Millionaires: do they pay off their mortgages?

[Alex]

I'd never pay off a mortgage as long as we have the current tax laws in place. In fact, I am only paying interest. Why pay off a home? It actually costs you money to pay off a mortgage. It shocks me to see so many on this forum who find hundreds of ways to save money, but cling to the idea that being mortgage free is a good thing. Its old school thinking that costs you serious money. The higher your tax bracket the more important it is to have a mortgage. Even the lowest tax brackets would be far better off with a mortgage. Here is an example.

Ric Edelman has educated his clients for years on the benefits of integrating their mortgage into their overall financial plan. In his book, The New Rules of Money, Ric tells the story of two brothers, each of whom secures a mortgage to buy a $200,000 home. Each brother earns $70,000 a year and has $40,000 in savings.
The first brother, Brother A, believes in the old way of paying off a mortgage, which is as soon as possible. Brother A bites the bullet and secures a fifteen-year mortgage at 6.38% APR and shells out all $40,000 of his savings as a 20% down payment, leaving him zero dollars to invest. This leaves him with a monthly payment
of $1,383. Since he has a combined federal and state income tax rate of 32%, he is left with an average monthly net after-tax cost of $1,227. Also, in an effort to eliminate his mortgage sooner, Brother A sends an extra $100 to his lender every month.

Brother B, in contrast, subscribes to the new way of mortgage planning, choosing instead to carry a big, long-term mortgage. He secures a 30-year, interest-only loan at 7.42% APR. He outlays a small 5% down payment of $10,000 and invests the remaining $30,000 in a safe, moneymaking side account. His monthly payment is $1,175, 100% of which is tax deductible over the first 15 years, and 64% over the life of the loan, leaving him a monthly net after-tax cost of $799. Every month he adds $100 to his investments (the same $100 Brother A sent to his lender), plus the $428 he’s saved from his lower mortgage payment. His investment account earns an 8% rate of return. Which brother made the right decision?
The answer can be found by looking into the future. After just five years
Brother A has received $14,216 in tax savings, however he made zero dollars in savings and investments. Brother B, on the other hand, has received $22,557 in tax savings and his savings and investment account has grown to $83,513.

Now, what if both brothers suddenly lose their jobs? The story here turns rather bleak for Brother A. Without any money in savings, he has no way to get through the crisis. Even though he has $74,320 of equity in his home, he can’t get a loan because he doesn’t have a job. With no job and no savings, he can’t make his monthly payments and has no choice but to sell his home in order to avoid foreclosure. Unfortunately, at this point it’s a fire sale so he must sell at a discount, and then pay real estate commissions.
Brother B, while not particularly happy at the prospects of searching for a new job, is not worried because he has $83,513 in savings to tide him over. He doesn’t need a loan and can easily make his monthly payments, even if he is unemployed for years. He has no reason to panic, as he is still in control. Remember… Cash is King!

Now, let’s say neither brother lost his job. We’ll check in on them after fifteen years have passed since they purchased their homes and evaluate the results of their financing strategies.
Brother A has now received $25,080 in tax savings, he has $30,421 in savings and investments (once his home was paid off he started saving the equivalent of his mortgage payment each month), and owns his home outright. Not too bad, right?

Now let’s check on his Brother. Brother B has received $67,670 in tax savings and has $282,019 in savings and investments. If he chooses to, he can pay off the remaining mortgage balance of $190,000 and still have $92,019 left over in savings, free and clear.

I'd rather be brother B...... When I retire I will still have a mortgage. When they change the tax laws, then I'll change my strategy.

[rs0460a]

Originally Posted by Alex

I'd never pay off a mortgage as long as we have the current tax laws in place. In fact, I am only paying interest. Why pay off a home? It actually costs you money to pay off a mortgage. It shocks me to see so many on this forum who find hundreds of ways to save money, but cling to the idea that being mortgage free is a good thing. Its old school thinking that costs you serious money. The higher your tax bracket the more important it is to have a mortgage. Even the lowest tax brackets would be far better off with a mortgage. Here is an example. I'd rather be brother B...... When I retire I will still have a mortgage. When they change the tax laws, then I'll change my strategy.

Alex, that's just the point. I'm retiring May 1st, at age 59. I will not have any income. I will not be drawing SS till age 66, I don't have a pension, and I don't have a mortgage. I don't need the "tax deduction", since I have no income (other than what I draw from my retirement investments, which tax-wise, will be lower). However, if I still had to make a mortgage payment (based upon the 4% rule) I would have to take the mortgage payment x number of years I still need to pay it off and have this included in my retirement "base".

Remember, the view from before retirement (and having a steady income) is different from those "on their own", financially - folks like me that have no other income.

We built our home in 1994 (30-yr fixed mortgage). We paid it off in late 1999 (5.5 years, as a matter of fact). We "converted" our mortgage payment into an "investment payment" (100% of it). Guess what happend in the market from late 1999 till late 2002, and the subsequent run-up since then - that early mortgage payoff (with the subsequent investment in the market) allowed us to become FI at a much earler age...

- Ron

[donheff]

Originally Posted by Alex

I'd rather be brother B...... When I retire I will still have a mortgage. When they change the tax laws, then I'll change my strategy.

We have this debate all the time. Most of us carried mortgages throughout our earning, saving and high tax lives. But some of us don't carry them into negative cash flow, low tax retirement. The flip side to the benefits is when Mr Permanent Mortgage retires in 2000 with $1M in savings and $40K in expenses. In 2003 with his portfolio battered that $1,000+ monthly payment (remember the deduction is only whatever exceeds his standard deduction * his new very low tax rate) looks like it needs $300K in the nest egg that he doesn't have anymore. Either strategy has its pluses and minuses.

[retire@40]

Originally Posted by Alex

I'd never pay off a mortgage as long as we have the current tax laws in place. In fact, I am only paying interest. Why pay off a home? It actually costs you money to pay off a mortgage. It shocks me to see so many on this forum who find hundreds of ways to save money, but cling to the idea that being mortgage free is a good thing. Its old school thinking that costs you serious money. The higher your tax bracket the more important it is to have a mortgage. Even the lowest tax brackets would be far better off with a mortgage. Here is an example. I'd rather be brother B...... When I retire I will still have a mortgage. When they change the tax laws, then I'll change my strategy.

I just did a quick read of that quote and I'm confused about the math...

His monthly payment is $1,175, 100% of which is tax deductible over the first 15 years, and 64% over the life of the loan, leaving him a monthly net after-tax cost of $799.

If it is 64% deductible over the life of the loan, shouldn't it be $1,175*64%*32% tax savings = $241 tax savings making the monthly net after-tax cost $934, not $799?

[Evelyne]

I paid mine off last year after deciding to ER.

[honobob]

Year 6: After one year of economic downturn in Happyville, Villagers accuse Brother B of witchcraft and ciphering and is burned in the Town Square, ironically at the ceremonial mortgage burning altar.


Alex, I agree 100% with you but understand the "urge" to pay off a property. I refi'd a couple of properties a few years ago to get the 15 year rate and partly because I felt the need to pay down. I'll retire with over $400K in mortgages because it makes financial sense. Sometimes it may make sense to pay off a mortgage, but most people do so even when it does not make economic sense. I wonder if those same people argue that you are wrong to retire as a renter?

[2B]

I was Brother A on two occasions where I lost my job. The liquidity and cash flow issues are very true and I will avoid it until I am retired where I will be financially independent by definition. At that point, my tax rate will be at the marginal 15% rate by our current laws (unlikely to remain this low for much longer) even though I'll be living heavily out of my IRA. At that point, the lower cost of living will probably have more impact on my withdrawl rate and taxes since I'll get the full $10,000 standard deduction (guessing at the exact amount) and not have to withdraw the mortgage payment at the 15% or higher marginal tax rate. Currently, I'm at the marginal 25% rate so the tax deduction is worth more.

[deserat]

Yes, this is an argument all the time - right now I could pay off my mortgage, but have decided to just pre-pay some of the principal - I want the other money to be working for me in my investments. I actually re-fi'd to a low rate last year on a 10 year payoff - if I keep at the rate I'm pre-apying now, I'd probably have it paid off in 5 years.

To me, the peace of mind that I have a roof over my head paid for is worth any arbitrage I might wish to play - again, YMMV.

[Khan]

I am incredibly lazy, and one less thing to worry about is always a good idea.

Paid off 10 or so years ago.

[ZMAN]

We had a 6.75% mortgage at a time when bond funds were paying in the low 4% range. We wanted more bond investments and thought that paying off the mortgage was the best 6.75% "bond" investment we could make. So that is what we did and, even with less in mortgage tax deductions, we have ever been sorry.

[Alan]

Originally Posted by ZMAN

We had a 6.75% mortgage at a time when bond funds were paying in the low 4% range. We wanted more bond investments and thought that paying off the mortgage was the best 6.75% "bond" investment we could make. So that is what we did and, even with less in mortgage tax deductions, we have ever been sorry.

Ditto. about 7 years out from #1 child going to college we upped our payments so that mortgage (7.25% back then) ended as she went to college.

[JustCurious]

Originally Posted by Alex

I'd never pay off a mortgage as long as we have the current tax laws in place. In fact, I am only paying interest. Why pay off a home? It actually costs you money to pay off a mortgage. It shocks me to see so many on this forum who find hundreds of ways to save money, but cling to the idea that being mortgage free is a good thing. Its old school thinking that costs you serious money. The higher your tax bracket the more important it is to have a mortgage. Even the lowest tax brackets would be far better off with a mortgage. Here is an example. I'd rather be brother B...... When I retire I will still have a mortgage. When they change the tax laws, then I'll change my strategy.

Alex, both you and Ric Edelman make a critical assumption that is false....that all of the mortgage interest is tax deductible. In many cases, this is simply not true at all. (See my posts in the other thread called "Not permitted to deduct mortgage interest.....").

The bottom line is that most people (including me) do not itemize, therefore, we get zero, that's right... zero tax benefit from the mortgage interest that we pay. And even for those people who itemize, the benefit is often less than the full amount of interest paid, because the benefit only accrues to the extent that total amount of itemized deductions exceeds the standard deduction.

When you base your argument on flawed assumptions, the conclusion is usually flawed.

[maddythebeagle]

Originally Posted by JustCurious

Alex, both you and Ric Edelman make a critical assumption that is false....that all of the mortgage interest is tax deductible. In many cases, this is simply not true at all. (See my posts in the other thread called "Not permitted to deduct mortgage interest.....").

The bottom line is that most people (including me) do not itemize, therefore, we get zero, that's right... zero tax benefit from the mortgage interest that we pay. And even for those people who itemize, the benefit is often less than the full amount of interest paid, because the benefit only accrues to the extent that total amount of itemized deductions exceeds the standard deduction.

When you base your argument on flawed assumptions, the conclusion is usually flawed.

What I think might gets lost in these ever ending arguments is that some folks are living in areas with huge housing costs (east and west coasts) and those in the middle probably see this all differently....why the heck would I carry a mortgage on a 150-200k house in the midwest into retirement...on the contrary, if I was Nords with a 400-500k mortgage, I probably would take the tax deduction rather than reducing my portfolio....

[heyyou]

Agree with Khan and deserat. Been on both sides and I slept better in a paid off house while working a risky job. I lost money in leveraged RE in the 80's using money that could have gone to paying down mortgage. I was lucky since my job in Phoenix was not in the RE industry.
I can control my debt, my expenses, and my risk. Leverage assumes your career is not tied to an industry that can fail. I've seen real estate and banking, defense and aerospace, IT and communications, steel, automotive, and most natural resources boom and bust with devastating effects on Los Angeles, Seattle, Denver, Houston, Phoenix, Detroit, and Pittsburg. How many IT workers are laid off in their 50's who can't get another 10 years of work to finish off the mortgage? It is not all blue sky, there is risk embedded somewhere although the math is impeccable.
Joe

[honobob]

Maddy tTB
You make an excellent point. But I think you can also include all those people in Texas and other low value areas that I read here that are paying astronomical property taxes! I can't imagine paying $9-12K property each year in taxes and NOT itemizing!

Plus.........LEVERAGE. If I have 100K in a 600K property that is appreciating 11% a year aren't I better off with a 5.25% loan ( with the 500K invested at 6.25%) than if I had $600K sitting in my home?

Plus.........INFLATION. 2024 thru 2034 I'll be paying off $300K in installments that will be equivalent to cable bills.

But I do understand the midwest mindset. I sold my Dad's home in Indiana for $65,000 at a time when my home was appreciating that much in 6 months.

Location, loction, location.

As a single high earner, by national standards, give me the deduction!

[Alex]

Originally Posted by JustCurious

Alex, both you and Ric Edelman make a critical assumption that is false....that all of the mortgage interest is tax deductible. In many cases, this is simply not true at all. (See my posts in the other thread called "Not permitted to deduct mortgage interest.....").

The bottom line is that most people (including me) do not itemize, therefore, we get zero, that's right... zero tax benefit from the mortgage interest that we pay. And even for those people who itemize, the benefit is often less than the full amount of interest paid, because the benefit only accrues to the extent that total amount of itemized deductions exceeds the standard deduction.

When you base your argument on flawed assumptions, the conclusion is usually flawed.

I can only speak for my own situation. I have a large mortgage (partly by choice) and more than the income needed to carry it. So for me, it does not make sense to eliminate a very large deduction.

Now, If I had a house in Michigan or Ohio that was worth 150-250k, I might see things differently.

[JustCurious]

Originally Posted by Alex

I can only speak for my own situation. I have a large mortgage (partly by choice) and more than the income needed to carry it. So for me, it does not make sense to eliminate a very large deduction.

Now, If I had a house in Michigan or Ohio that was worth 150-250k, I might see things differently.

Alex, the value of your "very large deduction" is probably less than what you think it is. I agree that if your property taxes are high, and you pay a large amount of mortgage interest so that the combined total of both is well in excess of your standard deduction, then the mortgage interest tax deduction certainly has some marginal benefit to you.

However, as I said before, it is a fact that most people do not itemize their deductions. (This is not my opinion, this is a fact reported by the IRS). Therefore, most people (including me) do not deduct their mortgage interest. Yet some so-called financial experts like Ric Edelman just assume that everyone can deduct all of their mortgage interest, and then they go on to argue that this "fact" justifies always having a mortgage! I can understand how the average Joe gets fooled and blindly follows the popular misconception that all mortgage interest is tax deductible, but it's really ridiculous that financial advisors like Ric Edelman actually publish books and mislead people. Ric Edelman either doesn't understand what he is talking about, or, he knows better and he is simply ignoring it because it gets in the way of his argument and he knows that the average Joe doesn't understand anyway. Either way, he has zero credibility with me.

[2B]

Originally Posted by JustCurious

Alex, the value of your "very large deduction" is probably less than what you think it is.

I can understand how the average Joe gets fooled and blindly follows the popular misconception that all mortgage interest is tax deductible, but it's really ridiculous that financial advisors like Ric Edelman actually publish books and mislead people.

Scott Burns has a mortgage deduction calculator to tell you what your mortgage, property tax, etcetera are all worth.

[maddythebeagle]

Originally Posted by Alex

I can only speak for my own situation. I have a large mortgage (partly by choice) and more than the income needed to carry it. So for me, it does not make sense to eliminate a very large deduction.

Now, If I had a house in Michigan or Ohio that was worth 150-250k, I might see things differently.

If you lived in Michigan or Ohio, you probably wouldnt live next to a bunch of fools that use interest only, etc. to drive up housing costs faster than wage growth but hey, I have seen enough posts from folks like you that want to rationalize their situation....just keep on saying that it is different this time...