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Mortgage Question - NOT about paying it off.
Old 05-07-2016, 05:12 AM   #1
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Mortgage Question - NOT about paying it off.

Actually, just the opposite, kind of. Quick background:

DW and I are both 51 and planning on ER within the next 5 years. We max out 401(k), including catch-up and make too much to fund any other tax advantaged investments. So our goal is to minimize tax and maximize after-tax savings to fund the GAP.

We have a home valued at about 400K and owe 270K. 2 years in on a 30 year loan at 3.75%. We also owe about 25K on her car and have 39 payments of $623 left, (3% loan). No other debt.

We will be here a while, so I was thinking about refinancing with enough cash out to pay off the car loan and maybe a little more to invest elsewhere. I can't shave any more off that 3.75% but can lock in the same rate with fairly low closing costs. This would provide some tax savings as the interest we are now paying on the car loan becomes tax deductible. We would also free up about 500 a month, (difference between the increased mortgage payment and elimination of the car payment), that could be socked away and grow if the market cooperates. And I could get even more cash out to invest as well.

I know I am paying 75 basis point higher on the car and I would have to wrap my head around the thought of technically still paying off THIS car for 30 more years while we will likely be buying others along the way. But the slightly higher interest rate is wiped out by the tax advantage of the mortgage debt and I like the additional cash flow.

I'm thinking it makes sense but what am I missing? Thanks much for any assistance.
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Old 05-07-2016, 05:57 AM   #2
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Originally Posted by mbnj77 View Post
I'm thinking it makes sense but what am I missing? Thanks much for any assistance.
Well, this does assume that you will itemize your expenses every year and that your marginal tax rate will be always be around 20% or more. If not, this increases your net interest cost.
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Old 05-07-2016, 06:55 AM   #3
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Different strokes...

My preference would be to sit tight and look forward to a $623 increase in monthly cash flow beginning in 39 months. With the option of accelerating that cash flow increase by paying off the car note early.

Assuming you plan to stay in the house after you ER, your plan locks in a higher monthly fixed cost for the duration of retirement, albeit a modest one at $123/ month +/-. My approach has been to place a higher value on keeping a lid on ER fixed costs rather than fine-tuning for relatively small tax savings before ER.
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Old 05-07-2016, 07:02 AM   #4
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Pay the car off directly. It is only $25K. To refinance will cost some fees. And you want to mortgage your home to 'invest', which may not be too good of an idea. And you will owe a mortgage for a longer period.

Make extra payments on the car. You KNOW you can make an extra $100+ a month payment, easily. $25K goes fast.
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Old 05-07-2016, 07:09 AM   #5
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Originally Posted by mbnj77 View Post
.... pay off the car loan and maybe a little more to invest elsewhere. ...
car loan = 39 months (39 x 623=$24,297), new mortgage = 360 months (360 x estimated 123 = $44,280)

Invest elsewhere = risk tolerance = personal choice
Depends on your other investments

Overall, it would not appeal to me, but that's a personal choice.
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Old 05-07-2016, 07:11 AM   #6
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I agree with Senator.

I have a lot of equity in my home (owe 660K on value of 1.4m) and can refinance at 3.7 ish. Considering the tax deduction and historic market returns + ample liquidity it seems like an obvious thing to refinance and invest. I don't have a car loan right now but will buy a new car soon so the math is similar.

So why not do it?

Because the fluctuation in markets is much higher than in home values. What I mean is if my house is paid off my monthly expenses become VERY flexible and thus a 30-40% market sell off doesn't impact me as much as if I carry a large mortgage with the money in the market.

You can easily model this in firecalc by changing the investable assets you start with and treating you mortgage as a non inflation adjusted cost that is offset by the same amount of income when the mortgage ends.

What you see is that the maximum upside in the "mortgage and invest" scenario is reasonably higher... and the downside is reasonably lower. From a pure math perspective I should mortgage and invest... but the fluctuations along the way may cause me to do stupid things at worst and give me sleepless nights at best.

My #1 financial goal going into retirement is low mandatory spending.


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Old 05-07-2016, 07:23 AM   #7
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Fundamentally, I think financing a car using a mortgage is not wise. A 15 or 30 year term for a car just does not make economic sense.


The car loan is only 3%. Pay it off, then add the payment to your savings, so you can buy the next car with cash.
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Old 05-07-2016, 07:29 AM   #8
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Consider refinancing the car loan. You can get 1.99%/36 mo at PenFed CU, maybe even better rates if you shop around.
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Old 05-07-2016, 07:48 AM   #9
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Thanks much. I knew I could count on you all for well thought out points of view. My personal choice would be to not pay off the car loan. For the same reason I don't pay anything extra toward principal on my mortgage, the rate is so much lower than potential market gains, I just assume keep the money there than the relative illiquidity of home equity. (One thing that I agree with Ric Edelman about; the whole potential piece of mind thing notwithstanding).

Where I saw value, besides short term tax savings albeit small, was the almost $20K that could be put in the market over the next 39 months by the increased cash flow. I expect to have a mortgage payment through most of retirement so that extra $125 per month 20 years from now, which is fixed and a decreasing % of my expenses, (not impacted by inflation), will be less important then than what that 20K can grow to and spin off in the shorter term. With a pension, SS and 401(k), post 65 has a lot more cushion than 55-65.

And we would still have the option of paying off more principle whenever we wanted to with the flexibility that the liquidity and cash flow provides.

Of course, the rub is market performance and our time horizon is not long enough for these dollars to underperform.
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Old 05-07-2016, 08:07 AM   #10
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Can you get a free or low cost HELOC with rate < 3%/(1- tax rate)? My CU charges processing fees of $300-1000. Their rates are 2.75%.
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Old 05-07-2016, 08:14 AM   #11
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Can you get a free or low cost HELOC with rate < 3%/(1- tax rate)? My CU charges processing fees of $300-1000. Their rates are 2.75%.

Thanks, I tried. But I couldn't find rates low enough for the amount of money I was looking for. It's crazy, but BOA charges less interest the more you take out on a home-equity line. But the converse is true for refinancing with cash out. My rate went up the more cash I was looking to get out. The loan officer could not explain why. We will NOT be going to BOA if we do this.


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Old 05-07-2016, 08:22 AM   #12
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Have you considered refinancing with a 15 year loan instead of a 30 year loan? Rates for 15 year loans are much lower... around 3% IIRC... higher payments but lower interest cost.

I refinanced our mortgage in Jan 2012 just before I retired... in fact I had stopped working but was still on payroll but on vacation when they did the employment verification just prior to closing and I went off payroll 3 weeks later. I reduced our interest rate by 1% (from 4.375% to 3.375%). Since the market has been good over the last few years it has worked out well... my portfolio has earned 8.31% since I refinanced but I have paid 3.375%.

However, the cash out on that mortgage was minimal... I refinanced in Dec 2009 from 5.8% to 4.375% and took $77k cash out and since then I have earned about 8.11% so things have worked out well.

That is all pre-tax.... after-tax is a little harder for me to fathom because our itemized deductions excluding mortgage interest are less than the standard deduction so we get some minor benefit.

In our case our mortgage is only about 10% of our net worth so it isn't a big bet... while some people sleep soundly with a paid off house I sleep soundly with the knowledge that I could have a paid off house anytime with a few clicks of a mouse but I concede it holding a mortgage in retirement isn't for everyone. I just recall that my Dad, who was very successful, said that one of his regrets was to taking advantage of leverage more than he did.
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Old 05-07-2016, 09:34 AM   #13
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My personal choice would be to pay off the car loan. But my second choice would be to refinance the car loan with a much cheaper car loan thru a credit union. My credit union offers 1.74% for car loan. Just do the refinance to save on interest payment, if you don't want to shell out any cash.
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Old 05-07-2016, 09:46 AM   #14
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One downside of holding a larger mortgage in retirement is that you'll need to generate the cash flow to make the payments. If that cash flow comes from tax advantaged accounts (IRA, 401k, etc.), you will have taxable income that could disqualify you from things that are means tested, such as ACA subsidies. It also could affect the taxation of your Social Security, the rate at which you pay capital gains tax, and your ability to do Roth conversions.
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Old 05-07-2016, 09:54 AM   #15
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Holding a mortgage allows us to do bigger Roth conversions by the excess of our itemized deductions (which include mortgage interest) over the standard deduction... more Roth conversion fits within the 15% tax bracket. However, impact is small... only ~$3k.
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Old 05-07-2016, 10:31 AM   #16
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MBnj77, you want to increase your mortgage to refinance car and invest in the stock market? .....I wouldn't suggest that.

I agree with Senator, paying off the car fast first is a good idea. Paying off mortgage early will also free up more cash to invest and reduce your monthly expenses at the same time. If you have no debt during retirement, your monthly expenses will be very low and the peace of mind that comes with having no debt is bliss!

In hindsight paying off our home mortgage in 2009 by making additional principal payments each month thru the last market downturn (2007 -2009)was the best thing we did. Thereafter we kept investing the amount of mortgage payment in to our after tax brokerage accounts. We now look forward to retiring next year at 57.

Good luck!
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Old 05-07-2016, 10:32 AM   #17
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Aside from the other good points raised here against doing the cash-out refi, you need to also check carefully about the deductibility of the cash-out portion of your proposed loan. I can't recall all the details, but certainly if AMT comes into play in your particular situation, then anything above the actual principal left on the refi loan (i.e. any cash-out you use to pay off the car or invest in other non-home improvement projects) may not be deductible after refi, so you shouldn't automatically assume that there is actually a tax advantage to be had.
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Old 05-07-2016, 12:12 PM   #18
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Aside from the other good points raised here against doing the cash-out refi, you need to also check carefully about the deductibility of the cash-out portion of your proposed loan. I can't recall all the details, but certainly if AMT comes into play in your particular situation, then anything above the actual principal left on the refi loan (i.e. any cash-out you use to pay off the car or invest in other non-home improvement projects) may not be deductible after refi, so you shouldn't automatically assume that there is actually a tax advantage to be had.


That is a very good point indeed as are all of them. I will schedule a meeting with my accountant to see about the true tax benefit if there is any.

I guess my concern is funding the gap adequately. I really don't need to pre-pay my mortgage. Once SS kicks in, even if it was at 62, in 12 years, my mortgage payment will not be a concern. It's more important, for us, to have as much after-tax dollars now so we can support ER. If by paying more down the road we can free up more cash flow for savings now, I thought it may be worth it. We have about 5 years to go and we are putting away about 60% of our take home pay. I'm trying to find ways of socking away even more.
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Old 05-07-2016, 12:32 PM   #19
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Since you would be retiring after age 55 many 401ks allow penalty-free withdrawals so that could be used to fund the gap. But I agree that it is nice having a big ol' taxable account balance.
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Old 05-07-2016, 04:11 PM   #20
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If no additional discretionary funds were available and I wanted to pay off the car early then I would temporarily only invest in the 401(K)s up to whatever match I was receiving and use the remainder to pay off the car early.

Since you are already investing at the catch up level I would think you could pay off the car in a relatively short period of time and then go back to fully investing into the 401(k)s.
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