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Pay off mortgage or invest
Old 08-24-2012, 10:46 AM   #1
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Pay off mortgage or invest

DW and I own 3 houses. Two houses worth around $500k each with $250k left in mortgages, four years into 10 year mortgages at 3.5%. We live in one and rent the other.

Our third house has a 30 yr mortgage at 5.375%. Worth around $180k and we still owe $160k. We have a renter and rent covers the mortgage and taxes at $1100/mo.

We have the cash currently to pay off that house. Should I, or should I invest the cash.

Currently our portfolio excluding the 160k in cash:
$40 k cash
$300k non-retirement funds
$275k retirement funds
$50 k in college funds

We both just turned 40, have one child
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Old 08-24-2012, 11:19 AM   #2
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This question comes up often on this and every other financial forum.

And the answer is...

If the returns (after taxes) of an investment can beat the mortgage interest rate (after taxes) then you'll come out ahead.

But don't kid yourself you just may be taking on lots more risk by investing. Paying off the mortgage is pretty low risk.

So perhaps youd want to throw in some sort of rsik normalization into the expected returns from an investment.
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Old 08-24-2012, 12:39 PM   #3
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I would agree with Master but add a great big KEEP THE MORTGAGE. This is my individual opinion, but I feel very strongly that interest rates have to go up in mid term. There are any number of reasons that rates are low today, but the external factors must go away some day and then rates will either return to the norm or exceed the norm in reaction to being so low for so long. At that point in time, you will have low rate loan and be able to invest your $250K at a higher rate. 2nd reason, if you use $250K to pay off mortgage and something happens (knock on wood we hope not) you will not have that $ to see you through a tough time. What if you need the $$ and due to your circumstances can't get a mortgate on your homes?
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Old 08-24-2012, 04:35 PM   #4
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Concur with retireby90. Keep the mortage. If something happens and you become upsidedown, owing more than the home is worth, all you are out is your downpayment if your renter is paying the mortgage in essence through their rent.

If this will help you retire, suggest paying off the loan gradually in coming years so that your retirement date and loan free date coincide.
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Old 08-24-2012, 05:06 PM   #5
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Agree with webdiva and retireby90. Your interest rates are very reasonable.
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Old 08-24-2012, 09:44 PM   #6
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I would refi the 5.375% mortgage to a lower rate and then keep all three mortgages. This assumes that the portfolio return on the funds that you would have used to pay off the mortgage is expected to be more than the mortgage interest rate AND you are willing to take the risk that the portfolio return might be less than the mortgage rate.
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Old 08-24-2012, 10:44 PM   #7
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I would refi the 5.375% mortgage to a lower rate and then keep all three mortgages. This assumes that the portfolio return on the funds that you would have used to pay off the mortgage is expected to be more than the mortgage interest rate AND you are willing to take the risk that the portfolio return might be less than the mortgage rate.
+1, if you can. I'd even add a little cash if necessary to make it happen. At 5.375% you are in a gray area for matching it with investment returns.
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Old 08-27-2012, 01:46 AM   #8
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Need to look where you are in the loan Amortization Schedule. A mature loan has gone thru the 7/10s Rule, and the interest penalty stage is behind you - mature loan payments are mostly equity payments. Dump the young 30yr note for a 10-15 yr. If you dream of early retirement, get your residence paid off. Retirees have no business carrying a note.
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Old 08-27-2012, 06:13 AM   #9
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Originally Posted by pb4uski View Post
I would refi the 5.375% mortgage to a lower rate and then keep all three mortgages. This assumes that the portfolio return on the funds that you would have used to pay off the mortgage is expected to be more than the mortgage interest rate AND you are willing to take the risk that the portfolio return might be less than the mortgage rate.
+1

I'd also try to lower the rate and shorten the term of the 5.375% Mtge. that way, all three loans will be paid off about the time you're 50; in plenty of time for ER.

You haven't said anything about your emergency fund, which I think should be full before you consider pay off of any of these loans.

I was in a similar situation recently, with just one Mtge, and decided to pay it. But, my circumstances were a little different. I'm older than you, nearing ER, have a renter in the property, have a full emergency fund, the pay off is a much smaller % of my portfolio, and I'm getting ~5% low risk return on the equity in the property now that the Mtge is paid.

Good luck.
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Old 08-27-2012, 06:57 AM   #10
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Retirees have no business carrying a note.
True for many folks, but it's not an ironclad rule. For example, If you've got a solid source of dependable retirement income but are short of cash for a big expense/possible big expense, then carrying a mortgage at today's low rates can reduce risk (vs trying to get a loan in the future when you'll have no job, lower income and rates might be quite a bit higher).
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Old 08-27-2012, 10:44 AM   #11
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.....Retirees have no business carrying a note.
Not necessarily true for everyone- it is very situational. My "note" is only about 10% of my nestegg so I could easily pay it off at anytime if I want to but I believe my nestegg will generate a return in excess of my 3.375% mortgage interest rate over the next 15 years and I'm willing to take the risk that I will have suboptimized if it doesn't.
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Old 08-27-2012, 02:07 PM   #12
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Thanks for everyone's insight.

I was considering paying off the house with a 30 yr mortgage because it's the highest rate mortgage that we have and we are early in the amortization schedule, only 4 years in. We have the cash available and would have another 40k left over for an emergency fund which would cover about 5-6 months.

I am not so concerned about having funds in the near future as we have a combined income of $400k and we LBYM. We saved up the $200k in just over a year. We Just want to make the best decision from an investment standpoint. I would like to refinance to a lower rate at10-15 years, but I'm not sure we have enough equity in the house to do that -- don't you typically need 20-30%.

Thank you again for everyone's insight. I'm leaning more now towards investing the cash instead...
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Old 08-27-2012, 02:12 PM   #13
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Oh yes. Forgot. We are hoping to retire within the next 10 years! Hopefully when the two other houses are paid off.
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Old 08-27-2012, 08:08 PM   #14
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.... I would like to refinance to a lower rate at10-15 years, but I'm not sure we have enough equity in the house to do that -- don't you typically need 20-30%.....
Yes, but if you refi'd you would just need to bring some cash to closing to get the advantage of the lower interest rate.
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Old 08-28-2012, 10:21 AM   #15
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Hi,
Well at your age it is a coin flip. You can do it in steps and see how it feels, like 40k at a time. I paid off all of mine(rentals and home) in my early 50's and considerd it my bond portion of my investments. I felt like it was a safe investment, investing in yourself rather than some fund manager.
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Old 08-28-2012, 12:36 PM   #16
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Originally Posted by Retire45 View Post
DW and I own 3 houses. Two houses worth around $500k each with $250k left in mortgages, four years into 10 year mortgages at 3.5%. We live in one and rent the other.

Our third house has a 30 yr mortgage at 5.375%. Worth around $180k and we still owe $160k. We have a renter and rent covers the mortgage and taxes at $1100/mo.

We have the cash currently to pay off that house. Should I, or should I invest the cash.

Currently our portfolio excluding the 160k in cash:
$40 k cash
$300k non-retirement funds
$275k retirement funds
$50 k in college funds

We both just turned 40, have one child
You really can't go wrong no matter what you do quite honestly, but here's what I would do if it were me.

1) The two homes with the 3.5% mortgages and 6 years left...let them just finish their schedule...they'll be done in 6 years...no real advantage to paying them off early.

2) I would pay that third house off today. The rate isn't GREAT, and while you could refinance for a lower rate, you'll likely pay at least some closing costs. I'd just pay it off and be done with it. I don't really care that rates are at historic lows and that you might not be able to get rates that low again. Low rates are only important if you plan to borrow money. Once you have these homes all paid for, do you EVER plan to borrow money again?

3) I would take the money from the income of the now paid for house and invest that. If you plan to retire in 10 years, I would make sure that those other two houses are paid for by then and save/invest at least $100,000 of your $400,000 income. I would invest MOST of that $100,000 a year in the non-retirement funds since you plan to retire before age 59 1/2.

Assuming 7% return annually over the next 10 years if you put $80,000 a year into the non-retirement fund account, by age 50 you'll have $1,615,461.

Assuming 7% return annually over the next 10 years, if you put $20,000 into your retirement accounts, you'll have $797,295 in there.

Knowing that at age 50 you have NO DEBT and potentially income coming from two rentals, you could take 4% of the $1,615,461 for $64,618.44 in income (when you add the rental income it's even better of course). Then, leave the retirement account alone until you are 60. At age 60 if you don't even add anything to it between age 50 and age 60, it will be worth $1,568,401, so if you take 4% of that, that's another $62,736.04 a year.

Having no debt in retirement and even leading up to retirement helps to eliminate risk...you've got risk in your investments (which is fine)...now you can balance that out by owning all three of those homes within 6 years...the first of which could be the one with $160,000 left. If slightly more than $64,000 a year (plus whatever the rental income brings in) doesn't sit well for you at age 50 you could always sell 2 or even 3 of your homes for well over $1,000,000 and go buy a small house for cash and use the remaining to add to your income-producing pile...or work until age 52 or 54 or or or.

You've put yourself into a great position. Almost nothing you do would be bad (regarding paying off or not). I just told you what I would do.
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