 and 2011 (a one time provision).
The other question is, why convert to a Roth if you are going to withdraw it in a year? Generally, you get the benefit of a Roth as it grows over a longer horizon. Noone knows what the market will do next year, so you don’t really know if you will make 5-8% or lose money.
If you are paying 25% of $80,000=$20,000 tax, you won’t save nearly that much on your mortgage payoff.
We have $57,000 left on our 4.85% mortgage. Thinking of converting my IRA of $80.000 to a Roth, then in 12 months use part of it to pay off my mortgage. I know I’ll have tax of (25% tax bracket) to pay on the conversion (quarterly installments during 2010) – but no penalty as I’m 59.5. I figure the conversion will grow by 5-8% during 2010 so I can handle the taxes – which may come from the conversion, or my existing Roth.
I’m I crazy to do this?
Whew. It took me a while to read ALL the comments.
There’s a handful of people who got it right, and with very few exception, it’s never a good idea to pay off your mortgage for most people.
Thanks to whoever posted the link to Ric Edelman’s website.
Go to http://www.ricedelman.com/cs/education/article?articleId=232&titleParam=10+Great+Reasons+to+Carry+a+Big%2C+Long+Mortgage and read reason #10.
I have a question about paying off the mortgage. What happened to my Home Equity Line of Credit if I decide to payoff the mortgage?
If I have a 3.25% HELOC, should I use it to payoff my 5.625% mortgage which has only $10,000 left?
Stephen,
Yes, anything could happen in a year (as we unfortunately know) with the markets. The only sure things are what your investments are worth today which you could lock in by selling if you were fixed on needing the money. If you want to let it ride, the odds are in your favor for better returns in the long run, but next year is a crap shoot. I hope it goes up and makes your decision easy.
Ken,
Thanks for your comment. I guess it would be best to let the mutual funds lie until I really need to secure that second mortgage. I’m under no obligation to buy the house, so if the market does not rise as I am thinking, I don’t need to redeem shares that have underperformed. I’m paying 5.25 % on the mortgage, and stocks have historically done better than that.
Stephen,
The stock market may go up in the next year or so, or it may go down — remember it already up > 50% from lows. So, your plan may work out. If you and your parents don’t have any alternatives, then you have a decent chance of this working out. Is your Plan B not to buy the house if the market doesn’t go up, because there is a good chance of that happening, too? If you want to be super-sure that you can buy the house (as opposed to, “it would be nice”), you probably need another plan or a backup plan).
I may be in the position to purchase my parents’ house. To do that I would need to get a mortgage. I don’t think I could handle two mortgages with our current cash flow situation. I am betting that the market will rise in the next year or so. After that I would redeem my mutual fund shares, pay off my mortgage, and then be in a postion to get the mortgage I need to purchase that second home. Is this faulty reasoning on my part?
How can you say that paying off a mortgage gives one “peace of mind? ” To NOT owe a mortgage company payments (plus interest) is a relief, – however you never, ever get out from under the heavy weight of rising real estate taxes. You think you are free once your mortgage has been discharged? Think again. The tax collector owns your house the minute you fail to make those real estate tax payments, and can they not auction it off for the amount of taxes owed? Once the mortgage is paid off, will you decide to stop paying Hazard Insurance, thus saving $3000 a year? So, if not, you may still be on the hook for an ever rising insurance PLUS taxes, even if you’ve eliminated the dastardly bankers.
i love all the comments! my question is related to paying off the mortgage of my rental property.
first:
age 39
income over 500k/yr,
plan to slow down work at 45-47
max out on 401k
max out in espp (employee stock purchase plan)
no credit card debt
still have 90k on school loan (5% over 30yrs)
2 houses still with about 500k in mortgage
emergency funds very adequate
no car loans
single no kids
just wanted your comments, i was thinking of paying off my triplex mtg of 340k @6.5% (600k purchase)over next 2-3yrs. rental income is about 3300/mo. by doing this, i get peace of mind and collecting income. rough guess since no mtg, 3300/mo x 12 is appx 40k/yr (about 32k/yr after overhead taxes and utilites and vacancies) then 32k x 25yrs of income is appx 800k plus the 600k in interest payments i save if i keep for next 25yrs. once fully paid, this is making money to help payoff another rental property, i call it a domino effect. once i reach a certain amount, i can buy and payoff properties rather quickly say if my net rentals were 100k, that would paydown a newly acquired rental sooner as well.
as for my other obligations, my current income can easily cover that should i decide to stay with the company.
good idea? or should i refinance (i will still have a positive cash flow) and instead of paying down my mortgage, put it into the stock market?
losing sleep over this, cuz im inpatient
Most of the interest is paid at the beginning of a loan and less towards the end. The “low interest” surely doesn’t look like a small amount (4-6%) at the beginning of the loan. The bulk of the monthly payment in the beginning is going towards the interest. When deciding to pay a mortgage off early or invest, I wouldn’t just look at the interest rate. Look at the age of the loan and the percentage of the payment that is going towards interest. It wouldn’t make as much sense to pay a loan off early if most of the interest has already been payed in. However if the loan is fairly new, it would make much more sense to pay it down, ahead of schedule.
In Canada we do not get a tax break for mortgage interest. We have elected to eliminate the mortgage, then invest.
Dennis B. thanks for the heads up. Of course that’s what they did. I was just about to do some online paying via online banking and it was kinda bothering me that I had no way of directing the extra payment to principle. I’m convinced I was suspicious of just what you described. You saved me the hassle.
As for the topic under debate…I’ve been debating this subject and happy to hear it is not so clear cut. I’m in the fortunate position making this choice and although I don’t want to drag my feet in the decision making, right now I’m just making extra payments, trying to match my interest rate and vow to maintain the funds to payoff if I so choose. I must say I like the liquidity and I guess if I get sick of having to make the payment I can opt to payoff.
Lily
Tom, I’m sure it feels good to be free of the mortgage but it’s just emotions…..what’s your yield on the paid off house. Meaning, divide your net rent cash flows by the value of the home. That’s the yield on the investment. So, take your rent, sub tract your actual physical expenses for the property and that’s your net cash flow….include the tax advantage of the depreciation if you like…..divide by the value of the home. If that yiled is greater than the yield of of REIT or decent bond portfolio, then your making a decent decision in keeping the home….if not you’re making a bad decision because it feels good. If you can get a better yield some place else with no land lord hassles or liabilities, you’d be stupid to keep the house….
Getting close to paying off our mortgage and the bank is trying sap every last penny! We paid an additional $9,200 PRINCIPLE payment with on-line banking. We were waiting for that to post, so we can make our normal monthly payment. The bank took it upon themselves to split that extra principle payment into 6 months worth of prepaid regular payments (including interest) and then applied only about $2,000 towards the principle. If not for following up on the posting of our payment, the bank would have milked an additional couple of thousand dollars of interest out of us.
Can’t wait to be done dealing with these thieves!
Or I could by 4k shares of GE at 14 bucks. I say in 4 years this will def. be back to at least double 28 bucks. That’s a 25% return each year for 4 years.
K so three months ago paid off the mortage. Three months mortage free, heck yes felt good and yes there was extra money – right into savings. But now we found another house to buy. And yes it is everything we want in a house – damnit to heck. So put in the contract – acctepted. Moving in Sept. 9th. Guess what new mortage – but guess what now – have a renter for the paid off property no need to sell good solid person who is paying my new mortage – this is a good thing. Just another option – pay it off and you can do what you want in life. Do it folks it works, screw what all those others state – invest insted, use the write off – BS they must all work for the man. Talk about a tax benefit, someone else paying your mortage.
I’m amazed at easily smart people are confused on this issue. I won’t go in to too much detail but I will give enough info for the smart folks to get this right on their own. First, the only reason to pay off a mortgage is for the piece of mind. The is never an advantage on paper to paying it off. You can spend hours and days analyzing all of the wrong info…like what rate of return vs. the mort int rate……for the most part doesn’t matter. Seriously. Do the math. Project out the value of your home for the lenght of the loan, add to that the investment that you’ve made with the money that you don’t pay to the mortgage – even at a nominal rate of return – one that is lower than the interest you are paying. Compare this to the future projected value of the home paying it off early (notice this is the same) and not having the additional money accumulated…..which pile is bigger? The pile at the end with the money saved – even at low rates will be bigger. Your wealth will be larger if you do not pay down the debt faster…..guaranteed.
I have a 30 fixed 6.12 %( 26 yrs left ) and a 15 yr fixed 7.5% ( 13 yrs left ) piggyback. I owe 79k on the piggy back but will have 3/4 of that saved up as cash shortly. I can refi to about 5% ( have 800 credit) 30 yr and invest or even less with a 15 yr ( not invest ). Or I could just knock the piggy back out in a short amount of time and concentrate on big loan after that. I’m not sure what to do.
We have two more payments on our primary house. In the last year we’ve paid an additional $58,000 to pay it off early. We delayed purchasing cars, furniture and doing home improvement projects. All of which would have been difficult to delay if we didn’t have the short term goal of paying off our mortgage. A year and a half ago our accountant advised us against paying off our house early. Oh by the way he has a reverse mortgage and is heavily invested in the market. Wonder how that portfolio looks about now….
The piece of mind that having a paid off home mortgage, especially in today’s economic climate is priceless.
@D- – Inflation is still a maybe at this point. There is still a significant risk of things going the other way–a la Japan. Many respected economists are still on the fence as to whether or not the stimulus is enough to treat the size of the problem we created. In addition, if personal savings rates continue to climb or make it to 10% or more, the risk of inflation could remain low (in economics, personal savings is usually a good indicator that people will continue to buy bonds which will drive down interest rates and demand–thereby reducing the risk of hyperinflation). Add to this the problem of corporations cleaning up balance sheets by paying off debt instead of trying to grow and hire more employees, and you can quickly see that hyperinflation isn’t a certainty by any stretch.
With that in mind, that is why a more diversified approach to saving and investing is favored over an ‘all or none’ approach like paying the mortgage off first, then moving onto the next step of saving for retirement. Even the ‘gazelle intense’ master, Dave Ramsey, favors a more balanced approach to saving (investing is a different story with him) by wiping out all debt except the first mortgage, then shoring up the emergency fund, then saving 15% for retirement, and finally paying off the mortgage.
Of course, the biggest problem with waiting 15 years to begin saving for retirement is the time value of money. With the past decade of investment returns having vanished, the odds are heavily in favor of better returns over the next 30 years. As a result, participating in these returns is very important to securing your retirement. Once you’re behind the 8-ball, it is very difficult to catch up to the power of the time value of money.
Now that the high level discussion is out of the way, let’s get down to your situation. If you are still paying PMI, I would favor dropping contributions to retirement to only monies that would be matched by an employer sponsored retirement plan like a 401k, SIMPLE-IRA, etc. I would set a goal to get rid of PMI within two to three years because this is a cost that has no tax benefit and getting to 20% equity is an important step.
If you want to go with your plan of paying off the mortgage first, then saving, it’s not going to kill you…as long as you get the mortgage paid off quickly. Go to http://www.bankrate.com and use their mortgage calculator to see what your payments would need to be to get it paid off in 10 years instead of 15 or more. If you can’t make it happen, consider selling the house.
Ideally, you should leave yourself 20 years or more to work and save for retirement. The reason for this is that if you are saving 25% of your gross income after the mortgage is paid off, you will be able to save 5 times your gross income which equates to between 9 and 10 times your net expenses (100% gross income – 25% savings – 20% taxes = 55%, 500% / 55% = 9+ times expenses). While you’ll need to get to 20 times expenses or more for a secure retirement, having 9+ times expenses from pure savings coupled with investment returns over the 20 year period (which are more certain compared to 15 or 10 years) should be enough to fill the gap.
One other point, there isn’t a major asset class in the world that responds well to hyperinflation. It doesn’t matter if it’s real estate, bonds, stocks, etc. Hyperinflationary periods do not possess an asset class that produces the kinds of real returns (net of inflation) that stocks do during periods of modest inflation (typically inflation + 4% to 6%). However, it is a great time to accumulate shares of stock that will eventually rise sharply after inflation has passed. In other words, during hyperinflation, no one really ‘gets ahead’, but soon after the inflation subsides, there has ALWAYS been substantial growth in the equity markets.
One thing that i haven’t really heard alot about yet is the effects of inflation with regards to paying down a mortgage. Washington is printing off money at an astonishing rate which is driving the “value” of our dollar down. Now, assume I place 10% of my gross income into savings, retirement, etc. This is a reasonable size of my paycheck right now, but in 30 years when i retire, what will the “value” of my hard earned savings dollars be? Why not try and pay off the mortgage in 15-18 years, then take the last 12-15 years of income (which will be closer to the currency rate) to save for retirement? I am no expert so someone please correct me if i’m wrong in my newly founded opinions. I do see the flip-side, however, which is that with a fixed rate mortgage and inflation, my monthly payments will be a cinch to pay in 29 years. It is hard to sway me away from the benefits of my first mentioned option though. (not to mention getting rid of PMI in my case).
@Squimp – Two scenarios:
(1) If you can payoff the mortgage by the time your child(ren) go to college while continuing to max out retirement contributions (assuming this will put you on track for retirement), do the 15 year and sacrifice the 529 contributions. This way, you can pay for college via earnings instead of the 529 plan. While this may be less tax efficient, it is a lower risk scenario since the 529 plan will endure the ups and downs of the market. I am NOT a fan of fully prefunding a child’s education with a 529 plan and typically only recommend up to 50% of the projected cost be put into them (the reasons for this are many and it could be a topic for another day).
(2) If your child(ren) will begin college before you can payoff the mortgage, take the 30 year mortgage and amortize it over 19 years so you can retire debt free. If it takes longer than 19 years to get the mortgage paid off, you can always decide to downsize at retirement or time out some distributions based on prevailing tax rates in the future.
While it sounds like you’re already locked into the home and have made your decision, a really crazy plan would be:
Take out a mortgage equal to your annual income and buy whatever you can at that point with your equity carryover. Pay it off in 5 years, then upsize to the same sized house you want today with a 5 year mortgage that is again equal to your then current income. This means you would own the house you’re looking at right now with no mortgage in just 10 years. This is a bold plan that many find laughable, but owning a home outright in 10 years with cash versus 15, 19, or even 30 years is a pretty good deal. Ideal personal traits are patience and discipline. Ideal market conditions are for stable real estate markets.
By the way, I didn’t see IRA in your asset listing, but you may want to consider dropping money into an IRA and converting it to a Roth next year (I’d even use some of the equity from the sale of your home to max it out this year and next). You shouldn’t have much growth to pay taxes on, but you will get tax free distributions from the Roth when you retire. Just a thought.
we need advice. We are right now trying to decide between locking in a 15 yr vs 30 yr mortgage on a replacement home. This is our scenario.
we are married, both 41, both with permanent federal jobs taking in $180K combined income annually. We like our work and probably won’t retire for another 20 years.
we are now selling our home and getting $180K in cash, using $100K of proceeds to make 20% down on a replacement home (450K) in a stable/desirable college town housing market. Some proceeds ($20K) will go to renovations. We are maxing out tax-deferred TSP and college 529K contributions for one daughter.
so, we have the same question as many others – should we be paying down more on the house with a higher down payment and 15 yr mortgage, or investing the difference in the market through our fairly conservative broker (we can’t be bothered to play the market ourselves)
thanks for any input – a couple of pretty smart people who are very dumb about all this!
squimp
@Mona – It sounds like the prospective financial planners you’ve met with are a little too math heavy and human light. This means that while they’re good at crunching numbers, they have failed to connect with you on a human level. The bottom line with virtually all people is that budgeting is…well…irritating.
What you need to do is construct a high level budget by eliminating the stuff that won’t be there when you’re retired. This is a much simpler way of figuring out what your ‘lifestyle’ budget looks like. After you eliminate all of your debt payments, the money you’re paying for college, the financial support you are lending to your children, and the amount you are currently saving, you wind up with what your ‘lifestyle’ budget is.
The reason this is so effective is because when you enter retirement, you hope to be debt free with adult children that are supporting themselves. As a result, your retirement income needs are typically far less than your current income.
Once you have that number, planning becomes much easier.
Now, your question is definitely best suited for a fee based advisor sitting across from you because there are a number of issues that need to be properly addressed. That said, here is a quick synopsis of the things you need to workout:
1. How much annual retirement income do you really need?
2. When will you sell your house? (notice that this is not an IF discussion)
3. How much equity do you need to realize from the downsizing of your house? (this will tell you what size/value house you can afford during retirement)
4. To determine the available retirement assets you will need (available assets are anything outside of your retirement house and pensions/social security), take your retirement income from #1 and subtract out the annual income from pensions and social security. Next, take this difference and multiply by 15 (low end) to 22 (high end). This is the amount of assets you’ll need to realize from your savings and the downsizing of your home.
The feeling that you have of dog paddling and sinking is very common. To get rid of it, you’ll have to put in the hard work of planning your retirement and making some very difficult decisions along the way. If you want some professional grade retirement planning software, you can go to http://www.efinplan.com that offers a relatively easy to use, but sophisticated retirement plan (the most important output is a monte carlo projection that will give you a percentage likelihood that your nest egg will last through your life expectancy).
From your iteration, it is apparent that you have a family first attitude. Just remember that as you go through this process of planning retirement and then actually doing it, you’ll need to move your and your husband’s interests higher on the priority list.
By the way, congratulations on getting your children through college. I am several years out, but it is a major accomplishment to be sure.
One last thing, if you want to try to find an advisor that can really help you, look for one that is in their 50s or 60s, does NOT have a CFP, runs an independent practice, charges by the hour, and has been in the industry for 20 years or more. These attributes will be most likely to land you with someone who isn’t overly numbers driven, can relate to your life experiences, and has enough experience to know that numbers are a small part of the equation. Look for advisors affiliated with Raymond James, LPL, Cambridge Investment Research, Commonwealth, or those that have their own Federally Registered Investment Advisor. You’ll be able to tell the difference on their websites by reading the little disclosures at the bottom of each page.
Good luck.
This blog has been very inspiring, and I hope that someone can shine a clear light on our situation and help us to move forward:
Husband 64 (federally employed for past 20 years, and expecting to need to work for possibly 5-6 more yrs 🙁 He will have a modest pension plus social security.)
Me 57 and contribute very little to our income (part time work from home plus two days work at school in exchange for 3/4 of children’s tuition).
Besides 189,000 and 27 yrs. left on a mortgage at 5.6% (house worth 700,000 right now); 36,000 and 16 yrs. left on an equity loan @ 6.4%; 16,000 left on credit card at 7.9%; 140,000 in our 401K, we have a very modest emergency fund. We have a great desire to pay off our debts and become financially fit, but do find it hard to stay focused…with a large family and several children in college, the priorities are always shifting.
I would appreciate any kind suggestions from you or your clear-sighted viewers regarding steps we definitely should be taking to achieve financial health. We have tried a financial planner once or twice, but it always ended with “make a budget” then come back. Please don’t say only the same thing…believe it or not, I think about this all the time and perpetually crunch numbers, but would like to move forward instead of dog paddling and sinking! Thanks!
Does this question belong on a different line of questions?
@Erik – To get off the fence, you need more analysis of the rest of your financial life. Start with a retirement plan using one of the many free retirement calculators online and find the monthly amount you would need to contribute to be on track.
-If you are able to save more than the amount stated in the plan, designate this for early mortgage payoff and/or beefing up your emergency fund
-If you are unable to save more than the amount stated in the plan, put all of your dollars into the 403(b) while knowing that you should keep the term of your mortgage to your retirement date or earlier
Put more simply, make sure you’re on track for retirement first, then consider paying down the mortgage earlier.
As to the question of whether or not to re-fi, if the difference in payment is significant AND the APR is equal or lower, do it. This will give you greater flexibility with your cash flow and if the rate is lower, you will ultimately save money that can be used elsewhere.
Helpful next actions:
1. Construct a retirement plan
2. Identify the amount you need to save monthly or annually to reach retirement on time
3. Compare the retirement savings requirements to your available cash flow
4. If you don’t have excess cash above retirement savings requirements, re-evaluate paying the mortgage off early when cash flow improves. If you do have excess cash above retirement, put the money first to fill up your emergency fund and second towards paying off the mortgage early.
5. Examine the costs and APR of the proposed new loan.
6. If the costs are within reason and the APR is lower or equal, do the re-fi to create flexibility in your cash flow. If the costs are excessive, look for another loan provider. If the costs are reasonable, but the APR is higher, skip it.
I hope this is helpful.
I loved reading everyone’s responses here–it totally made me remain firmly planted on the fence about paying off my mortgage or not! I’m a teacher with two young children (18 mos and 1 month). I could pay off our mortgage in 6 years if I stop all contributions to retirement. One friend is advising me to actually refinance to a 30 year mortgage so I have very low payments ($130,000 principal balance on a 5.6% mortgage) which would then allow me to make high contributions to my 403(b) plan. His argument is that I immediately gain a 30% return on that money since it’s pre-tax dollars. The lower payments also give me some extra monthly cash flow for the kids’ activities (music classes, trips to amusement parks, etc.). Any thoughts?
@SoConflicted – You are correct, the cap on capital losses is still $3k and there is no limit. In fact, you can die with a huge capital loss carryforward, never to actually benefit from them. This is one of the serious problems with the tax code that puts capital loss treatment squarely in favor of the government. I worked with a client that had some massive losses and will have to live until age 266 to recoup them (before we met he was an active trader in options contracts).
The main reason you want to be able to absorb the losses or at least match them with gains as soon as possible is because of the time value of money. While waiting to use your capital loss carryforward, your money and the deduction will be worth less every year out from today. You might want to drop a line to your Congressman to see if they can at least index the $3k to inflation, but I doubt we’ll ever see any significant changes.
As for your habits, always remember that you are the exception and not the rule. There are very, very few who can save at the rate you have, and even fewer who will take the time to research their investments. In my decade plus of experience as an advisor, I met exactly one person that had this combination of qualities. After I met him for the initial appointment, I told him, “you don’t need my help; you’re doing just fine on your own.”
Don’t forget to throw a proper mortgage burning party when you pay it off. You can get as creative as you want, but invite all of your friends. This is a tradition that used to be widely known, but has seemed to dwindle over the last couple of decades. It is a great lesson for friends and family to know that living without a mortgage is possible and they know someone who is doing it. Sometimes your financial footprint needs to be seen by others before they can follow you.
Thanks for the kind words on my blog, and best of luck in securing your financial future. You also might want to start figuring out what you’d like to do with that early retirement you’re tracking;-)~
Michael – Thank you very much for your insights. It helped quite a bit for someone else to validate that my mortgage pay-off plan was not flawed in some profound way. I think my paralysis was due to my concern that I was overlooking something and didn’t want to end up kicking myself. I will definitely structure the assets I sell to take advantage of the carryover write-off within as few years as possible (Is there a max number of years during which the loss must be absorbed?). I know there is a cap on the annual write-off, I just don’t recall what it is (But for some reason, the figure 3k is stuck in my head). I’ll need to do some search during next couple of weeks to determine which investments will be sold.
By the way, thanks for the compliment on my savings habits. I wish I could take full credit for them but have had some pretty good influences in my life that helped to get me focused. As a result of those influences, I now enjoy researching investments, reading 10-k reports, and can’t walk by a newspaper without reading the business/financial sections.
I am officially off the fence and racing towards the finish line. I hope to cross it before my 40th B-day in a couple months.
Thanks again. I just bookmarked your wealth uncomplicated blog (It’s awesome). keep sharing.
@Sandy – Also, there are advisors that specialize in divorces and if you’re in a metro area, you will likely find one nearby. They are familiar with all of the issues that divorcees endure and are comfortable working with divorce attorneys, estate attorneys, accountants, forensic accountants, etc.
@Sandy – I am sorry to hear about your divorce, but it is becoming more and more common in retirement.
The short answer is: Slow down.
Divorce is always a bitter pill and adding financial suicide by a spouse to the list is never helpful. I would hesitate making any decisions until you get settled into being divorced and the emotional side of things has dissipated. There will be plenty of houses available six, twelve, or eighteen months from now, so take your time and figure out what your new life is going to look like.
The only things you MUST do is pay the attorneys and complete all of the paperwork to move the assets into your name. Aside from this, you may even want to park your money in cash until you have a very clear plan as to how you want to proceed.
Also, I am guessing hubbie went out and racked up some pretty nice sized debts. If that is the case, make sure the divorce decree forces him to put those debts solely in his name. I’d also sign up for LifeLock or something similar to lock down your credit for a period of time until everything is under his name. Even if the decree requires him to pay debts that also have your name, it will still impact your credit report until he pays them off or moves the debt under his name. Beyond the credit report, LifeLock or similar services can help you prevent future identity theft. The likelihood of this is much greater from people that know you and your not-so-secret information (like an ex-spouse). These services are usually anywhere from $10 to $30/month and they’re definitely worth paying for until things settle down.
From here, take a few months to:
1. Create a retirement plan
2. Create a housing plan
3. Develop an investing plan for long-term money
4. Sit down with a CPA to figure out how best to buy your home (a lump sum all at once will likely be a terrible tax outcome that could do irreparable harm to your retirement plan)
5. Figure out what you want to do with the rest of your life
I can’t tell you how many divorcees I’ve met that made a series of bad decisions immediately following the divorce (like cashing out a retirement plan). Take your time and explore all of the options. You have experienced a major change, treat it as such.
Good luck, and if you need help, don’t hesitate to reach out to an hourly fee advisor in your area.
@SoConflicted – This is an easy call with your age, assets, and tax situation. Pay it off as soon as possible. Based on the information you’ve provided, it is clear that you are a terrific saver and have made a lot of good decisions to get you to this point. To be 39 and have a net worth that puts you in the top 20% of ALL Americans is OUT-standing.
In all seriousness, the hesitation that you are feeling probably relates to the market losses and the really low interest rate that you have on your mortgage. The odds are that the market will not move past 1999 highs until 2015 or later and we’ll trade up and down without solidly moving higher for a number of years. In addition, the interest rate is nice, but with only $75k on a mortgage, much of your interest is probably being eaten up by the standard deduction anyway. If you believe the market isn’t going to move significantly higher AND you take a hard look at your taxes with and without a mortgage, you will find that paying off the mortgage is in your best interests.
If you’re concerned about losing out on the market move upward, keep in mind that at your young age, you will have more than enough time to dollar cost average into the market and put you back ahead of where you would be without paying off the mortgage. In stagnant markets with many ups and downs, dollar cost averaging is the most effective way to stabilize your portfolio returns when compared to a lump sum (like the $75k you’d have to sell).
In my opinion, you are a perfect candidate for an early payoff of the mortgage.
The only thing that might be a bad deal is if you have massive capital losses that would be set to carryforward. If this is the case, you should try to get the loss recapture within the next three years or so.
In the grand scheme, paying off the mortgage will significantly reduce the amount of capital required to retire, act as a stabilizing asset to your overall financial condition, and allow you greater freedom in your career choices.
If this comment isn’t enough to get you off the fence, go to a CFP in your area that charges by the hour and let them know that you will not be moving assets to him/her and you only want help with this single decision. This will eliminate biases since an advisor that charges based on assets will not have the cloud of “If I recommend not paying it off, I can make money on the other $75k”. That’s why hourly is much better than asset fees. For $200 to $500, you can get all the information you need to make a good decision. What you get for that money should be a tax projection with and without the mortgage and monte carlo retirement probabilities with and without the mortgage (where without the mortgage you dollar cost average the amount you’re paying on the mortgage today and with the mortgage, you keep the $75k invested). Having those analyses completed should give you the confidence you need to put this decision to bed.
I am at a point where I can now see the light at the end of the mortgage tunnel. I owe approx 75k on my mortgage and am considering calling upon assets sitting in a variety of mutual funds to wipe the slate clean. If I take this action, I would sell the funds that would not trigger a capital gain(Thanks to the horrible market of the past couple years). I have been dancing on this fence for soooooooo long that I figured I would seek the opinions and recommendations from others.
Here is a bit more info. I have a fully funded 401k with a balance of approx 400k, I just opened an IRA within the past couple of years and have a balance of nearly 5k. I have non-tax advantaged accounts of about 90k. If I use the non-tax advantages assets to payoff the mortgage, I will have about 16k left as emergency funds.
Intrest rate on the loan is 4.625%
I have no other debts and am 39 yrs old.
Please help me get past my paralysis.
Lot of great reads here! Now wondering what the input will be on my devastating financial situation? Just went thru a hell of a divorce. Someone had a midlife crisis and along with that committed financial suicide. So long story short after home is sold and I get my portion of TSP account I must purchase new home for myself. Rather than have a mortgage I basically have decided that it would be best to take the monies from both the house sale and the TSP account and pay for the house in cash. The TSP account has to be turned over to me (my portion) and cashed out which will cause a 20% early tax penalty any way…which is necessary in order for me to have the ability to pay my lawyers fees (which are incredible). Of course I could pay from the house sale but than their would be a delinquent amount for the house purchase that I need to make. Either way I need to cash out the TSP plan. My income is fixed as I am retired already. Who would have thought that divorce would happen when life was just suppose to get good? Thanks for anyones comments
Wow. Thanks SO much! I had never even heard of this option before. I will print this out and share it with my husband — we’ve been needing exactly this type of advice.
Your blog looks great, by the way! I added it to my Google Reader RSS. 🙂
Thanks again!
Heather
@Heather Idoni – I would postpone paying down the mortgage with a full distribution until your husband has his next job. The reason here is that while maintaining any debt adds risk, you face greater risks if you lose your job. In addition, you don’t have long until the magic age of 59 1/2 comes around when the 10% penalty would go away.
IF you decide to go down the path of taking money out of the retirement account, consider a 72t distribution program that would allow you to take a small percentage of the account out annually before 59 1/2 without penalties. Sometimes 72t distributions are referred to as substantially equal periodic payments (SEPP) and what it amounts to is you are making a permanent election to take money out at least yearly from the retirement account. To break down the term SEPP, ‘substantially equal’ means that you will have to take out similar amounts each year. This can be tabulated as a percentage or dollar figure that must come out each year. ‘Periodic’ means that you must take them out periodically and the IRS requires this to be at least annually. ‘Payments’ just means withdrawals. This will save you the 10% penalty, but it will also eliminate your ability to take a lump sum or the entire balance at once. If you deviate from the SEPP arrangement, all distributions are subject to a 10% penalty going back to day 1.
What is attractive about the SEPP route is that you can have a little more freedom about what to do with the money. If you maintain your job and can continue to support your family, then you can use the withdrawals to pay down the mortgage. If you lose your job later, you can use the withdrawals to live off of. If you payoff the mortgage earlier than 59 1/2, you can simply increase your employer sponsored retirement plan contributions to offset the distribution. It just gives you more options while reducing your tax burden and still accelerating your mortgage burning party.
Also, since your husband is back in school, you are likely eligible for the $2,500 tax credit meaning that you could withdraw in a lump sum the amount that corresponds to that tax credit and still be even up on your tax rate from last year. (if you’re in the 25% bracket, it would correspond to a $7,142 withdrawal inclusive of the 10% penalty).
You should also check into your state’s returning student financial aid package. Some states require early filing of the FAFSA, but many states offer grants to adult students and I would not be surprised to see some kind of grant/tax credit/tax deduction from states hit hard by auto industry layoffs.
In short, you’re not crazy to want to do this, but from a risk perspective, you will do better by delaying the distribution or setting up SEPPs. IF you do decide to do the lump sum anyway, sit with an accountant or use a tax prep software package to see if you would be better served taking the distribution this year, next year, or both. The way you figure it out is by computing your marginal tax bracket based on your income and deductions. I’m sure you can do a Google search to find a basic tax calculator and I believe the IRS has one on its site too.
Hope that helps.
There is one thing I think everyone has been overlooking when paying extra towards the principle of your mortgage. That is this, the extra money is going to you not the bank. Everyone knows that the interest charged is based on the remaining loan balance each month, so as you pay down the balance the bank gets less money from you and you are actually paying yourself more. Also the earlier you make the extra payments the better, as the loan is designed to get the most money for the bank early on. That is why banks are happy to refinance, as that just starts the cycle over again allowing the banks to rake in more cash from us. Try to limit the number of refinances you make. Investing the extra money in other ventures always carries risk, paying off your mortgage carries no risk, especially if you have already set up an emergency fund for yourself, and you continue funding for retirement. I agree with others in this post that the mortgage deduction is a crock, why do people think that paying $10,000 in interest to the bank and getting a $3,000 tax credit is good? That makes no sense to me at all I’d rather pay the taxes on the $10,000 and keep what’s left over.
J.
My husband recently got laid off from General Motors (permanently), but he’ll be an RN in about 18 months and resume working at a hospital with benefits, IRA, etc.
We are thinking about paying down our 15 year mortgage (was $215K originally, now $140K, so about 6 years to go) by absorbing the penalties on his current IRA and using the remaining $50K after taxes/penalties (he’s 48, not retirement age) to pay DOWN our mortgage. (We are doing fine making regular payments with my income.)
Now — the penalties are about $30K, but will we save more in interest at this point in our mortgage by doing this?
We are planning on aggressively starting over with an IRA when his nursing career begins.
Is this nuts???
H.
@Chuck – So, based on your logic, I suppose that whole life insurance was created by the government for the government’s benefit and sold by insurance agents (like you) for the benefit of life insurance agents. A smokescreen of complicated products and services have been created over decades that are to the detriment of the average consumer.
Or is it that you prefer to pay a higher amount of taxes, reduce total compensation paid to individuals by employers (by leaving the match on the table), and would prefer to completely ignore the tax-free withdrawal benefits offered by a Roth IRA. Tell me you’re kidding.
@Tom Layne – The reason it matters if you lock in at a low rate today and inflation (and consequently interest rates) spikes later is the risk of a liquidity event–meaning if you had to move and sell your house. If you sell your house and hold these lower yielding bonds, then you could be forced to purchase your next home with a higher interest rate mortgage AND either have to continue to hold low yield bonds OR sell them at a significant loss.
Also, there is something known as managing ROI for relative returns. What this means is that you want to be near appropriate benchmarks over time and not have significant +/- performance in any given year because you are assuming that the average historical rate of return will be achieved over the long-term. Passive investors like Bogle and his followers use this approach. They don’t care (at least not as much) that the market drops or interest rates are horrible in any given year. They diversify their assets so they can meet the benchmark index and over time they will achieve their expected rate of return.
The other school of thought on ROI is absolute returns. This is more likely something that you would appreciate since you’ve indicated a preference for more conservative investments. In this school of thought, you try to achieve say an 8% or 7% rate of return every single year. Sometimes this means shifting into stocks, long bonds, short bonds, etc., but what you try to do is get to a stated rate of return consistently using the ‘best’ asset class each year. The problem with absolute return strategies is that if you set your target return too high, you’ll find it extremely difficult to manage to the number. If your target is say 5% instead of 10%, you’ll have better luck. Of course, the problem with this is inflation.
If inflation is 5% and you receive 5% on your investments, you have a net return of zero. That’s why CDs have historically been a poor investment because they offer a near zero net rate of return. When a CD is paying 15%, it’s likely inflation is around 14%. When this happens, if you can buy long maturities at the top, CDs can potentially offer a significant premium over inflation. However, timing is hard to pull off and that’s why relative performance is used by so many.
As for your specific situation, here’s what you should do:
1. Construct a retirement plan that will tell you if you are on track or not. You can use something like MyPlan from Fidelity or something similar.
2. If you’re on track, you have more options that we can get into offline. If you’re not on track, you’ll need to increase your contributions for retirement in this order:
If you qualify for the Roth IRA:
-Contribute to 401k to match level (you’re already there)
-Max out Roth IRA contribution for you and your wife
-Max out 401k or to the level you need to be on track for retirement
-Consider a low-cost variable annuity for post 59 1/2 retirement money OR a taxable account with tax efficient investments for pre 59 1/2 retirement money
If you don’t qualify for the Roth IRA:
-Contribute to 401k to match level
-Contribute to 401k to max
-Contribute to a non-deductible traditional IRA
-Consider a low-cost variable annuity for post 59 1/2 retirement money OR a taxable account with tax efficient investments for pre 59 1/2 retirement money
Keep in mind that these accounts only designate how you are taxed currently, on the investment returns until withdrawal, and on the withdrawal. In other words, these accounts designate tax status, not investments held.
For clients that were on track for an early retirement, we would typically max out tax advantaged contributions until they were on track for their post 59 1/2 portion of their retirement and then do a second retirement plan for their retirement age until age 59 1/2. This way, we made sure we had money that wouldn’t be subject to more limited 72t distributions and we could be sure they would have plenty of liquid assets for their pre 59 1/2 retirement days.
I hope this helps, but if you have additional questions, feel free to hit my blog and drop me an email.
I used to comment on this subject but I have become too busy helping people get out of debt. The amount of time I was spending took away from that effort.
I wholeheartedly agree that each individual situation needs to be addressed, problems identified, implications of the problem outlined and then viable solutions to the problem implemented using goals and strategies that are tailored to the individual situation.
Let me state that 401Ks and most tax deferred plans are approved by the Federal Government for the benefit of the Federal Government and implemented by financial planners for the good of financial planners. A smokescreen of complicated products and services have been created over decades that are to the detriment of the average consumer.
That is not to say that financial planners etc are dishonest, it is just the way the system is built. ROI is the big come on when actual ROI after expenses and taxes is much lower. Lower ROI instruments that are not taxed or are favorabley taxed make a lot more sense in the long run.
Sorry I am ranting. I am just tired of seeing people investing in high powered investments that invariably lose over time.
As for using 401K money to start a business?? Well I know hundreds of unqualified people that have gone down that path and failed. The only ones that gained were those that got them into the business, or promoted the myth that “anyone can do it” or it is a “no-brainer” or everyone uses this product (not to mention that a ton of people are promoting the same product). NOT everyone is qualified or should be in business for themselves. Most small business people have traded on kind of JOB (Just Over Broke) for another JOB.
If you decide to go that route go to your State Department that handles training, find out where to get tested to see if you are in fact the type of person that should be a small business owner, own a franchise or should actually work for someone else.
Well let us see how many toes I stepped on this time. I am passionate about helping people and getting older and wiser by the day.
Have a great 4th of July.
I’ve reviewed most of these comments, including reading a post that strongly pushes for early mortgage payoff, with the argument via a monte carlo analysis that those with mortgages at retirement will run out of money faster than those without mortgages.
There are so many variables to consider here that there is no one right solution-it depends on your circumstance. No financial planner would encourage a client to pour into his/her mortgage extra payments and not have a cash cushion for emergencies. Likewise, financial planners will certainly encourage early mortgage payoffs when there is a reasonable long term retirement cushion and emergency reserves.
Not discussed, but critically important, any investments, be they to pay off the mortgage early or place money into 401k’s are passive uses of money, not active ones.
Instead, think of the use of extra money to BUILD A BUSINESS. This use of money becomes active, not passive, and trumps any passive investment. Of course, actively invested money into your own business is the riskiest type of investment, but with the greatest rewards. So, if one is foregoing the risk of developing a business to come home and write a check to pay off his/her mortgage, that person may have lost out on the biggest potential source of financial freedom.
Just found this from a google search. I’ve been turning this issue over in my mind for months now. I just got a new job six months ago, and am contributing the maximum matched amount to my 401k (6%). I’m also maxing out my Roth IRA every year.
I’m currently in a 15yr 6.375% mtg, and most of this year I’ve been paying triple monthly payments, except for a couple months between which I paid an entire extra year of payments on top of the triple payments. I’ve been in this house for almost two years, and at the rate I’m going, I can have it entirely paid off in two more years.
I have no debt whatsoever, and have, between my IRA and 401k, savings equal to 1/3 of the remaining amount owed on the house. I have another 1/3 worth of money invested in individual stocks. I’ve been putting money in the market, getting some great returns in this little bull run we’ve had, and then pulling back out and paying off the mortgage with the investment returns.
I’m just looking for some opinions on whether I should continue this plan, or move more towards investing longer term with all my extra money. My wife and I are expecting our first child early next year, so that’s another concern. To me it seems better to get the mortgage out of the way, and then just start piling into a variety of savings methods afterward. I look forward to everyone’s thoughts!
@ Michael Harr
Following up on your advice to Tom Layne, if a person wants to implement the interest rate arbitrage investment (like we discussed), he or she needs to be open to making constant adjustments, which a lot of people won’t want to do. When we talked about it bonds were trading at a point where I could beat my after-tax mortgage rate, but T bonds have since fallen so I am back to prepaying the mortgage. I kind of enjoy messing around with it (OK, I’m weird) but a lot of people won’t like to spend time focusing on their allocation of capital. Automating mortgage prepayment is a good way to implement a strategy and then forget it.
Thanks for the feedback Michael. My wife and I are 35 so retirement is a long ways off / we should have our house paid off by then regardless of what we do by then, assuming we stay in this house as we intend. We have an equal 150k in our retirment accounts, and at this point we are only maxing out to the company match – not sure if you have a view on that. I think its the inflation point Im somewhat thick about – I dont understand why that significantly increases my risk. If I can lock in a 6.5% 7 year CD & I have a fixed rate mtg of 5.125, do I really care if a year later I couldve gotten a 10% CD? Im only concerned with beating my mtg rate bogey – the rest would just be gravy (and gravy I wouldnt be served if I instead paid off the mtg with this $). I have no desire to increase risk by investing in bonds – Im only interested in a risk free return that beats my mtg rate and keeps the funds more liquid in the event of true emergency. Another reason I think we dont want to pay the house directly is if we DID have to move and the mkt is still terrible Id hate to have put 150k into the house only to get 50k of it back when selling. Frankly I find myself hoping inflation comes and interest rates skyrocket as a side effect – Id love to see a CD at 15% that I can drop this $ in. We live modestly and dont buy tons of stuff so I think any inflation to our cost of living would be more than offset by the CD interest that is now paying a huge chunk of our mtg. Is this plain stupid and Im hoping for my own funeral? Where do you see interest rates going in the intermediate term? I know some of this has been discussed above / its really largely circumstance dependant – Im just trying to get a view on my circumstance!
@ Tom Layne – As DCGuy and I discussed, it makes sense from an investment return perspective if you meet certain conditions. If you have $150k sitting outside of tax favored accounts and a 12 month emergency fund, this is an indicator that you would likely be able to sustain the interest rate arbitrage strategy because you already max out your tax favored savings opportunities and have sufficient liquid assets to cover an emergency (and assuming you have appropriate insurance coverage). This also indicates that your financial house is in the exceptional category rather than the norm.
Keep in mind that the probabilities favor paying off the mortgage once in retirement even if the interest rate opportunity exists due to the loss of income and beginning of withdrawals. This is the result of statistical analysis that accounts for the investment risks over a long period of time. Please see one of my earlier comments for a link to the post with the analysis. While it appears to be a riskless transaction on the surface (guaranteed return on investment backed by the FDIC and financed through a fixed rate mortgage), upward movements in interest rates and inflation present significant long-term risks to the strategy–i.e. if you lock in at 6.5% on a CD, but yields push up to 10% during the term of the original CD, you would lose out on the higher interest rate.
At present, the best rate on a CD is still short of 4% on a five year term. Overall, there are opportunities in investment grade corporate bonds to pull off the strategy based on your mortgage rate, but that would add credit risk to the cons of the strategy.
Fundamentally, the home where you live is not an investment and shouldn’t be treated as such. It is an assets that shows no net appreciation over the long-term after factoring in maintenance, taxes, insurance, furnishings, etc. and very few are willing or able to downsize on a dollar basis if significant net appreciation is realized. It IS a place to live and a great purchase. In the bigger picture, all but a few are better served paying off the mortgage early (or at least by the time they reach retirement) rather than attempting to make a percentage point or two in an arbitrage strategy.
I will be back over the weekend to reply – it is getting very hectic around here.
Im confused. If I have a 300k mtg @ 5.125 and 150k sitting in the bank above and beyond a 12 month living expense cushion, what should I do? It seems to me rates will rise in the near term and I can conceivably find something like a 5 year CD at 6.5%. If I believe that, shouldnt I invest in the CD and then revaluate after the 5 years (or consutrct a ladder as long as the rates are higher than 5.125)? Isnt it more liquid in the CD / more than offsetting what I would benefit if I paid down the mortgage?
@Charles – To be clear, that was not condescension, but disdain that you were picking up on. I have a heightened sensitivity to strategies relying on permanent life insurance because I have yet to see this sold properly and fairly to individuals and families. In every instance where I met someone who was sold this strategy, I wound up having to play cleanup crew to unwind a poorly conceived and even more poorly executed strategy.
While you are correct that being completely out of debt will be highly rewarding and is certainly the right path, I would really enjoy a detailed treatise of the part that involves leveraging permanent life insurance to create wealth. This is the wrinkle that I have yet to see ironed out by proponents of the strategy.
If you would like a larger platform, perhaps Nickel would be so kind as to host a guest post.
@Michael
First, I may have not sequenced my comments correctly because I mixed paying off your debt with creating your own bank. If one can save tens of thousands of interest by paying off a mortgage early (and all other debt at the same time) the return will be greater than investing in anything. Dollar for dollar. This savings is not taxed.
Getting rid of debt is the best way to go for all but the most sophisticated investor who spends his or her life making all the right decisions all of the time.
I will send your reply to someone that has been doing what Nelson Nash and others advocate for a lot longer than they have. I will post his reply. He is more articulate than I am.
Because he may take a few days and will be better at this, I am not going to refute each item in your list. I am too busy getting people out of debt, and keeping them from financial disaster, and showing them how to be financially fee. I am helping them keep it simple so they do not have to risk their savings on the stock market, and weird hybrid concotions that only benefit those that tend to confuse people.
I do not mind be rebutted but your condescending attitude (“I am so sorry; give me a break”) reflects your attitude towards the rest of us mere mortals. I would rather be rich than right, happy than right. Therefore, if my seasoned vetern agrees with some of you points, I will gladly say that I am wrong.
@Charles – I have a WAY better idea than being your own bank and borrowing from yourself (via cash value life insurance). How about NEVER using another loan.
I’m sorry that you’ve been swept up into the permanent life ‘be your own bank’ philosophy, as it has an incredible number of inherent problems. Chief among them is the extra layer of expense created by having the insurance company serve as middleman for the investment part of the equation. While the insurance company will guarantee a minimum rate on the cash value accumulation, there is no guarantee that the insurance company will pass on gains from their general account. After all, that IS a major profit center – excess returns on the general account.
‘Being your own bank’ is a great idea that is really easy to sell, but when scrutinized, it doesn’t hold up.
Perhaps you could also explain why state insurance commissioners have repeatedly demanded that insurance agents stop selling cash value life insurance as a retirement vehicle. Here are the facts:
1. Whole life insurance provides a low rate of return that is typically between cash equivalents and intermediate term bonds.
2. Whole life insurance is a contract for insurance that requires payments be made until the contract is in effect, self funding.
3. Because properly funded whole life insurance continues through age 100 (in most cases), the cost of insurance on the back end is considerably higher–i.e. you’re a helluvalot more likely to die at age 90 than age 65.
4. The interest rate paid by the insurance company is dictated by the insurance company and NOT prevailing market conditions.
5. Most young people cannot afford premiums for a whole life policy with a face amount equal to their needs. This leads to a whole life/term life combination solution that increases overall administrative costs to the detriment of the insured.
6. Loans provisions in permanent life policies (WL, UL, VUL) vary from one insurer to the next, but most will have a significant interest rate early in the policy lifetime (when loans are more likely to be taken out by insureds) which negates a meaningful advantage over loans in the marketplace.
7. Permanent policies often carry long surrender periods where a substantial portion of cash value accumulated can be forfeited if a withdrawal would need to be made or if premium payments don’t continue as scheduled.
8. While being your own bank is attractive, it’s far more attractive outside of a life insurance vehicle. It is a better proposition to maintain sufficient cash reserves and take the money out when needed.
…I could go on, but for those peddling this strategy, gimme a break.
Now, if you are older, have a nasty estate tax burden, and really hate the idea of giving cash to the government, we can start talking about permanent life insurance.
Bottom Line: Insurance is insurance. Loans are loans. Cash is cash. Investments are investments. Whenever you see products designed for one, but you’re trying to turn it into something else, you will lose in the end. If you want permanent insurance to insure a permanent need, buy it. Otherwise, buy term insurance to insure the temporary need, and invest as much as you can above the premiums.
Also, please try to avoid making statements like ‘you will have found a way that outshines any investment strategy available bar none’. This is an incredible statement.
Now, let’s have a lively discussion.
Ken,
Yu brought up a good point, but not necessarily the one I intended. I momentarily forgot the subject of this blog, discussion or whatever you would like to call it. “Pay off your mortgage early or Invest?”. I am passionate about people getting out of debt, and went down a path to not only get people out of debt and keep them out of debt, but a way for them to be their own bank. R. Nelson Nash, Jeffrey Reeves and others illustrate the financial model that I promote far more eloquently than I can. If you can pay off all your debt in 10 – 12 years without changing your life style and save thousands, tens of thousands or even hundreds of thousands in interest while at the same time building your own bank so that you can borrow from yourself, you will have found a way that outshines any investment strategy available bar none. Interest free or low cost borrowings, dividends that are not taxed, and a whole host of positives outweigh investments that produce taxable income.
I hope this fires up this discussion.
By The Way, if you ever have the opportunity to attend a Millionaire Mind Intensive go for it. It is three long days, but well worth the time.
Take care and have a good life.
Generally, whole life insurance is not a good investment vehicle. Buy cheap term life insurance and invest using vehicles with low cost.
The decision to pay off your mortgage early is simple math. Run your numbers under both scenarios (paying it off early or using whatever method you think would be better). If you have a consistent system for paying off all of your debt (including mortgage) and stick with it, market influences and guestimates, even highly sophisticated algorithms designed to reduce risk, paying off your debt early and investing in the right kind of whole life insurance will payoff better in the long run as you become your own bank.
I could have made that sentence a bit longer, but I am trying to be brief.
If you ever get a chance go to T. Harv Ecker’s MIllionaire Mind seminars. It will change the way you look at money.
Take care and have a great weekend.
@ Michael Harr
I think that the people who think real estate is a great investment forget about the property taxes and maintenance expenses! It is more realistic to view it as consumption, and then be pleasantly surprised if you actually make money on it.
@DCGuy – Great discussion to be sure. I never view a primary residence as an investment. It is in fact a very poor investment over time unless you happen to buy right and downsize later (this usually doesn’t happen…once you get accustomed to your home most don’t want to take a step back). I had a number of clients in your area post 9/11 and even though there was an initial shock to prices, they recovered. Until the most recent downturn anyway. Central suburbs are still doing well relative to the outlying suburbs (think Leesburg…ouch!).
I knew you were a high net worth investor by the ideas and arguments forwarded and you are correct; there are very few people in your financial position.
Best of luck to you. If you have a strong balance sheet with sufficient liquid assets, I’d bet a good chunk of cash that you’ll find this strategy quite prosperous.
@ Michael Harr
Just one last note to thank you for the productive discussion. I appreciate it. You make a lot of good points for people to consider. In my case the mortgage prepayment is a small part of my overall investment/saving strategy, so I have the luxury to focus primarily on maximizing return. But that might not be right for every person’s situation, as you highlighted.
I hope you got some sleep!
@Michael Harr
Btw, one other risk that you did not mention that argues against putting all of the eggs in the mortgage prepay basket is the undiversified nature of a real estate investment in a particular city. I live in DC and, post-9/11, one risk that would be foolish to ignore is a major terrorist incident in the capital that could very negatively affect real estate prices. B/c one can always walk away from a secured loan like a mortgage, you can effectively force the mortgage company to face part of that risk. If you own the house free and clear, you face that risk all alone. That factor is probably most relevant for NY and DC. Of course, other assets would be affected by such an incident as well, but that is a factor that should be considered.
@DCGuy – You’re right, I do distinguish between the two choices. It isn’t the same as buying a LT Bond. It’s similar, but not the same. The biggest difference is that a failure to pay the mortgage will result in fees, collections calls, and if delinquent long enough, foreclosure. While strictly from a return perspective they are in effect, the same, they are incredibly different from a risk perspective. If I buy LT Bonds and they later result in a capital loss, it’s not nearly as big a deal as facing foreclosure.
In addition, paying down the mortgage now does not confine the total return and life decisions like LT Bonds. Though you have every intention of staying in the home for twenty years, there is always the possibility that you would move for a better opportunity, health reasons, etc. This further increases risk not only in the potential cap loss on the bonds, but also in your ability to move since the mortgage could be underwater at the time coupled with bonds that are carrying unrealized cap losses…a double dose of pain. If you eliminate the bonds from the equation, you have a reduced mortgage and can move about more freely.
In exploring what to do with additional free cash flow after purchasing appropriate insurance coverages, fully funding an emergency fund, and maxing out tax-favored retirement opportunities, it is a ‘next dollar invested’ question. Paying down the mortgage (while having similar return characteristics) represents a mechanism of reducing risk in one’s overall financial condition. There is less risk in owning one’s home outright than in owning a large portfolio of LT Bonds AND carrying a matching mortgage balance. When interest rates move to high levels, the LT Bonds will still yield above the mortgage rate, but will be essentially illiquid unless a major capital loss is desired. On the other hand, interest rates will not have quite the negative impact on the home’s value plus you get to live there.
Ultimately, I think our differences amount to the size of the financial landscape that we’re accounting for. With your analysis, it involves a somewhat more confined view that emphasizes investment return. I’m coming from a slightly more global view that emphasizes personal financial risk. In the end, I believe it a superior goal to be debt free whereas you would prefer to maximize net investment returns as long as it makes sense. The strategy you propose does make sense, but I perceive greater risk in the strategy than you.
Okay, it’s 4:30 a.m. and I’m a bit delirious…hopefully this makes sense.
@ Michael Harr
The only thing that confuses me about what you have written is that you don’t seem to view paying off mortgage principal early as buying a long term bond with a fixed interest rate. Anyone who pays off additional principal IS buying a LT bond in a near record low interest rate period! (Unless you didn’t refinance at the lower rates, but that is a whole separate discussion). It just seems to me that if a person is going to allocate part of his or her savings to buying LT bonds, he or she should at least purchase the bonds that yield the highest after tax return. Sometimes that involves prepaying the mortgage, sometimes not.
@DCGuy – I wouldn’t advise LT Government Bonds during any near record low interest rate period. I would much prefer to pay down the mortgage quickly now, and when inflation returns, purchase TIPS/I Bonds. That’s a more conservative play as it allows participation in the upside while reducing risk from personal debt. As for neglecting the inherent illiquidity of a residence, it is one thing to pay a 10% second mortgage if you need cash later and entirely another to lose 40% on LT Gov’t Bonds. Given the choice, I’d always choose the more conservative path of paying the mortgage down and if a balance remains when hyperinflation kicks up, I’ll take my TIPS and I Bonds all the way to the bank.
Either way, you have a legitimate strategy, but (without calculating the numbers) I’d say the risk/return relationship is better overall with the more conservative play. Also, I wouldn’t have any problem with LT Gov’t Bonds allocated at least to the level of the then current mortgage balance if we were already in a hyperinflation environment. At that point, it’d be hard to stop me from buying them–lots of them.
I can’t tell you how many stories clients have shared with me about ‘oh I wish I would’ve bought more long-term bonds back then’.
At any rate, great discussion.
@ Michael Harr
I probably have not been clear, which has sparked some confusion. When I refinanced my mortgage, I wanted to keep the time to amortize the note the same time as it was under the old mortgage, so I calculated the amount of extra principal I would need to pay every month to accomplish that. I could just send that cash mechanistically to the mortgage company every month, and I would then accomplish my goal But my point is that, in my case, given the tax rates that I face, I can accomplish the same goal at lower cost by buying T bonds that mature at the same date. If interest rates fall again that will no longer be true, and I will shift back to sending money to the mortgage company (and in that case I will have made a capital gain on the bonds). But, as you say, it is more likely that rates will rise, so it makes more sense to profit from the spread between T bonds and my mortgage. Essentially I am dollar cost averaging into bonds.
You are correct, of course, that I could sustain a capital loss if I needed to sell some of the bonds in an emergency, but you neglect to point out that if I had sent the money to the mortgage company I couldn’t access it at all, unless I refinanced, which would be at a higher mortgage rate if your assumptions that we are in hyperinflation hold true!
My situation is a little special b/c I plan to stay in my current house for at least 20 more years, and possibly permanently. That issue should generally affect people’s planning.
My main point is that there may be alternative strategies that are better than simply cutting the same check to the mortgage company every month.
Incidentally, if we had hyperinflation and rates were very high, would you really advise people to continue paying principal early on a 4.75% mortgage? Probably not.
@DCGuy – I understand your strategy, and it makes sense as long as many assumptions hold true. Based on the information you’ve provided, you have a fixed rate mortgage at 4.75% and are buying Treasuries that coincide with the duration of your mortgage or are close approximations. The portfolio you are building is following the long end of the yield curve which is and will continue to increase as loose monetary policy and heavy fiscal spending push the probability of inflation and ensuing interest rates higher. Your strategy will feed off of this trend as you continue to purchase Treasuries at increasing yields, improving your spreads. All of this is well and good as long as you don’t encounter a major financial emergency.
The point I am making is that unless you have sufficient cash reserves and the entire gamut of insurance coverages, a financial emergency could force you to sell Treasuries at a major discount in the secondary market. In keeping with the edge of the sword that will likely make you a good bit of money if trends hold true, the other edge has an equal potential to implode your strategy. While it is possible that your home could drop in value (as we’ve all seen in the last few years), in a hyperinflationary environment, real estate will hold up better than low-yield Treasuries purchased today. At this point, I think we can all agree that real estate has taken it’s bath and is now getting to more realistic prices. In addition, we can all agree that Treasuries are near the bottom of the yield range which is what sparked your strategy to begin with. Taking this into account, when inflation does accelerate (hyperinflation is a real risk assuming we get out of this recession and the Fed/Treasury don’t choke off a recovery), holding a paid off home will be a better bet than holding Treasuries at today’s yields.
To illustrate the potential loss on a T-Bond, let’s go through an example. Say we buy $10,000 in T-Bonds today at 4.65% and five years from now, Treasury is auctioning bonds at 8%. Your $10,000 initial purchase would need to be discounted to match the 8% yield offered at auction five years from now. Your $10,000 invested would then be worth only $5,812 or a loss of $4,188. While losses on housing have been significant of late, they still fail to reach this level with the most limited of exceptions. When inflation does move up significantly, real estate will be unlikely to see the kind of losses that Treasuries purchased today will.
Of course, you can argue that if you’re well positioned with your cash reserves and insurance that you can seriously diminish the probability of having to sell Treasuries at a bad time, but I would suggest there are very, very few people who have properly addressed all of these areas of their finances. It could be true in your case (and it sounds like you know your business), but for others out there, it’s a dangerous proposition and the risk of selling what many believe are safe assets at the wrong time must be accounted for.
CONGRATULATIONS TOM!
DCGuy – Thanks – I run many sceanarios for my clients – and just compare dollars saved as opposed to dollars spent on home mortgage (and other debt) interest. Clients can still invest as they are today by adjusting entries in the software. I am NOT a financial planner or investment person and neither are my clients (well a couple are) so just comparing $ to $ makes sense to get people out of debt.
I really appreciate your reply and would love to run your numbers in this program, but that is not why I am on this blog. Maybe we could trade hypotheticals.
Got get on my trusted steed and speed off to save one more soul by getting them out of debt.
YOu all have a great day
(typos due to haste)
DONE. Never have to write a check to the MAN again to pay for this house. Still it was a bit hard to pay the big chunck at one time. But it is over and now we can focus on the things we want to do. Save like crazy for the next seven years. Then full retirement at age 50, 44 for my beautiifual wife. And we did not even win the lotto. Just got lucky.
@ deletealldebt:
Here is an investment that has a higher ROI than paying off my mortgage: My mortgage rate is 4.75% (I just refinanced at the bottom). On Friday 30 year Treasuries were yielding about 4.65%, roughly the same maturity as my mortgage. But the after-tax yield on the Treasury bonds is higher for me, b/c I live in DC, where the state tax is pretty high (8.5%). Thus, b/c you do not pay state tax on interest earned on T-bonds, the after-tax return on buying Treasuries that mature at the same time as my mortgage is a bit higher than paying off the mortgage, and as I pointed out in my earlier post, it is a much more liquid investment. If interest rates go up, it will make less and less sense to prepay a mortgage, b/c better ROIs will be available on other financial instruments of comparable duration and risk.
It is simple math to assess this issue, but it is important that all of the relevant factors are considered. In my case it really is the different tax treatment of mortgage interest vs. bond interest that makes the mortgage prepayment a worse investment.
Pleae tell me of an investment that has a greter ROI than paying off your mortgage. I have seen some very interesting suggestions, opportunities, etc., on this blog. Paying off your mortgage early, as soon as possible gives the greatest rate of return. It is just simple math. A lot of you (but not all of you) seem to be more finacially savvy than I am, but then that is what I thought of my ex-broker also. And my ex-financial adviser, and the guy at the water cooler (do they still have those?) 🙂
I wish all blogs were this civil. Take care have a great week and see you on the upside of life.
Remember the distance between two people is a smile.
House has just been paid off —— Mentally Goal met.
Next – Invest as possible.
Security was the answer for me.
This is some good info, for what its worth, I think you should do as this, in this order:
1) Max out any matched 401K
2) Max out Roth contribution for each year
3) Make sure you have enough reserves for 1 year
4) Take any money left over and pay that amount off of the house each year until its paid off
5) Once the house is paid off and #s 1 – 3 still apply, invest in whatever is most logical at the time, for me right now the safest thing I can see out there is CDs, thats just my opinion from what I have seen, maybe some other people that have done some further investigating/monitoring of returns (besides the stock market) could provide a better investment, maybe even gold is a safe investment nowadays.
6) Play the lottery once in a while (hey, you never know) 🙂
@Michael Harr: I think that you are missing the point. When you prepay your mortgage, you are effectively buying a bond with a fixed rate equal to the interest rate on your mortgage. And you are forced to hold that bond until maturity. If it traded on the secondary market, its value would fluctuate as interest rates change, just like a T bond. But b/c that bond does not trade, you never see the fluctuation. You face the same effective interest rate risk whether you buy a T bond or prepay your mortgage, provided your strategy with the bonds is to hold them to maturity, which lines up with the date by which you want to pay off the mortgage. If the after tax rate of return on the bond is higher than your mortgage, you should put marginal dollars there. If the after tax rate of return on the bond is lower than your mortgage, you should put marginal dollars there.
I’m not buying new 30 year T bonds; I’m buying T bonds in the secondary market that mature at the date by which I want to be mortgage-free. My intention is to hold them to maturity and then collect the face value, which will exactly equal the remaining principal balance on the mortgage. Because this strategy gives you the flexibility to buy bonds when interest rates are higher than my mortgage, and prepay the mortgage when interest rates are lower, it is a less expensive way to achieve the same goal. The additional liquidity of the T bonds is just a bonus.
@DCGuy – Just remember that your bonds carry a good deal of long-term risk with them. While the yield is guaranteed by Treasury, it still leaves you with significant long-term interest rate risk. Keep in mind that yields are in the basement and with any kind of inflation, you could be eating a double digit loss on bonds purchased today. Considering the incredibly loose monetary policy and a spend as much as humanly possible fiscal policy, inflation and higher interest rates won’t be too far off in the distance.
Whether to pay off one’s mortgage early depends on looking at the alternatives. I just refinanced at a low rate, but I would still like to pay the mortgage off early. However, by investing in Treasury bonds with a maturity at my target date for retiring the mortgage, I can earn a higher after tax return on the money and hold a liquid investment. It only makes sense to prepay the mortgage if that investment earns a higher return than a comparable alternative (comparable in terms of risk profile and maturity). Putting the money into Treasury bonds is better in my case, b/c the return is higher and the liquidity is much higher.
@AnnJo – love your thinking. I’d just point out that Zimbabwe was never seriously considered as a reserve currency and while they’ve had a dictator installed for decades, it doesn’t mean that his power has achieved the kind of political stability that we enjoy here.
As for your comments about the gov, I love it! I’d add emphasis on the trust in borrowing. The credibility factor of the dollar as a reserve currency is the ONE thing that could absolutely obliterate our economy.
Great comment.
This is one of the most interesting “blogs” I have been on in quite awhile.
Tom – your situation is a no-brainer. You should spend tomorrow morning making the moves to pay off your mortgage.
With the kind of disposable income you have investigate and sign up for a divedend pay whole life insurance (I can do it for you, but selling is not the object of this discussion) and become your own bank.
I obviously agree that you should pay off that mortgage sooner than later. All the complicated math based on speculative returns advocated by expertscan not match the ROI of paying off your mortgage early. It is pure simple math based on real numbers not projections or formulas.
You need a system and you need to follow it to pay off your mortgage and ALL your debt. People without the pedigrees of some of the contributors to this blog need to get out of debt and plan for the future.
I will be out of debt soon, my major investments ar ein some munis (doing ok) and whole life. I am my own bank. It is great.
Ok so I read all these posts and many have made good arguments for both sides. My wife and I recently came into enough cash to pay off our mortgage 150,000 and still have 35,000 left over. I have a guaranteed government pension where I get 70% of my income (in 10years I can retire) plus I have another 150,000 in separate retirement vehicles and still adding, 100,000 in cash in the bank. I think I should pay off the mortgage and save the 850.00 bucks per month, I am good at saving. Not having to PAY THE MAN would be so cool. So what do you all think?
Interesting comments, Michael. My two remaining rentals are in one of the few areas of the country where house prices were historically stunningly low in relation to rents for years ($1,200 rent on a house purchased in 1996 for $110,000, for example) and only in the last few years experienced stagnant rents with price increases (we sold that house for $145,000 a couple of years ago) which so far seem to be holding. Sometimes you just get lucky.
I agree with the cap rate analysis, although I factor in expected price appreciation along with net income before deciding whether its time to sell, and the depreciation deduction also makes rental income attractive.
I include rental real estate, commodities and secured private debts (real estate contracts) in my asset allocation model as well as stocks, bonds and cash. I believe this leaves me somewhat less exposed to the vagaries of the market
I have no evidence to back this up with, but it wouldn’t surprise me a bit if George Soros was a major contributor to last year’s financial crisis – he’s always known how to make a buck out of wrecking a country’s economy – and Krugman is only a good economist when he isn’t being a partisan, so I take what they say with a grain of salt. I think it is highly improbable that Obama will allow himself to go into the next election with extraordinarily high unemployment figures, just to keep inflation down.
In fact, if the CPI included the price of government services (legal system, law enforcement, public education, nagging, berating and meddling, etc.), inflation has always been much higher than is realized and is growing at a very rapid clip.
There are only four ways a government can spend so wildly beyond its means as ours is doing and proposing to do: tax, borrow, inflate or dramatically increase productivity. HIgher taxes stifle growth and often reduce revenue rather than increase it; borrowing requires people who will trust you with their savings; increasing productivity is not something governments are very good at. If not inflation, which of those other three are you counting on?
Zimbabwe did not always have a trillion dollar bill. During the 1970s, its inflation rate was almost identical to ours at the time. Since there’s a reasonable possibility that I’ll still be kicking (weakly) 35 years from now, the deterioration of this country along those lines has to be on my horizon. And it’s problem is not, as you suggest, political instability. They have had the same dictator for more than 20 years. Their problem is the dictator’s beliefs and their effects on the economy. Dictators per se are not bad for economies (not defending dictatorship, just pointing out a reality) – witness Pinochet in Chile, Batista in Cuba, what’s his name (Kew?) in Singapore, or at present, CCP in China.
@AnnJo – Definitely the smarter play to payoff the mortgages. As you get closer to retirement, there are a few things you’ll want to monitor. The first is the capitalization rate (net income divided by property value) on your rental property. If you find that the rate falls below that of investment grade bonds, it’s time to sell. This was one key indicator for folks holding rental properties in very expensive real estate markets prior to the bubble bursting. If a property was renting at a 3% cap rate, it was pretty clear that the rent charged wasn’t out of whack, it was the value of the property that had driven the cap rate down.
With respect to stock investing, we’re in the midst of a long-term stagnant market meaning that returns in the early part of retirement are going to be far less dependable than when we’re in a long-term expansion market. This will add importance to clearly defining your asset allocation model (stocks, bonds, and cash) and then rebalancing over time and in response to market changes. A good rule of thumb is to set a reminder for every time the market moves up or down 10% and then rebalance your portfolio. By doing this, you get to buy/sell at relative lows/highs respectively. This can really make your nest egg last longer.
Also, I wouldn’t worry too much about the Zimbabwe path because they have a far less stable political environment and keep in mind that they do have a trillion dollar bill. Our policymakers won’t let inflation get that far out of control (they’ll produce enough unemployment to kill inflation however painful it might be). There was a great discussion yesterday with Roubini, Soros, Krugman, and others about this topic. The real fear is not inflation, but going Japan and seeing an extended period of deflation. Unfortunately, we are using a similar model that they used in handling our banking crisis although fiscal stimulus has been far greater from us.
The only way we go Zimbabwe is if we lose all credibility in the global financial markets. It’s possible, but only remotely so.
Right now my HELOC rate is only 2.99% with a balance from recently paying off a small mortgage on a rental property, my home mortgage rate is 5.5% and the rates available for savings/CD investments are about 1.75%. Leaving my emergency fund aside, my extra cash right now is going to pay off my mortgage. But that’s because I’m hoping to retire in about three years, and want to reduce my after-retirement expenses; if I were a decade or two younger, I’d probably be putting that extra money into more stock investments. I guess.
I do have some grave concerns about having a sizable amount of my net worth (40%) tied up in one asset, my home, and over 50% in real estate, but the current poltical climate is so hostile to business and growth, and likely to get worse before it gets better, that I’m just too nervous to put more money out there (in the market) to be seized. Of course, when hating business doesn’t work at turning things around, hating anybody with anything usually comes next, but if we truly are going down the Zimbabwe-style path, I’m not sure what can save us. There’s only so much you can worry about, though.
Interesting conversations.
Yes you should have a “rainy day” fund. You can still get Home Equity Lines of Credit (HELOCs) despite al the hoopla (harder to get sure, but still out there) and have that as an emergency fund.
Build up a whole life insurance policy and be your own bank.
There is always a way with good planning, good discipline and good thoughts. Be positive and the world will be positive with you.
@Joe Bleaux – the plan to payoff a mortgage early is only suggested if you already have an adequate emergency fund, no other debt, and are maxing out tax-favored savings options. Also, if you consider many have mortgage payments that suck 25% of their gross income away, you need only live in a paid off home for three years to have a rock solid emergency fund that would be equivalent of a full year of take-home pay.
If you have a good income, no debt, decent emergency fund, and are saving like mad, paying off a mortgage is the best option.
@JFP – if you lose your job, you’ll want to have cash or liquid securities available. If you’ve put your cash into your house, you won’t be able to get it back out. The same is true if you have a major medical problem. Do you want to be forced into selling your house when the real estate market is low because you put all your cash into paying off your mortgage?
The same is true in the bizarre case of the tree – don’t you want to have some money in a liquid account so you can cover this sort of contingency? Might it also make sense to pay for the repairs with a credit card (gasp!) so they can be completed and you can get your insurance payments and get on with your life?
Just a quick note. We are paying off our mortgage early. The interest deduction on Schedule A of your 1040 is a prime example of negative cash flow. Give your mortgage holder $1,000 then take a deduction on your Schedule A, Form 1040. If you are in the 25% tax bracket you get a credit for $250.00, heck of a return on the $1,000 you gave the mortgage holder. Any deduction that you put on Schedule A, 1040 works exactly this way. You may not be able to itemize your deductions if you don’t have that large Mortgage Interest deduction. You will lose the Mortgage Interest deduction over time, not all at once. You are still better off getting rid of that large Mortgage Interest payment. There is not any better rate of return anywhere. Most investment interest is taxable; some dividends are not, etc and you can flip, flop, hedge, nudge and calculate until the cows come home but it just plain simple math. Have a great day –
Our plan was to pay off our mortgage by retirement. However, when I took early retirement in 2007, we were only 4 years into a thirty year mortgage, and making payments to pay it off in 15 years. Unfortunately, I convinced my spouse to keep the mortgage to stay invested in the stock market. In hindsight, a bad decision 🙁
Last week, we decided to cash out most of our stock investments and pay off the mortgage. Our main reason was to reduce our monthly expenses and our retirement savings withdrawal rate. Even if the stock market goes up another 30% in the next two months, I believe that we have made the right decision for us 🙂
JFP hit it right on the head. There are many hidden risks involved that are difficult to mathematically factor in. In the end you have to learn as much as you can and go with a plan that allows you to sleep comfortably at night.
I don’t care what the Journal of Financial Planning says. For most people, my advice would be, Pay off your house. When people say, “When you run the numbers, etc.,” my response is, “You tell me the numbers you’re running, and I’ll tell you the numbers you’re ignoring.”
Here are some of the numbers these people are ignoring:
1. Probability that you will lose your job.
2. Probability that you will have a major medical problem.
3. Probability that you will invest in a ponzi scheme.
4. Probability that you will have some hassle from your bank (see #24 above).
For these factors, it is much better to have your house paid off when dealing with them, and over the course of a thirty-year mortgage, they become rather likely to happen. And so for most people the answer will be, Pay off your house.
I admit that if you are unlikely to lose your job or can easily get another one, go right ahead and invest instead.
I agree with Ric Edelman, the CPA Journal, and the Journal of Financial Planning . In mine and I believe most cases, the opportunity costs, loss of flexibility, and loss of liquidity are overwhelming bad reasons to invest in your mortgage. Particularly so when rates are so low – mortgages are the cheapest financing around. With a 30-year fixed rate of 5%, my real interest rate is just above 3%.
Debt is a tool like any other – it can be used effectively or abused to evil ends. So many of the comments here reflect a belief that debt is bad in and of itself. Generally debts are good if used to acquire generally appreciating assets, such as education (student loans) and real estate (mortgages).
My wife and I like a balanced approach and therefore put money into the following; mortgage prepayment, 401k, 529, money market. Why? We don’t know what the future holds.
When we were paying down our mortgage, all the ‘professionals’ advised against this, saying ‘cash is king’. I think they meant ‘debt is king’, which we disagree with. What allowed us to afford extra mortgage payments was the fact that we bought a small house (could have gone big). With a lower monthly payment we paid off 100k of principal much easier than otherwise. After 3 years we were in a position to buy a much nicer home. If we bought the big house first it would have been much more difficult to pay down the principal, since the interest portion of the load would have been prohibitive. Imagine where we’d be if we bought a large home on an interest only mortgage? Not that my point here is revolutionary, but note that the real estate ‘professionals’ would never be heard iterating such advice. In fact, if you were to listen to a ‘professionals’ advice, then do the opposite, you’d probably be in a better financial position.
From a diversification point of view, paying down the mortgage seemed quite clever, considering the direction the DOW has taken. But we didn’t know this would happen while cutting those checks, so deserve no credit for ‘predicting the future’.
We also invested in our 401k, which took a beating, but since we also have liquid assets as a safety net, we don’t need to take this out and get hit with a loss/penalties.
So on a high level, diversify. On a lower level, diversify (no individual stocks). It’s easy, it’s boring but it’s working very well for us.
And yes, cash is king, if it’s going into your pocket and not the banks.
@Brent – Amen, amen, amen!
Since it’s publishing I have been kicking around this debate within my own mind (see comments #16 & #23 above).
The more I debate it w/myself the more I conclude, “Self. You should pay off that mortgage and experience true freedom from debt.”
My self finally agrees with me. 😉 Looks like it is settled.
Thanks for bringing it up Nickel.
This post presents a great question — one that has crossed my mind a few times. I just made a post on our blog about this topic, with a link to this article, to build on the discussion. Cheers!
Leaving aside the psychological aspects of paying off a mortgage sooner (peace of mind, additional discipline), I think that you have to look at not paying off a mortgage and investing the cash NOT used for extra principal as similar to extra leverage in a portfolio. That is, the expected rate of return on your assets and risk will be magnified with borrowed money. As you pay down your mortgage, you deleverage and your expected rate of return and risk decrease. A lot people, including me, are more comfortable with lower risk, but should realize that this comes with a lower expected rate of return. The discipline in early payments, i.e. lower consumption, can eventually result in a re boost of return (not rate, but total return) once a mortgage is paid off and the mortgage payments redirected to a higher level of investment, at a lower leverage.
I’d pay my house off 110 times out of 100.
Strange things happen when the house is paid off. You can deal with job layoffs, bad economy, emergencies, building wealth, giving and saving at a much higher rate than if you have a mortgage. Another thing that happens when you don’t have a mortgage is you don’t get foreclosed on.
To many people forget to take risk into the equation when talking about paying off the home or not. You always hear why wouldn’t I invest my money to get 10% back instead of 5%? Once you take risk and inflation into account the difference is very small.
You should be putting 15% into retirement and saving for kids college but after that anything left should go to paying the house off.
I’m not this far yet as we’re still paying off debt, only a couple months left though.
If you have to ask all these questions about taxes and details about where to better invest your money. Look at comment number 27 and do it. You’ll be much happier. This is from someone who timed the market well in 2000 and 2007.
My mother’s home is paid off before retirement and her stock portfolio didn’t take the loss in the recent down turn. She’s got her son to manage her money instead of leaving it to a financial advisor. I was hired as a financial advisor for Ameriprise but couldn’t bring myself to sell junk to people. So I had to end that career quickly. Most financial advisors follow computer based allocation and don’t take market condition into account nor do they have the time to manage every account. Stock is very risky and you’re more likely to loose money if you don’t time the market right. Please take it from someone who’s very good with the stock market but won’t sell bad advice for money. See comment 27.
In some of the comments, there seems to be some confusion regarding taxes and comparing pre-paying a mortgaage to a taxable investment. If the investment is taxable compare your mortgage rate to the expected rate of return (obiviously everyone needs to do there own risk adjustment). But DON’T adjust your mortgage interest rate for taxes unless you also adjust the investment rate of return.
@DDFD – If someone is pursuing this strategy that you advocate, then placing money aside in an emergency fund would negate the premium returns that make this myth go. While you might put a portion of this aside, when the markets drop like a rock, your core investment fund will look like less of a safety net and more of a fire pit fueled by your hard earned cash. The risk/return metrics just don’t add up.
The tax deduction is a pittance compared to the multitude of risks endured over the course of a 15 or 30 year mortgage.
@ Michael – Quantifying risk is a function of standard deviation and can be accomplished through Monte Carlo Analysis. For those that are unfamiliar with these types of analyses, you essentially enter the expected rate of return along with the standard deviation. As an example, if you have a portfolio that is expected to return 8% annually over the long haul, and has a 14% standard deviation rate (meaning that in most years the return will be between -6% and +22%), you can determine the probability of your investments paying off. These programs will run through anywhere from 10,000 to 1,000,000 hypothetical series of returns to spit out a simple percentage probability of achieving success. In the case of paying off a mortgage versus keeping the mortgage and investing the savings, we find that paying a mortgage off makes sense based on the variability of investment returns each year–not to mention behavioral and environmental factors specific to the individual/family. If you want to grab some software, Money Tree Software is one of the better (and least expensive) providers.
At any rate, you 100% did the right thing in paying off the mortgage.
If you want to see the analysis, the link is somewhere in one of the comments I made above.
We just paid ours off. The hard thing is placing a value on is the risk that you remove from your life. If I got laid off then I don’t have to worry about that mortgage payment and we can cut our discretionary expenses way back. Most banks don’t like it when you try to cut back on your mortgage payments.
Sure historically, you can earn more than the low interest you usually pay on your mortgage, but investment returns that earn more than 5-6% per year usually have some sort of investment risk involved whereas your mortgage interest is locked in.
Paying off the mortgage early removes one of the greatest tax deductions people have– mortgage interest.
Invest the extra money and use it as a fall back to pay the mortgage in an emergency.
@Nickel – I wrote an extensive piece on this subject to finally disprove the myth that keeping a mortgage and investing the difference is smart. I’ll leave it here for your readers at the end, but your strategy is exactly where it needs to be. Max out tax-favored retirement accounts, payoff the mortgage, then enjoy your freedom. From a behavioral perspective, keeping a mortgage doesn’t work; from a mathematical perspective, keeping a mortgage doesn’t work; from an environmental (externalities) perspective, keeping a mortgage doesn’t work. Here’s the analysis:
http://www.wealthuncomplicated.com/wealthuncomplicated/2009/03/tax-myth-keep-your-mortgage-invest-the-tax-savings.html
Is anyone aware of an on-line calculator or software package that can help us weigh all of the variable in our particular situation? We are pretty balanced right now between very conservative investments and property, with our $100K mortage (5% fixed 15 year) being our only debt. My husband wants to pay off the mortgage as CDs mature.
I have less than $35k left on my mortgage. Once my car was paid off that money snowballed into my house payment. I now pay $1000 to the principal every month.
With luck I’ll even have my Roth IRA fully funded by the end of June. Right now my intent is to have that money accrue in my mutual fund and use that to fully fund my 2010 Roth in early January. I know doing it this way doesn’t allow for dollar cost averaging, but my track record for years previous has left a serious dent in my retirement investments.
For my mother and for most people, who have better things to do then spend all their time on stock market timing. I recommend this:
1. Build 3 months of emergency funds
2. Pay off all high interest credit card debts
3. Build 6 months of emergency funds
4. Pay off all car loans
5. Build 1 1/2 to 2 years of emergency funds
6. Invest in the most solid returns with the lowest risk – payoff your mortgage or save for 20% down payment on a house.
7. Invest money you can afford to loose 50% of in stocks.
Do this and you’ll sleep better and retired better then the majority of the people.
Like some other commenters, I would say both. And, the allocation of money and effort depends on your goals. If you just want to retire on Social Security (good luck!), then it is OK to invest mostly on paying off the mortgage.
However, if you want to be rich, happy and wealthy, you need to become a successful investor. So most of the time and energy should be focussed on investing.
Quite popular concern, wonderfully and timely handled.
It may have a little off-track experience here as I have a car loan at present. I had this same question in my mind for days and I decided to go with following strategy:
1) accumulate enough for my emergency funds
2) start paying double the monthly minimum towards car loan
3) create a simple CD Ladder with what I am left with
Definitely stocks might also be a great place to park some of your money but I am considering to think stocks a little later.
Here’s why I’m working furiously on paying my house off:
A year ago, my neighbor’s tree fell on my house. My home-owner’s insurance sent me a draw of $20K to start repairs, with the “carrot” of $12K when the repairs were complete. The check was made out to me and the bank that owns my mortgage. The bank’s policy is to release $10K and then when the repairs are 50% complete, they will send another check for $5K and at 90% completion, they will send the last $5K draw.
I have tried explaining to the bank that I can’t possibly get the job 90% done with only $15K. Like they care. So every extra penny I have is going into getting my house to 90% completion so that I can get the rest of the repair money so that I can get it 100% completion so that insurance will send me the rest of the money.
So, eventually, I will end up with my house repaired and an extra $12K check. But I vowed when this is over that I will never owe a dime to anyone again. If another tree falls on my house, the insurance checks will be made out to me and only me to do with as I feel best.
@Jim:
I totally agree, this is exactly what I have planned. Everything in balance & moderation.
We’re working on paying off our home early. The primary reason is the security we’ll have once we own our home debt free. But we made sure we had a good emergency fund first and that we also fully fund our Roth IRAs annually. IMO Paying down a mortgage should come after paying off other debts, building emergency fund and saving for retirement.
Undertrader,the big issue is that the house is not easily convertible into cash, especially right now – if you lost your job and moved to get a new one, you’d be paying living expenses in the new place while trying to sell the old one. Being a landlord is like getting a second job, except if you get fed up or have a health crisis or something, you can’t just quit – it takes some untangling.
Even if you don’t “make more money” on your investments (something that depends a lot on luck and market timing for both stocks & the house) for a lot of people the agility is important.
I understand that the market has underperformed & there is no gaurantee of a higher return than your current mortgage rate. Let’s say you have a 30-year fixed rate loan for $200,000 at 6.0% and you have an extra $1,000 that you want to either a) apply to your principal or b) invest. If you happen to be sitting at year 5 of your mortgage when you have this $1,000 bonus, then you could pre-pay the mortgage and save over $3,400 in interest and immediately increase the equity in your home by $1,000. But if you invested that same $1,000 and happened to get an average of 8% growth over the next 25 years, then you’d have an investment account worth about $6,800.
I’m investing the cash; isn’t having an investment portfolio that exceeds your mortgage the same as having it paid off? With the added bonus of higher returns.
I paid off both of my houses and here’s why:
1) The stock market was tanking and there was no way I was going to be making a 10% return anytime soon without day trading, which I could do, but I’d rather play video games and go bike riding.
2) I lowered my monthly expenses by $2000. That’s $2000 extra per month in my pocket while I have 2 paid for houses. That’s the most important thing to me. I could lose my job and have the market tank and go get a job at McDonalds and still be able to live in my 1900 sq ft house and pay all my bills with no problem at all. If I can make 10% on my investment cash, I can effectively retire.
While everyone always says, “You could make more if you invest the cash!” Sure, you COULD make more, but you may not and then where are you? Without money and without your home potentially, which is what a good chunk of the country is looking at. My family is going through this recession and laughing. Our monthly bills including food come to less than $1000 a month with 2 incomes and 2 paid for homes, one of which is being rented by someone who lost their home that is bringing us $1500 a month. We could retire right now and have $500 cash extra a month and the stock market and recession wouldn’t affect us in any way at all.
Now, with no bills, we can take that $2000 a month and do whatever we want with it, throw it in a Roth IRA, go on a cruise, buy a car with cash at the end of the year. It opens up so many opportunities and lowers your risk to the point where the current economic situation doesn’t matter. We can leave our investments and know we don’t need to sell our stock for the next 30 years, well after this recession is over.
Pay off the mortgage if you can, the peace of mind is worth it.
– Undertrader
We do both – we’re actually refinancing right now from a 30- to a 15-year mortgage, and if we continue to pay at our current rate we’ll be done in a total of about 15 years over both (the new mortgage is 2% lower than our current rate, so even with fees & taxes it’s going to save us quite a bit of money). That will put us completely out of debt before age 45.
At the same time, we both contribute to 401ks and Roths. Plus a 529 for the kid – we treat the retirement and college accounts as monthly bills, along with monthly charitable donations & utilities.
This lets us balance the insecurity of the stock market against the known cost of our mortgage. Plus, it means if one of the tactics turns out to be better than the other, we didnt’ miss out completely.
I’m not sure about the psychological benefit of not having a mortgage – we will still have taxes & insurance to pay when the debt is gone, so we’ll either have to self-escrow or pay biannually anyway.
Dave — I don’t think that’s an example of imputed income. Having fewer expenses per month doesn’t mean you’re earning more money, it means you don’t _have_ to earn as much money. That is, without a $1,000/mo loan payment you would be able to survive with a $1,333/mo lower salary.
Or you could continue earning the $1,333, pay taxes, and invest the remaining $1,000. Which brings us to the question under debate.
A few things:
1. It is VERY attractive for me to pay off my mortgage early so I no longer have the payment. This would allow me to “semi-retire” and work at whatever job I wanted, however often I wanted.
2. RANT **Inflation wouldn’t factor in nearly as much if our gov’t didn’t run the largest counterfeit operation in the history of the world – aka, they just print money whenever they want for all the wrong reasons** RANT OVER.
3. Taking into account my point #1 above, I see myself being torn between choosing to completely pay it off early or do as Nickel suggests and do both. Pay off mortgage in around 7 years while maxing out retirement contributions.
When it’s all said & done I’m going to say I would definitely lean toward having it paid off within 10 years, thus eliminating the huge interest amounts most home owners pay. In doing so, I would also prefer to max out my savings contributions along the way.
I will let you know for sure once I pay off my $12,000 left in high interest consumer debt, which will take me another 6 – 12 months…Lord willing.
I like the idea of having the money in an safe(er)investment that offers a return equal to the interest rate or better. With the CD rates being low, an investment in a muni would offer a return close to the interest rate on the mortgage.
That way the earnings on the investment are not taxed, you have the advantage of itemized deductions and in the event of a job loss or some other traumatic event, you can cash in your investment and pay off your mortgage.
Additionally, you will need less of the amount invested to pay off your mortgage every month since the principal outstanding will reduce every month. So as you pay off your mortgage, this in essence becomes a nest egg.
Of course one should have the amount needed to pay off the mortgage at hand in the first place and secondly have a disciplined approach never to touch this money for anything else.
We’re doing both just as Nickel outlines above. We max out our IRA, and then put the rest toward extra principle on our mortgage. Personally, in this economic climate, there is more of an emotional pull to enjoy a mortgage hanging over my head.
Mike hit the nail on the head. Not having to pay a mortgage is called “imputed income” and it isn’t taxed. For example, how much money do you have to earn every month to pay your mortgage? Say your payment is $1,000. If you are in the 25% tax bracket, you have to earn $1,333 to see $1,000 after taxes. So NOT having to pay $1,000 a month is like earning $1,333 tax free. (The government hasn’t caught on to taxing this “imputed income…..yet! LOL!”) This “imputed income” combined with the increasing value of your home (and yes, homes will again start to increase, at least the rate of inflation) would bring in as good or better return than stocks. Here is a Scott Burns article that explains the concept:
http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/columns/archives/1999/990525TU.htm
We decided to do a bit of both as well. We’re on track to pay our 30-year mortgage off in 15 years or less, but we’re saving at the same time.
Bi-weekly payments brought our 30-year to about 22.5 years, and we’re throwing in some extra each month towards the principal to bring it closer to 15 years.
For me the tipping point is if one can earn more than the after tax rate of mortgage however I was unaware of asset protection bough up by Christine, so I have to give this another thought…
Interesting point, Christine. I had never thought about that.
Another advantage of paying off/down your primary residence mortgage that many overlook is asset protection, meaning that, in some states, the equity in your home is protected in the event of a lawsuit (like in Florida). So, someone may sue you and may get your non-retirement bank accounts/investments, but the equity in your home cannot be touched. It is different in every state and there are certain limits, etc., but it is worth looking in to.
We bought a house last month and decided to make a sizable extra principal payment each month (effectively making our 30 yr into a 15yr). Rationale behind the extra payment is that it forces us to remain frugal with our discretionary spending. If the money isn’t there to spend, it becomes a mentality. Whereas if we put the money in the market, its doesn’t have the same effect as being “gone”. We can alway close out positions. Our hope is that it reigns in our pattern of spending earlier in our careers, putting us on the path to financial independence down the road.
I think it’s important to realize that these two goals aren’t mutually exclusive. What’s the point of paying off the mortgage if you’ll be 55 with no investments when it’s paid off?
We ran the numbers and are working to pay off the mortgage and hit semi-retirement in the same year. It worked out to be a 60/40 split, with 60% of our extra money going towards investments and 40% towards the mortgage. Of course, paying off the mortgage also reduces the amount of cash flow needed – which made our investment goals just a bit more reachable! We’ll run the numbers again once a year to make sure we’re still on track.
I was laid off in 2002 and was looking at a prolonged unemployment. Salaries in my profession were plummeting. I ended up being unemployed for about 18 months with a salary about 50%.
I had the cash available from a great contract the previous year. I looked at how many months of house payments that cash would make vs. paying it off. I considered the interest part of the payments as a waste of cash at the time and paid it off.
Piece of mind has value…
Now I am probably saving about 50% between various retirement & personal accounts. Savings can build fast if your not sending it to someone else, and you maintain your same lifestyle.
This is a great overview of the issue. I don’t own a home, nor do I invest, however you asked my opinion (at the end of the post) so here it is.
When I hear people talk about this issue, I always like backing into the question. By that I mean examining on whether or not you would borrow additional money on your house to invest in the stock market or bond markets.
For most, the answer would be no. I understand you always are going to need more motivation to change than to not change. But for me, I can’t imagine myself doing that, so I would primarily focus on the mortgage debt first.
Maybe my tune will change in 2-5 years once I’m faced with the issue head on! Hopefully, I’ll be lucky to be in your situation Nickel. A little for everyone!
To us, mortgage = debt, and we wanted to rid ourselves of all debt. It’s a great feeling having one less monthly payment, and a big one at that. You can go through all of the analysis that you’re missing out on tax deductible interest, or the opportunity cost to your missed investments, but each extra principal payment brought us closer to financial freedom. I don’t regret the decision at all.
Depending on your tax situation, you might be able to buy municipal bonds with a higher after-tax return than the mortgage rate right now.
Matt: The vehicle doesn’t technically matter as long as it outperforms the mortgage interest rate. Going “all in” on equities will raise your expected average rate of return, but will also create a very volatile (risky) portfolio.
Look at it this way… Back in the early 1980s, CDs were paying 10-12%. I know this, because I was heading into middle school around that time and I bought some with the money I was saving for college. Now, I’m not suggesting that 10-12% CDs are just around the corner, but think of the (guaranteed) killing that you could make if they were.
Using mortgage proceeds to invest in the stock market could make sense for the reasons you give. But it doesn’t make sense to invest mortgage proceeds in bonds, CD’s, or other low-return investments because the marginal return (if any) isn’t worth the risk. In practice, this means your investment portfolio should be 100% stocks until you’re out of mortgage debt. Only after that does it make sense to hold the ‘diversified portfolio of stocks and bonds’ the experts talk about.