Should we pay off the mortgage if we "lock in a loss"?

[Cheesehead]

I don't have a Wise Uncle so I am posting here to confirm my fear that if I pay off the mortgage I think I will be "locking in the loss" (?)

There have been many threads regarding whether to pay off one’s mortgage but my situation is a little unique. They say when your stock goes down you don’t have a loss unless you sell. We bought our house at the height of the bubble for $500K and we’d get $400-$410K now, so I think that would lock in the loss if we sell. We plan to retire in two years.

We are carrying a $330K mortgage at 4.8% and if we paid it off that would use up 1/3rd of our nest egg. The reason we have a high mortgage is we banked our profit from the sale of the last house rather then put more into the purchase of the new house. Perhaps that is an inadvertent good thing?

This is probably not our “forever home”, in fact we’d like to move somewhere warmer with lower taxes and HOA fees in two years. We live here because my wife’s commute is three minutes and we have family in the area.

If we did pay off the mortgage using nest egg funds in two years then we would be inclined to stay and consider it a “lock & leave”, go somewhere warm from Jan-April but we would still have housing costs of $2K a month in taxes, insurance, HOA and utilities and those housing costs would represent about 25% of our annual retirement income which is too high.

So, am I correct in thinking that we should not pay off the mortgage because we would be locking in the loss? I'd like advice regardless of the other factors such as high taxes, etc. Am I really locking in the "loss"?

Thanks

 

[Sunset]

You won't be if your state is one where you are responsible for the debt if you stop paying and let them foreclose.
If you don't plan to let the house go to forclosure, or are in a recourse state, then no you will not be locking in the loss.
Now could be a good time to sell long term capital gain stocks to pay off the house mortgage, as the market won't stay high forever.

Your mortgage rate is pretty high, if you have interest bearing earnings, you are losing ~3 per year by having the mortgage.

Not sure why you think having the house paid off means you cannot sell and move, that is just silly. If it makes it easier, you can pay if off, and 1 month before you go take out a 200K HELOC on it, so you no longer own the entire thing. The $$$ work out to the same (less interest) either way.

 

[bad_LNIP]

Are you expecting a different response from the last thread you started on this?

http://www.early-retirement.org/forums/f28/should-we-pay-off-mortgage-if-it-is-a-loss-74275.html

 

[RunningBum]

Are you expecting a different response from the last thread you started on this?

http://www.early-retirement.org/forums/f28/should-we-pay-off-mortgage-if-it-is-a-loss-74275.html

I thought that sounded familiar. Paying off the loan still isn't "locking in the loss". But why don't you tell us exactly what answer you want to here and let's move on and not see threads like this again.

 

[robertf57]

I am not really understanding what you are even saying when you talk about "locking in the loss" by paying off the mortgage.... The minute you pay off the mortgage your house is still worth what it was worth the minute before when you still had a mortgage....When you sell the house you will realize the loss or gain for tax purposes but not really anything else. If you were willing to walk away from the house and have it forclosed and you are in a non-recourse situation as someone noted above you may escape the owed balance.

 

[pb4uski]

...We bought our house at the height of the bubble for $500K and we’d get $400-$410K now.....

So, am I correct in thinking that we should not pay off the mortgage because we would be locking in the loss? I'd like advice regardless of the other factors such as high taxes, etc. Am I really locking in the "loss"?

In short, no.

The loss you are concerned about is the difference between the $500k you paid for the house and its fair value of $400k. The $500k you paid will never change. The fair value will fluctuate depending on market conditions, but the fair value isn't any different if you have a mortgage or don't have a mortgage. So the answer is no, paying off your mortgage will not lock in a loss.

Think of it this way, if your property value doubled to $800k you would end up with a $300k gain. Conversely if it declined to $200k, you would end up with a $300k loss. Either way having a mortgage or having paid it off doesn't affect the loss you have.

The only thing paying off your mortgage would do is if the value declined to the point where it is less than your mortgage balance, you would no longer have the option to hand the bank the keys to the house and walk away (but there are other bad things that go along with that).

 

[Senator]

I don't have a Wise Uncle so I am posting here to confirm my fear that if I pay off the mortgage I think I will be "locking in the loss" (?)

So, am I correct in thinking that we should not pay off the mortgage because we would be locking in the loss? I'd like advice regardless of the other factors such as high taxes, etc. Am I really locking in the "loss"?

Unless you think the value will drop below your $330K mortgage, adding in any capital gains and selling expenses, you are above water. If you were under-water, and were considering a strategic default, paying off a mortgage would be locking in a loss.

Strategic defaults are indeed a valid investment alternative; when a bank loans money to purchase a home, they have in effect guaranteed the value to be above the mortgage amount, or you can give it back to them. At lease in the no-recourse states.

Whether or not you pay it off should be a matter of examining the alternative near 100% safe investments that pay at least 4.8%. Factor in how fast you can gather up that money again, and how long the investment is. If you have an ARM, it is a better alternative to pay it off.

 

[Bestwifeever]

I don't think you understand what "lock in a loss" means.

 

[Cheesehead]

Thanks pb4uski & Senator. I didn't get clarification from the last post and this time I mentioned about the nest egg being reduced 25% to pay off the mortgage of 4.8%. It seems to me that if the house is worth $100K less than what we bought it, and we lived here for 10 years, this means we paid an additional $833 a month on top of our mortgage to live here ($100K divided by 120 months) so in effect this has been one hell of an expensive rental. That's what I meant by "locking in a loss", sorry if I didn't word it properly.

I know we are above water and also our area's real estate values are not going to rise fast enough for us to get close to our purchase price in two years. So in sum, thanks to the advice I got from this post, and the last post's responses about the taxes and HOA, I feel that selling and taking the $90-100K in equity is the best option and I am not "locking in a loss", although I feel we still lost that amount on the house. I guess I equate it with a stock. All our previous homes we made money.

Also, I've read that in pre-retirement housing costs should not be above 30% of income and in retirement it shouldn't be more than 15%. So if we reduce the nest egg by 25% that would be a problem staying here.

Thanks all!

 

[Texas Proud]

You are using the wrong mentality of a loss.... that if you do not sell then the loss never happened.... get over that fast... it is stupid thinking...


Your house is worth what someone is willing to pay for it... if you owe more than that you have a loss... if you owe less you have a gain... it does not make any difference to the loss or gain if you sell or do not sell... it is a real loss....

Now, what will happen in the future is up in the air.... your house might go up... great, then you will have a gain from today.... if your house goes down you will have a loss from today....

Why do you think that they made the banks mark to market their investments Because the loss is REAL.... it is only REALIZED when you sell..... words are close, but mean two different things...

 

[pb4uski]

TP, I would quibble with you that the gain or loss is comparing what someone would buy it for to what was paid for the house rather than what is owed on it.

 

[rodi]

I have a big problem, in my personal finances, considering my house as an investment. Real estate, like stocks, can go up and can go down. But the home I live in is shelter, not a spendable asset. You purchase a house, rather than rent, to lock in a price, fix your costs , give yourself long term stability (landlord can't kick you out or sell it out from under you.)

FWIW - my house is a significant percentage of my net worth - but I don't use my networth in calculating my retirement spending... I use my investible/portfolio assets.

Our house went below our purchase price for a few years during the market downturn... I didn't consider it a loss - since it was still providing shelter, and we were still on track to pay it off sooner. The value has recovered - but we're still living here and don't care about that unrealized gain since it's not part of our spendable assets.

 

[Closet_Gamer]

You are using the wrong mentality of a loss.... that if you do not sell then the loss never happened.... get over that fast... it is stupid thinking...


Your house is worth what someone is willing to pay for it... if you owe more than that you have a loss... if you owe less you have a gain... it does not make any difference to the loss or gain if you sell or do not sell... it is a real loss....

Now, what will happen in the future is up in the air.... your house might go up... great, then you will have a gain from today.... if your house goes down you will have a loss from today....

Why do you think that they made the banks mark to market their investments Because the loss is REAL.... it is only REALIZED when you sell..... words are close, but mean two different things...

+1. I mark my house to market every 6 mos when I update my balance sheet.

 

[Texas Proud]

TP, I would quibble with you that the gain or loss is comparing what someone would buy it for to what was paid for the house rather than what is owed on it.

I can see that.... it is a quibble for if you have to take money out of your pocket or not.... but if you bought something for $500K and sold it for $400K you lost $100K no matter how much was owed on the property...

 

[pb4uski]

I can see that.... it is a quibble for if you have to take money out of your pocket or not.... but if you bought something for $500K and sold it for $400K you lost $100K no matter how much was owed on the property...

Exactly.

 

[eta2020]

I am not really understanding what you are even saying when you talk about "locking in the loss" by paying off the mortgage.... The minute you pay off the mortgage your house is still worth what it was worth the minute before when you still had a mortgage....When you sell the house you will realize the loss or gain for tax purposes but not really anything else. If you were willing to walk away from the house and have it forclosed and you are in a non-recourse situation as someone noted above you may escape the owed balance.

Old foreclosure debt coming back to haunt former homeowners - Nov. 17, 2014

Or you may end up paying 300 plus dollars an hour to some attorney

If you are not broke/bankrupt you may be at loss one way or another. Right now you have a loan on that loss.

 

[Cheesehead]

OP here: No matter how I look at it and take into consideration all these wise posts, if I bought for $500K and sell for $400K, in my mind I lost $100K but that loss does not occur until I sell. So I guess waiting until the last minute to sell gives the local real estate market time to inch upwards and minimize the loss.

Paying off the mortgage and then moving in a few years would save me the 4.8% I'm paying on the $333K mortgage, yet that gives me $333K less to invest and grow at the same time. So it seems it's a lose/lose situation: Take the $100K loss on the sale or pay off the mortgage but have 1/3rd less nest egg to invest.

I recently returned from a trip to the LA area near the water and real estate is going up 30% a year. I wish that would happen here...

 

[eta2020]

You are correct. If you wait it out and property goes up in value you will be fine.

You just need to decide how to wait it out at lowest cost. Maybe refinance to lower rate
would help you. Maybe loan pay off. Everybody's situation is different.

 

[2B]

Old foreclosure debt coming back to haunt former homeowners - Nov. 17, 2014

Or you may end up paying 300 plus dollars an hour to some attorney

If you are not broke/bankrupt you may be at loss one way or another. Right now you have a loan on that loss.

This doesn't apply to loans made in a non-recourse state. If the OP lives in California, they could stop making the payments and get free rent until evicted. They could walk away with only a trashed credit rating.

 

[eta2020]

This doesn't apply to loans made in a non-recourse state. If the OP lives in California, they could stop making the payments and get free rent until evicted. They could walk away with only a trashed credit rating.

Good point!! I think Wisconsin is recourse state.

Non-Recourse and Recourse States List

 

[Texas Proud]

Exactly.

OHHHHHH... my bad... I reread my post and I see that I wrote it wrong the first time... stupid me

 

[Texas Proud]

OP here: No matter how I look at it and take into consideration all these wise posts, if I bought for $500K and sell for $400K, in my mind I lost $100K but that loss does not occur until I sell. So I guess waiting until the last minute to sell gives the local real estate market time to inch upwards and minimize the loss.

Paying off the mortgage and then moving in a few years would save me the 4.8% I'm paying on the $333K mortgage, yet that gives me $333K less to invest and grow at the same time. So it seems it's a lose/lose situation: Take the $100K loss on the sale or pay off the mortgage but have 1/3rd less nest egg to invest.

I recently returned from a trip to the LA area near the water and real estate is going up 30% a year. I wish that would happen here...

Again... you are going with bad thinking.... you have lost that $100K... if your house never goes back up (hypothetical) then it is gone.... when did it go Prior to today... not the day you sell... So, as we are writing these posts you have a real loss of $100K... it is not imaginary...

As an example... if you needed to give a bank a financial stmt showing your net worth.... what price would you put down as to the value of the house If you put $500K down knowing it was worth $400K you could be charged with a crime.... (no joke... a friend of a BIL went to jail for doing something like this back in the S&L crisis here in Texas)....



Another point.... and my sister listened to this one and moved.... if your house is not going up as fast as where you want to live, then you would be 'losing' more if you do not sell and buy right now... Say both places are worth $400K today... and in a year your house will be worth $420K but the other house will be worth $450K.... you 'lost' $30K more waiting for your house to get back to $500K than doing what you want to do now.... and if you wait the whole time for your house to get back to $500K it could be much worse....

 

[RunningBum]

OP here: No matter how I look at it and take into consideration all these wise posts, if I bought for $500K and sell for $400K, in my mind I lost $100K but that loss does not occur until I sell. So I guess waiting until the last minute to sell gives the local real estate market time to inch upwards and minimize the loss.

Yes! You've got it!

Paying off the mortgage and then moving in a few years would save me the 4.8% I'm paying on the $333K mortgage, yet that gives me $333K less to invest and grow at the same time. So it seems it's a lose/lose situation: Take the $100K loss on the sale or pay off the mortgage but have 1/3rd less nest egg to invest.

Arghhh! No, you lost it again. Those are unrelated events.

You either want to sell the house, or not. A better way to think of it is that you have a 400K house. What you paid for it is really immaterial. You could hang onto the house and hope you get back to your original cost, but in the meantime whatever house you might look to buy instead is also rising in cost. So just make the sell or stay decision based on where you want to live and what you can get for the house today. What you paid for it in the past is irrelevant.

If you stay, you have the decision to pay off the mortgage or not. If you pay it off you lose $333K or whatever it was out of your nest egg, but you are monthly budget is reduced by whatever your mortgage payment was. Ideally you will invest that money each month. If you think you can safely invest and get a better return than the mortgage rate + income tax deduction on it, keep the mortgage. Otherwise pay it off.

I recently returned from a trip to the LA area near the water and real estate is going up 30% a year. I wish that would happen here...

I find that wishing for things to be different is not productive. Deal with reality.

The more I think about it, the more I think you should completely forget what you paid for the house. What does it matter if you paid $1M or $400K for it? It doesn't change anything. So, simplify your decision making and only consider factors that actually matter.

 

[NgineER]

How about a refi?!

Thanks pb4uski & Senator. I didn't get clarification from the last post and this time I mentioned about the nest egg being reduced 25% to pay off the mortgage of 4.8%. It seems to me that if the house is worth $100K less than what we bought it, and we lived here for 10 years, this means we paid an additional $833 a month on top of our mortgage to live here ($100K divided by 120 months) so in effect this has been one hell of an expensive rental. That's what I meant by "locking in a loss", sorry if I didn't word it properly.

I know we are above water and also our area's real estate values are not going to rise fast enough for us to get close to our purchase price in two years. So in sum, thanks to the advice I got from this post, and the last post's responses about the taxes and HOA, I feel that selling and taking the $90-100K in equity is the best option and I am not "locking in a loss", although I feel we still lost that amount on the house. I guess I equate it with a stock. All our previous homes we made money.

Also, I've read that in pre-retirement housing costs should not be above 30% of income and in retirement it shouldn't be more than 15%. So if we reduce the nest egg by 25% that would be a problem staying here.

Thanks all!

How about paying down your loan by $10k to get to 20% and refi... 15 year fixed is about 3.5%, 7/1 even a little lower.

Quick analysis:
4.8% 30 year fixed (in year ten now on $400,000), $26,200 annual payment with $9,600 prinicpal
3.5% 15 year on $320,000 refi, $27,600 annual payment, $16,2 principal-->$2400 payment to get $6,600 more equity
3.375 7/1 30 year on $320,000 refi, $17,000 annual payment, $6,000 principal--> $9,200 less spent on interest, with $3,600 less equity

Considering ~$2,000 refi cost, you have payback in 4-6 months with these published rates I found on Wells Fargo.

Might be worth considering...

 

[2B]

Good point!! I think Wisconsin is recourse state.

Non-Recourse and Recourse States List

Another thing to consider is the tax consequences of the default. When oil collapsed in the 1980s and the S&L Industry imploded, Congress implemented a "punishment" that the assets not recovered in a default by a bank could be assigned in a 1099 as "income" to the mortgage holder. Since IRS debt can't be erased in bankruptcy, the person that defaulted may find themselves perpetually targeted by the IRS. During the more recent crisis, this rule was temporarily blocked but I think it's now back in force.