Why not pay off mortgage?

In My Humble Opinion
21

Yeah.

Ditto to almost everything.

If I’d known for the last three months that the market would do what it has done, I’d have been putting my money into paying down my mortgage. But, you don’t know. Paying down the mortgage faster is a good way to have less money when you retire. . .especially if you’re not disciplined enough to put every cent you save on the back-end into the market when you’re done paying it off.

I once calculated with reasonable rates of return how much money I’m “losing” by having a 15 year mortgage instead of a 30.

The model assumes that I’d put the extra money in the market each month, which may not be reasonable, but paying down your mortgage is certainly no great way to build wealth.

22

[QUOTE=pulykamell]
That’s the problem. You play stock picks and you expose yourself to a lot of risk. You may do really well, you may do really shitty. Find some low cost ETFs that track major indices and, over a 30 year period you should, if historic S&P rates hold true, average out at 7-10% APY.
[/QUOTE]

If historic rates hold true. On the other hand, paying off the mortgage got me a sure thing 6%.

I do have other assets than just the house, this was not either or for us. We have other stock (the eTrade thing was for fun), some in individual stock, some in funds. We have bond funds. We have 401ks that are being max funded. Deferred comp. We have 529s for the kids.

The other emotional factor is discipline. Paying off the house meant we spent money on an obligation. Having stock sitting around means that we occasionally sell it and take a trip or buy a car. The money is there to spend, I don’t feel too guilty, but having the house paid off meets an obligation - a new car really isn’t an obligation. If you spend the money, then its not earning any return (well, except enjoyment - its a nice car).

23

But if you’re investing with after tax dollars, those are going to be taxed as well so the 7-10% invested in a safe mutual fund might turn into 6-9% after taxes (unless you invest in a broad array of actual stocks which would be expensive itself unless you have lots of money.)

What I’d personally do:
Choice between 401k mutual fund and pay off tax dedicutable mortgage: 401k even if it’s not matched.
Choice between 401k mutual fund and pay off NON deductable mortgage: hmmm, that’s a hard one. I don’t know what I’d do. Fortunately I have enough money to do both.
Choice between NON tax advantaged mutual fund and pay off NON deductible mortgage: now the tables are reversed. That %6 you are saving in mortgage can be the equivalent of %7.5 because if you invest it you will have to pay taxes on what you earn, whereas there is no interest on the interest you are NOT paying. I’d personally pay off my mortgage in that situation.

24

[QUOTE=Dangerosa]
If historic rates hold true. On the other hand, paying off the mortgage got me a sure thing 6%.

[/QUOTE]

Which I do mention in my first post. The peace of mind factor is probably why I would end up paying off a mortgage over less than 30 years, but, the rational side of me really can’t find any good reason why, given a disciplined approach to investing and putting all the money you’d be putting in a paying off a mortgage quicker into a broad market index ETF instead (and not spending any of it before the 30 years is up), why you wouldn’t end up significantly ahead monetarily in the latter scenario.

25

Like most others have stated it seems pretty clear.

Say a $200K mortgage.
If a 6% 30-year mortgage is actually a 4.75% after tax deductiuons,
and the 30-year average return on the S&P 500 is 8%,

it seems like a no-brainer to be able to borrow $200K at 4.75% and invest it at an 8% rate and net 3.25% over 30 years.

26

[QUOTE=Hampshire]

it seems like a no-brainer to be able to borrow $200K at 4.75% and invest it at an 8% rate and net 3.25% over 30 years.
[/QUOTE]

I don’t think it’s a no-brainer. As featherlou wisely points out, you can’t live in a no-load index fund. To me, the substantial risk-reduction of having full equity in a home is a better investment than anything that returns 3.25%.

But that’s just one hoopy frood’s opinion.

27

[QUOTE=friedo]
I don’t think it’s a no-brainer. As featherlou wisely points out, you can’t live in a no-load index fund. To me, the substantial risk-reduction of having full equity in a home is a better investment than anything that returns 3.25%.

[/QUOTE]

But at the end of 30 years, you have your house AND an extra couple of hundred thousand dollars from the interest differential (once again, assuming long-term trends continue). Also, if you should decide at some point, say 15 years in, that maybe you’re better off paying off the mortgage, you’ve got 15 years of invested funds you cash in and buy out your house.

28

I think one of the considerations is whether you have other debts. If you choose to unload a debt by paying it off early, go with one without the tax breaks, like a car payment.

29

Maybe I think darker than others…

Paying off your mortgage is a good thing. However, you then have an asset that can easily be seized or destroyed. The same thing could be done with money but you still have the opportunity to store some away in case of disaster where insurance isn’t coming forth or lawsuit etc.

I don’t live in fear of these things, but it does enter my mind when I consider having cash or paying off part of the mortgage.

Also, if you are a guy and are married with kids and your wife sleeps with the mailman and decides to divorce you…cash will most likely be split. However, the house will be for her and the kids.

I know it’s dark and people don’t want or like to think that way…but easily seen and non-liquid assets have a risk.

30

[QUOTE=friedo]
I don’t think it’s a no-brainer. As featherlou wisely points out, you can’t live in a no-load index fund. To me, the substantial risk-reduction of having full equity in a home is a better investment than anything that returns 3.25%.

But that’s just one hoopy frood’s opinion.
[/QUOTE]

Okay, let me rephrase it from:
“it seems like a no-brainer to be able to borrow $200K at 4.75% and invest it at an 8% rate and net 3.25% over 30 years.”

to:
“it seems like a no-brainer to be able to borrow $200K at 4.75%, have a sudden windfall of $200K cash and invest it at an 8% rate, and net a 3.25% over 30 years
rather than using that $200K windfall to pay off the $200K mortgage.”

31

Once you’ve paid off all your other debts, then it’s time to consider paying off a mortgage. A mortgage is the best loan, lowest rate anyway, that most of us will every get and so should be the last one to discharge. Car loans, home inprovement loans, credit card debt (ouch), bookie debts, that $5 you borrowed from your buddy back in '03 and a thousand others, even the money you are thinking about borrowing … get rid of those first.

Then, if your mortage rate is X% you just have to decide if you can make X% or greater by investing OVER THE LONG TERM, which you almost certainly can.

32

But still, the 8% is taxable, too. Unless you can put it in a 401k or the like, in which case that’s what I’d do (if your company has a good selection of funds, that is. I’ve been at places where the fees were over .5% for an index fund! At that place I still invested in the 401k but only to the extent it was matched.)

33

How will paying off your house give you LESS money at retirement?

If you have no monthly mortgage payment, then you have MORE of your fixed income to live on.

The “tax savings” argument doen’t wash ,either, since most retirees won’t have incomes out of the 15% bracket and , at any rate, can only take the deduction on interest above the amount of the Standard Deduction.

At any age, not just retirement age, one can find one’s neighborhood changing for the worse. If you don’t need a minimum price dictated by an indebtedness, you can bail out quickly. Indeed, the poor bastard with a debt of 80% of what the house was worth before the rendering plant,meth lab, whatever, came in could be left upside down as his paid-off/nearly paid-off neighbors bail.

34

[QUOTE=Ludovic]
But still, the 8% is taxable, too.
[/QUOTE]

Sure. What’s long-term capital gains these days? 15% until 2010, IIRC, then back to 20% if everything goes well. Even taking into account those gains, you’re still up by around over a hundred grand on a $200K mortgage over the course of a 30-year mortgage, assuming the stock markets historical average holds and you get an effective differential of 2-3% between your mortgage rates and your investment yield. If you get a difference of 3.75%, you’re looking at over $150K in extra cash, even after taxes, unless I’ve done a calculation wrong.

I’m doing this using a windfall scenario, in which you have $200K available at the outset and you have two choices: a) buy a house outright for $200K or b) invest $200K in an index ETF and take the mortgage out for 30 years. In that scenario, it seems to me that B is clearly the wise choice.

Now, I’d be interested to see how the numbers work on somebody starting from scratch, who, say, has a 30-year loan and instead of putting an extra $1000 into the mortgage every month to pay it off early, instead puts the $1000 into an an index fund. It still should work out better, but I imagine the gains would be much more negligible.

35

The problem with that being it assumes that you aren’t going to need the money.

If shit happens and the stock market tanks when I need the money to make mortgage payments (as has happened recently - the problem being that recessions tend to cause job loss and markets tanking at the same time), that can tank that return. I can’t turn the house liquid any faster, but since I need somewhere to live and my house is pretty reasonable, its not going to be the first thing I sell - I might, however, need to sell that stock in a down market to make ends meet - especially if I have a mortgage.

36

[QUOTE=zenith]
How will paying off your house give you LESS money at retirement?

If you have no monthly mortgage payment, then you have MORE of your fixed income to live on.

The “tax savings” argument doen’t wash ,either, since most retirees won’t have incomes out of the 15% bracket and , at any rate, can only take the deduction on interest above the amount of the Standard Deduction.

At any age, not just retirement age, one can find one’s neighborhood changing for the worse. If you don’t need a minimum price dictated by an indebtedness, you can bail out quickly. Indeed, the poor bastard with a debt of 80% of what the house was worth before the rendering plant,meth lab, whatever, came in could be left upside down as his paid-off/nearly paid-off neighbors bail.
[/QUOTE]

This perspective overlooks a lot of relevant factors.

Paying off your house instead of investing the money at a higher rate of return will give you less money in retirement. Let’s take an obvious case of someone who has an extra $100 per month after taxes that they can pay extra toward the mortgage. Alternatively, they can put $125 pre-tax in a 401(k) with a 1 to 1 match. The $100 and $125 reflect the fact that to pay $100 toward the mortgage you need to earn more than $100 gross.

(A one to one match is not that uncommon for a generous plan or for the first 1-2% of salary, although a 50 cent match is more typical.)

In the first year they can reduce mortgage by $1200, saving approx. 6% interest on that $1200. However, some of that interest would have been tax deductible, so the savings are more like 4.75%. Or, they can put the money in the matched 401(k). At the end of the first year, they have $3000, and can earn 6% or more on that investment. That money grows tax free until it is withdrawn in retirement, when, as you note, the person is likely to be at a low tax rate.

I did pick a case where the higher rate of return was flat-out obvious, but it’s one that many people in the US do have available and don’t take advantage of. Obviously, each individual needs to crunch his own numbers.

Having no monthly mortgage payment is a wash compared to having a larger investment income to pay it out of. True, there will be those months at the end when you can invest your former mortgage payment, but by that time you will have lost out on a lot of the power of compound interest.

Not sure what “tax savings” argument you are talking about, but tax deferred investments like a 401(k) or IRA allow you to put off paying taxes from when you are at a high rate to retirement when you are likely to be at a low rate. If you are referring to the value of the mortgage deduction in retirement being low, well, yeah, it will be, because by that time you are paying off a lot of principal and your income will be low. But you have also gotten the value of that deduction throughout your high-earning years.

In your last scenario, having investment assets outside your home will provide just as much if not more freedom if you need to move or sell in a hurry. The person who is screwed is the one who is upside-down with no savings.

37

It all comes down to opportunity cost. From a strict financial point of view the smartest thing to do is to invest your money in a mutual fund rather than paying off your mortgage. Consumer reports did a nice analysis of this.

http://www.consumerreports.org/cro/money/credit-loan/prepaying-your-mortgage-3-08/overview/prepay-mortgage-ov.htm

This discounts the “piece of mind” that you get from not having a mortgage. But paying off your house means that you money is tied up in a relatively non-liquid form rather than being more easily accessible if you need it.

38

It all depends on your situation and everyone’s is different.

To me, the $100 extra a month doesn’t really seem like a serious attempt to pay off your mortage. If that’s all the extra you can afford then you’re probably better off investing it. You might shave off, what, a couple years…?

But if, for example, you’re 3 years into a 30 year mortage and you have the income to pay it off over the next 5, while still saving for retirement, no credit card debt, emergency fund is full, and living expenses covered, then why not go for it, especially if peace of mind is a factor?

39

[QUOTE=friedo]
To me, the substantial risk-reduction of having full equity in a home is a better investment than anything that returns 3.25%.

But that’s just one hoopy frood’s opinion.
[/QUOTE]

Not sure if I understand this logic.

To my eye, having 100% equity in your home magnifies your risk to property value fluctuation. If home prices are softening and for whatever reason you have to sell, you run a serious risk of losing a piece of the actual equity you have in the house. But if you are leveraged, you pass some of that risk onto your lender. As long as your sale price can pay off your note (and the transaction costs), you don’t actually lose money even if the value of the property is less than the price you bought it for. At the very least, you can get all of the equity back that you put in.

40

Oh, I forgot.

One of the other factors in MY OWN calculations was that I had an ARM at 6% that would have adjusted eventually - with an 11% cap. So I probably would have needed to refinance and pay closing costs on a new loan. That ate a lot into the delta of what was going to net the most cash. I still came out slightly ahead if I would have invested it (though right now, I’m certainly ahead on having used it to pay off the house) but it wasn’t a huge difference.

I’m terribly conservative in financial calculations - so I’d run “worst case on house, worst case in market” as well as “best case with house, best case with market” scenarios. The down side if the ARM adjusted and the stock market tanked was scary.