| Should I pay off my mortgage? |
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davidinpa
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| Should I pay off my mortgage? |
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Why wife and I are considering paying off our mortgage. In a nutshell, we have 124K left on it -- 7 years at 5.25% The interest saved over the next 7 years would be about 20K. I am almost 50 years old.
Here is my analysis. Our mortgage payment is about 24K per year. To make that payment after taxes, we need to burn about 33500 of our income. We have access to retirement plans that would allow us to sock away that 33500 each year pretax, deferring taxation until retirement when we have less income and probably are in a lower rate.
From a balance sheet perspective, paying off the mortgage is neutral, I am exchanging stock for house equity. I can even sell stocks that haven't recovered so I am not going to pay any capital gains tax.
From an income perspective, I avoid 20K in interest payments, and start to rebuild the portfolio at the rate of 33500 per year (just putting away what I would have had to spend on mortgage payments). I figure I get back the money I paid extinguish the mortgage in 3.5 years or less (assuming modest return on the investments).
Plus I go to sleep knowing I have no mortgage.
Am I missing something? Why should I not do this?
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Mon Apr 25, 2011 11:14 pm |
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oldguy
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quote:
Am I missing something? Why should I not do this?
It would probably be almost a wash for only 7 yrs. But note that the $33,500/yr contribution is temporary, in 20 yrs you will be required to cash out an annual amount and repay that $13,500/yr. (RMD, I'm there, I know it well, LOL).
But I have done the opposite on several rental houses over the past 35 yrs with good success. Example - I refi a house and take out an extra $50,000 of equity. That costs about $300/m, ie, $108,000. I place the $50,000 lump sum in a SP500 index Fund that has a longterm average of 11%/yr and let it grow to $1,450,000 in 30 yrs. So, in my cases, paying the extra $58,000 of interest has worked very well.
The key thing is the comparative interest rates over the term. Ie, I borrow at 6%/yr and get a 11%/yr return over a 30 yr term. With a 7 yr term, you cannot count on getting an average return of over 6% with any certainty (look at the most recent 10 yrs). But over any 30 yr period, the market has time for statistical averaging to happen, the bad years are averaged away.
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Tue Apr 26, 2011 2:12 am |
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coaster
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It sounds like your main point is going to sleep at night with no debt. 
You should be able to refi for a lower rate than 5.25; that'll tip the scales in favor of keeping the mortgage, I think. You could refi that into a 15-year fixed at probably a full point less.
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Tue Apr 26, 2011 6:05 am |
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davidinpa
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coaster and oldguy, thanks for the responses -- so if I understand the fundamental point, it's that if you have enough time and a low mortgage interest rate, you can benefit from the spread between a low mortgage rate and a high investment return. Particularly attractive if real estate values are rising. This also explains why I am feeling so bleak as to think this is good idea after the past several years. On that theory though, shouldn't I take more equity out of my house and invest it in the market? So paying off your mortgage is not a good idea. Even though it feels good to be debt free.
Something feels very federal govermentish about this...
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Tue Apr 26, 2011 12:58 pm |
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littleroc02us
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I myself would prefer the peace of mind knowing I don't have any debt except tax payments on my house. Am I to assume that you are already investing 15% of your income into mutual funds or as you have stated you are investing in stocks? What does that mean exactly, single stocks or what? I would pay off the house in 3 years because that's such a short time you can start throwing the 33k at investments once the mortgage has been wiped out. I personally think you'd be in a better position than to risk you money in the stock market. Yes it is possible to see huge returns in such a short time period. My index funds were up 28% last year, which were down 27% the years before. My house only dropped 14% and is on it's way to recovery. IMO I believe a house is a less risky investment then the stock market. You can always fall back on selling it if things go awry. The greatest part about your situation is that you will have 33k to invest once the house is paid off. If you were to put away 33k just into a savings account making 2% for the next 15 years you would have over 500k and a paid for house. If you invested in a Vanguard Total Stock market index fund and received 8% you would have over 1 million dollars and a paid for house.
Romans 13:8 “Owe no man any thing, but to love one another: for he that loveth another hath fulfilled the law.”
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Tue Apr 26, 2011 1:52 pm |
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oldguy
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quote:
On that theory though, shouldn't I take more equity out of my house and invest it in the market? So paying off your mortgage is not a good idea.
That's what I do - ie, remove equity from our houses and invest it. But, as you suggest, you have to be willing to wait for it - if you set an arbitrary spot where "the house must be paid off" such as at retirement, etc, you may be constraining yourself. I'm age 72, one of our loans goes until age 94, I'm in no hurry to prepay it.
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Tue Apr 26, 2011 4:13 pm |
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coaster
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quote:
Originally posted by davidinpa
Something feels very federal govermentish about this...
Yes; a relevant observation. The government IS artificially maintaining low interest rates to goose the economy. My question is: so long as it's financially prudent for you, and in your interest to do so; why not take advantage of it?
investment returns generally track inflation.(*) Locking in a low mortgage rate now, with higher rates in the offing for the future, and the probability of higher investment returns along with rising inflation, means you can participate in that with some very "cheap" money.
* nominal returns, not real inflation-adjusted returns. But nominal at least means you're keeping pace; everything else is going backwards. 
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Tue Apr 26, 2011 4:19 pm |
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