Paying off my mortgage question

Factual Questions
41

Exactly. The problem is that it’s very hard to map out the future of long term investments - you will always have to make assumptions. Certified Financial Planners will say you can conservatively expect the a moderately aggressive stock portfolio (S&P 500 index, for example) to gain ~7%. Talk radio hosts like Dave Ramsey will say you can expect 12%, because they’re not held to any sort of fiduciary standard or responsibility.

Also, you can’t assign hard values to things like risk tolerance.

It has been my anecdotal experience as a financial professional that people who prioritize debt repayment do a better job of long-term wealth accumulation than those who try to juggle credit card promotions, T-Bill ladders, and other interest min/maxing schemes. I think the reason is because they tend to do a better job of creating and staying on a budget, and put a higher priority on the long-term aspects of balancing debt and wealth accumulation, rather than the short-term benefits of savings account shopping. Those types of habits sometimes bleed into thinking that they can time the market, which is a great way to limit your long term growth potential.

42

Also keep in mind that diversification is a thing. Even if paying down the mortgage isn’t numerically the absolute best option, throwing a hundred or three at it a month, while putting additional savings in other places, is a sound strategy.

I would not put all of your savings into the mortgage, though. If something comes up where you need that money, it will be very expensive to get it back out. That is the risk associated with putting it all into the mortgage.

43

As is all of itemization if you are middle-class.

44

Yup, state and local taxes as well. As someone in a high tax state, I say grrr.

45

This was how my wife and I felt and I think it has paid off for us focusing on getting completely out of debt. It definitely leads to lower stress in your life knowing that you need so much less to live on so in the event of job loss, you don’t need that much to get by on since you are just paying for groceries and utilities.

46

Just a note - Canada and USA are very different wrt morthgages - in Canada, you take out, say, a “25 year morthgage with a 5 year term” when the term is up, you refinance at current market rates. Rising interest is starting to bite homeowners here as the new rates become applicable upon mortgage renewal.

In the USA, you take out a mortgage for the life of the mortgage, with a fixed rate for that life. Interest is allegely deductible (not in Canada).

Canadian mortgages typically limit pay-down to 10% of original principal, and ability to double up payments. I assume your US mirtgage has no such limits.

Another important point to consider. What’s your marginal tax rate (i.e. on each extra dollar you earn)?

If you invest and make 5%, but pay (let’s say) 25% of those earnings in taxes, you only made 3.75% take-home. For $25K, 5%=>$1250, 25% tax=>$412.
If you pay down your mortgage, $25K is roughly 1/5 of $120K. So, you are paying $5604 or so in interest over a year. Subtract $25K from that debt, and you are paying $4,436 a year. (of course, this changes as you pay things down, and because of monthly calculation, yada yada) So, $1168 less of interest to deduct. If it can be deducted at marginal tax rate, $1168x1/4=$292. (Assuming you can deduct)

About $300 vs. $400, the break even is close over a year. Just with one, you don’t owe on the house much sooner. With the other, you may have a huge amount of resultant investment. “Rule of 70” says roughly(!) within 70/(interest rate) years, your money should double. 70/5=14. In 14 years you’d have $50K instead. Asuming (!!!) you can get a consistent 5% from the markets. They go up, they go down.

Another consideration, what investment? If you keep some cash around for a rainy day but invest, how easy is it to get the money out on short notice. Can you handle needing a new furnace, or air conditioner, or replacing the roof shingles? (Things we’ve done in the last 10 years on a relatively new house) My wife’s uncle was managing her grandmother’s money, and when she died there were some bonds that did not mature for a year, holding up the estate distribution. Usually the better and less risky investments hav lock-in provisions.

if it were me, I’d put $15K on the house and hold $10K in reserve. If you are confident your parents can cover or loan any emergency funds, then put down the whole amount. Myself, I prefer not being in debt so paying off the house is a priority.

47

If you have locked in an interest rate well below current mortgage rates (true for essentially everyone with a fixed rate mortgage right now), then the lender would strongly prefer that you pay it off as fast as possible.

48

Depends on what other deductions you have. Being retired, I didn’t have a lot, so the mortgage interest deduction became worthless and I paid off my mortgage since the effective interest rate went up.

49

Another thing to remember about itemizing and the mortgage interest deduction is that it’s instead of, not on top of, the standard deduction.

For a simplified example with representative = ballpark made-up numbers. Assume we’re talking about a single person and that the single person standard deduction is $12,000. Which it really was a couple of years ago.

If their mortgage interest is $13,000 and they have no other itemizable deductions then yes, they’re money ahead to itemize. But they’re only getting benefit on that last $1,000. They’ve spent $13K on interest to increase their deductions by $1K, which reduces they’re taxes owed by about $250.

Now if they’re somebody with a $900K mortgage and $80K of mortgage interest, then they’re getting the benefit of 80-12 = $68K of extra deductions = $17K reduction in taxes owed. Big difference in the tax reduction leverage.

At the other extreme of course is the person whose mortgage interest comes up to $11,995. They spent all that interest and get zero tax advantage at all; they’re still slightly (by a buck or two) better off taking the standard deduction.

50

So does the person who paid off their house get the benefit of the $12,000 deduction, meaning they come out ahead even more?

51

Also, I have a vague recollection of reading that investing money generally has better ultimate results than using it to pay off mortgage principal.

52

That would have been the case when investments (stocks especially) grew like crazy, and mortgage rates (or interest rates generally) were pretty close to zero. When the economy almost ground to a halt, rates dropped close to zero, and there never seemed to be a good time (or excuse) to correct that. The current round of inflation mitigation has corrected this imbalance. There’s also the current jitters that the stock market is due for a “correction”. So… who knows?

Indeed, my theory is that low interest rates aggravated the wild swings of the stock market, not to mention silliness like the Madoff scandal, and especially the subprime mortgage fiasco. With no reliable but decently-paying investments, people were willing to try assorted other venues to get a good return on investment.

Another factor to consider, which really is a blast from the past (the 80’s) is inflation. People would borrow or mortgage knowing that due to inflation, everything was going up but their debt would be fixed. You pay down debt with your increasing income. Of course, back then interest rates compensated for inflation. If today you are lucky to be locked into a low rate, but also lucky in getting good raises due to inflation, your debt as a proportion of your income is less.

53

Yes? I’m not sure what you’re asking. You get the larger personal deduction, regardless of the mortgage interest you paid, so you keep the interest you would have paid. However, if the money would have earned more in some other instrument, then you’re worse off. The $12,000 deduction doesn’t change that.

54

So it seems to me unless you have a fairly large mortgage interest bill (which OP does not - $5600) then the amount of interest is not greater than the default deduction; so mortgage interest deduction is not a factor in any decision to pay down or not.

55

That’s correct thinking. A few years ago, when the standard deduction was much smaller, say $5K, a LOT more people with mortgages could itemize.

So the idea of deductible mortgage interest as a tax dodge is still out there, and lots of websites have pages talking about it, and it’s still in the public consciousness today, a lot more than it’s actually applicable to most people. As us old farts fade, the new generation that don’t remember the old ways will gradually take over.

56

Yes. This is another major difference between the USA and Canada. Here. mortgage interest on on-investment properties (your home, your cottage) is not deductible. As a result, the incentive is to pay off the house ASAP. The news in the 2008 fiasco was that so many Americans enjoyed the deductible interest, and treated their house as an ATM. When equity got large enough, remortgage to the hilt and spend the balance on big boy toys. So when the economy took a dump, and house prices tumbled, people were left with underwater mortgage amounts.

57

Don’t forget that if you invest that money you will pay tax on the proceeds. If you use it to pay down the mortgage, you will not. So, depending on your tax bracket (and also whether you itemize deductions and get to use your mortgage deduction), you may need to a earn a good deal more than your interest to break even. Subject to having at least a small rainy day fund, I would pay down the mortgage.

58

The deductibility thing has always been overrated. As in people talk like it makes a bigger difference than it really does to people’s behavior.

IMO the “incentive to pay off ASAP” is cultural, not economic.

In an era of 2% loans and 10% stock market returns, paying off debt is economically foolhardy; it merely ensures you’ll always stay poor-ish. But people who’re culturally not aimed at max financial performance and who eschew “he who dies with the most toys wins” don’t consider economics foremost.

59

Not in my professional experience. As I mentioned earlier, clients with budgetary discipline tend to prioritize debt repayment and wealth accumulation. Those who accumulate debt don’t accumulate wealth (again, in my experience).

60

OP could conceivably open a Roth IRA and get the same tax free benefit.