Military Pre-Paying Mortgage

[VANGUARDROI]

Ladies and Gentlemen,

Am in the military and purchased a house 15 minutes from the coast in FL two years ago. We will be moving this summer and current plan is to rent out our house.

We locked in a 30 yr fixed mortgage at 5.625% APR, no pre-payment penalty, and have a $198K balance. So far we have not made any pre-payments.

Not certain if we will be able to move back here in next 10-15 yrs, but it is a possibility later. If we do not move back here, will likely seek civilian employment in FL. If nothing else, this house appears to be a good hedge against rising FL real estate prices and further diversifies our current portfolio of index funds & stocks in Roth/TSP/Trad IRA and taxable accts.

Recently have increased bi-weekly DCAing into Vanguard Totl Stk and Tot Intl but could shift $500-$600 a month toward pre-paying mortgage instead. According to Microsoft template, if I made $500 extra payment a month it would save $108K in interest and would pay off loan 14 years earlier.

Based upon this situation, does it make sense to pre-pay mortgage if not sure we will hold onto the house until loan payoff (because could sell and use home sale proceeds if future employment is in a different area) or would it be better to continue to push funds into VG index funds?

Thanks in advance for your thoughts.

 

[LOL!]

The standard reply is that if you can earn a better return elsewhere, then do not pre-pay your mortgage.

So if your software says you would save $108K in interest, how much does it say you will lose by not putting the $500-$600 a month into a long-term investment? Maybe even by investing
in a Roth IRA and max out any tax-deferred plans (government TSP?).

That is, don't just do one-half of the calculation.

In our case, we make more on investments than our mortgage costs us, so we invest and do not pre-pay our mortgage.

 

[Nords]

Welcome to the board, Vanguard.

Am in the military and purchased a house 15 minutes from the coast in FL two years ago. We will be moving this summer and current plan is to rent out our house.

I know dozens of military who've rented out their Florida homes for decades. Their cash-on-cash return is barely in the black but over two decades they've appreciated at about the rate of inflation. In other words they got locked into a terrible investment at a young age and have rented it out for years to avoid making a decision.

But let's presume that in 15 years your situation won't have changed much (good luck with that), you'll still think Florida is the best place in the world to live, and you'll come back to the home. The good news is that you'll have a mortgage at one of the lowest rates in 40 years. You'll also probably have a place that's appreciated at the rate of inflation through a couple of boom/bust market cycles (notwithstanding a possible hurricane or two), and plenty of interesting property-management memories.

I think your biggest advantage to this project will be the mortgage's interest rate. In the next year you'll probably be able to find long-term CDs offering nearly the same after-tax return, especially in the early years of the mortgage with such a big interest deduction. That makes keeping the mortgage a very low-risk investment.

You may have better tax-deferred or even tax-free investment choices than prepayment. Since you're in the military, I wouldn't pre-pay your mortgage until you've put every penny of your income (up to $15,000 in 2006) in the TSP and maxed out your Roth or conventional IRAs (up to another $8K if you're married). VG has some low ERs but the TSP's are even lower. The TSP tax deferral is larger than anything you'd be able to achieve in an IRA.

Assuming you max out both of those investments and you're still sleeping at night, I'd keep DCA'ing into the equity mutual funds. But that's a pretty aggressive stance and it's more important to be able to sleep at night.

This subject has been discussed ad nauseum in other threads, and I'd recommend searching for them before continuing the conversation. Here's a good start, but it's just one of many: http://early-retirement.org/forums/index.php?topic=1390.15

 

[VANGUARDROI]

Thanks LOL and Nords.

Plan on Roth for spouse and I in 06 but stopped TSP this year to put more $s into taxable accounts so would have access to potentially support ER b/f 59 1/2. Currently have approximatley the same amount in retirement and non-ret accounts.

Shortest possible time left in military is 5-7 years (to retire) but plan on working another 5-10 years in private sector after that.

Great points as I am now leaning toward plowing more $s into the market and maximizing Roths now. Could always purchase REITs if want more RE exposure.

VANGUARDROI

 

[Nords]

Plan on Roth for spouse and I in 06 but stopped TSP this year to put more $s into taxable accounts so would have access to potentially support ER b/f 59 1/2.  Currently have approximatley the same amount in retirement and non-ret accounts.

Phew, I'd find it hard to beat the TSP's single-digit ERs in any taxable account. With all the flexibility of 72(t)s and Roth withdrawals I'm not sure that the "flexibility" of a taxable account outweighs the advantage of a cheap ER.

 

[VANGUARDROI]

Nords,

What do you mean about the flex of 72(t)s and Roth withdrawls vice flex of taxable accts for easy access to $s for ER? Realize you can take $s out b/f 59 1/2 but with penalty.

Thanks in advance.

 

[TromboneAl]

Nords has gone surfing (playing hooky again!), but I expect that he meant this:

You may give up a little flexibility with 72t withdrawals and Roth funds as opposed to taxable accounts, but you are rewarded for this by getting to keep more of your money.

 

[Nords]

OK, I'm back. 4-6 feet quickly became 6-8, along with agitate/rinse/spin repeat. Quite the sinus power-flush experience. But I'm getting very good at "off the lip" without the "over the falls".

Realize you can take $s out  b/f 59 1/2 but with penalty.

We haven't actually made any TSP withdrawals yet. I was promptly booted out of the program when I retired (my balance was something like $1700, the max I could contribute at the time) and I rolled it to an IRA, but spouse's TSP has managed to compound up to $10,000 on her Reserve contributions. So she's technically still in the accumulation phase and we haven't had to learn what comes next.

But as I understand it, when you ER you can either leave your money with the TSP or roll it over to an IRA. The lower age limit on TSP withdrawals is probably 59½ but it looks like the TSP program itself will set you up with a 72(t) before then. Read "A series of monthly payments" on page 5 of this PDF document. Please seek professional advice; I could be wrong about monthly payments before age 59½.

If you roll your TSP funds to an IRA you can do a 72(t) withdrawal and you can get very creative about that, including multiple IRA accounts with some under 72(t) withdrawals and others left to compound. I know that can be done before age 59½. There's an excellent primer & calculator at this website and more info at 72(t).net.

A third option would be to roll everything over to an IRA and convert it to a Roth IRA, but withdrawals before 59½ would be limited to contributions or a couple of other special requirements.

Due to mutual funds' higher ERs, the TSP's incredibly low ERs, and the host of withdrawal options, choosing a taxable account is not necessarily a no-brainer. If the cost of a taxable account is an extra 1% per year over 20 years for an account in five or six figures, that flexibility is pretty expensive.

 

[virginia]

Have you already checked to see what your home could sell for now? I'm not sure about Florida's market, but I bought a condo in HI in 2001 and am selling now at a huge profit. My original plan was also to wait for many years to sell, but the house is selling so far above appraisal value right now that I'd be a fool not to. Bottom line is that nords may be right - your house will probably appreciate 3-4% a year unless the real estate market in FL hasn't hit it's high yet. I know it's only been 2 years for you, but the price of my home doubled in just 4 years.
If it were me, I would at least prepay until I got that 20% in so that I wouldn't have to pay PMI (you may already have that much in, I don't remember).

 

[Nords]

I'm not sure about Florida's market, but I bought a condo in HI in 2001 and am selling now at a huge profit. 

*Ahem* Um, what town/neighborhood might that condo be located in and what size is it? And the listing price?

 

[VANGUARDROI]

Virginia/Nords,

Actually we put down approx 28% so we could put it in a rentable range once we move and to diversify our heavy equity portfolio.

Almost bought at the top of the market but suspect we could make approx 25% (does not include realtor/closing costs).

As long as we don't get hammered by hurricane, believe this area will do very well over the coming years because of beautiful beaches and projected growth although housing market has clearly softened with much more inventory and much longer dates to sale.

Thought is to use this house as a potential hedge as FL RE continues to appreciate (think more than 3%-5% here but no guarentees).

Nords, seriously considering switching from Vanguard index funds (Totl Stk Mkt and Tot Intl) to TSP Tot Stk and Tot Intl. If start now could hit 15K cap by eoy. Know not much diff in exp ratios between taxable VG index funds and TSP but would definetely be a plus in reducing taxable incoome. Only concern would be use of TSP $s prior to 59 1/2 with substantially equal pymts but need to do more reading via your links. Thanks.