Originally Posted by Bestwifeever
Perhaps, but income in retirement may be reduced so one might not qualify. Also, interest rates sooner or later will go up; someone with today's low interest rates would have much higher monthly payments as a result.
This is part of my current conundrum. I keep turning it over in my head as to what is best.
We currently own one house with mortgage. For long term financial viability we must sell this house. Right now I'm working part time and it covers the cost of the house and right now I enjoy working part time. But, I don't want to feel forced to do it. While we have a mortgage on House 1 we can't possibly qualify for a mortgage on the House 2 (the house we plan to build).
But-- sell House 1 and while working part time we could qualify for a mortgage on House 2.
1. Build House 2 with a mortgage. To do this we have to defer building until House 1 is sold so will have costs for somewhere to live while we are building (we have 5 dogs and 2 cats so finding somewhere is not a trivial problem). Also, to long term have a mortgage even at low rates will certainly cut into our spending power. That is, money will have to go for interest on a mortgage that is an expense we wouldn't have without a mortgage. And, needing to take more money out of retirement accounts for a mortgage increases our taxable income each year with various negatives to that. The positive to this is that our taxable income is increased each year but the extra income to pay the mortgage may not throw us into a higher tax bracket. Also, we still have our complete portfolio to invest.
2. Build House 2 for cash (fundamentally this works out the same as paying off the mortgage on an existing house). I would prefer to do this in many ways. I think interest on a mortgage is an expense I don't want to have and I prefer to not forever have to have increased income to sustain a mortgage. The way I see it is that if I am paying say $15000 a year in a mortgage (after considering tax benefits), I need an additional $375,000 in my portfolio to sustain it. And if we do this and wanted a mortgage years from now, if I quit work at some point, we might not be able to qualify.
The big rub for me -- that not many talk about when debating whether to pay off the mortgage -- is that all of our funds are in tax deferred accounts. So let's say it will cost $275k to build the house we want to build. The total cost is closer to $400k once you include the taxes. And, in our case that is about 30% of our portfolio.
But doing this does reduce our expenses in retirement since don't have to service a mortgage. Also, it can be argued that it is false to include the entire $125k in taxes as part of the "cost" of building. To build in one year and pay the building cost in cash does result in us being in a higher marginal tax bracket for that year and higher taxes overall. However, if we have a mortgage we will have to draw out money each year to pay it and we will likely be in the 25% tax bracket. So, it really only the difference in taxes between the two scenarios that is an extra cost.
On the other hand, imagine we got a mortgage and decided to pay it off in 10 years. We would have some income taxes each year at a 25% tax rate versus probably at 33% tax rate if we build for cash. But, in paying it out over 10 years we get some benefit for having the money invested over that time (albeit a declining amount each year).
Every time I've tried to run the numbers on this, it still comes out that building for cash works out best. However, I do have conservative numbers for investment returns.