Save, invest or pay down debt?

[ForumBot]

[warning! not qualified to give advice on important things like money! quite likely giving bad advice!]

@friedo

There are many savings accounts that offer 5% interest, fully FDIC-insured, with no withdrawal penalties. ING Direct offers them, as does Citibank (but you have to be a Citi customer already.) If you put your cash into one of those, you’re only “losing” 2% on the debt. You still have the debt payments, but you’ve got an emergency cash stash as well.

You’re forgetting inflation. Your real income only comes in after taking out that 2-3% inflation rate, so even with a 5% interest rate you’re still only seeing a real 2% benefit at best, which is what his debt rate is. You’re coming out neutral if you invest it in one of these savings accounts.

Pay off the debt.

Then again, I’m a freak about debt and hate hate hate hate hate owing anybody money. It’s a constant drain on my psyche knowing that I have unpaid debts–even good ones, like school loans.

[Cat_Whisperer]

@Voyager

But that might not be a good idea. The best way of analyzing any choices is to look at return on each dollar, after accounting for risk. (Which is why the fairly easily accessible money market nest egg is good. But say you have a 5.5% mortgage, which looks like a 4% mortgage due to its tax advantage. If you can invest the money you’d be using to pay it off at 6%, then it makes no sense to invest it at 4. If you feel like it, you can use this money to pay it off in a lump sum when you retire. You also might decide to move to a smaller house or a less expensive housing market, in which case you might be able to pay off all that you owe and have a nice chunk of equity left. (Depending on the growth of the housing market, etc.)
I think someone has mentioned that mortgage investments aren’t very liquid. Much better to put the money someplace where you can get it out again in case of an emergency, and not have to borrow against equity.

I appreciate the emotional appeal of having no mortgage, but I’ve read enough behavioral economics to know emotional reasons are often not very good.

I can see what you’re saying, but there is a lot to be said for having your house paid off when you go into retirement, and knowing that you will have a roof over your head regardless of what else happens. I wouldn’t completely discount the emotions involved in finances; how many people toss and turn at night because of their debt loads? I’m pretty sure I will sleep better knowing that I won’t have a mortgage or rent expense to worry about when my income drops sharply at retirement. No investment is as financially stable as having no debt. Everyone is putting all their eggs in the RRSP baskets (401ks), but those aren’t written in stone guaranteed, either. I prefer to have a few eggs in a whole lotta baskets, and the paid off mortgage is one of them.

[Giraffe]

@ForumBot

[warning! not qualified to give advice on important things like money! quite likely giving bad advice!]

You’re forgetting inflation. Your real income only comes in after taking out that 2-3% inflation rate, so even with a 5% interest rate you’re still only seeing a real 2% benefit at best, which is what his debt rate is. You’re coming out neutral if you invest it in one of these savings accounts.

Pay off the debt.

Inflation works against the debt in the exact same way that it works against the interest on a savings account. It doesn’t make paying off the debt any more or less attractive than savings.

[Voyager]

@featherlou

I can see what you’re saying, but there is a lot to be said for having your house paid off when you go into retirement, and knowing that you will have a roof over your head regardless of what else happens. I wouldn’t completely discount the emotions involved in finances; how many people toss and turn at night because of their debt loads? I’m pretty sure I will sleep better knowing that I won’t have a mortgage or rent expense to worry about when my income drops sharply at retirement. No investment is as financially stable as having no debt. Everyone is putting all their eggs in the RRSP baskets (401ks), but those aren’t written in stone guaranteed, either. I prefer to have a few eggs in a whole lotta baskets, and the paid off mortgage is one of them.

I’m not discounting emotions - but when you make decisions, it is good to run the numbers and not do what feels good. There are countless cases of people making bad decisions by not doing that.

Clearly you’d want to put your mortgage money somewhere safe, and use other money for riskier investing. So what happens if the interest rate drops? In that case, I suspect you would be able to refinance, and the return of paying down the mortgage faster would drop also. The question is whether you can find a safe and reliable investment that returns better than a mortgage. I think the answer is yes, since mortgage rates are low because of the big collateral, and because of the tax break.

Now, our mortgage is small relative to the value of our house, and 1/3 of it is held by my wife’s father, who is 92. But I’ve deliberately avoided paying off the mortgage company mortgage early. I can track my other investments, and over the past 10 years they have yielded much better than a mortgage payment would have.

You’re ahead either way - you only get behind by spending money on stuff that soon becomes worthless. I doubt the difference will be all that big.