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Unexpected cash=pay off mortgage?
Old 12-24-2011, 10:19 AM   #1
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Unexpected cash=pay off mortgage?

My wife will shortly come into a large sum of money, ~$600,000 after taxes. We feel so fortunate and lucky, and have been contemplating how to best distribute the money. We are 32, no kids yet, and have about $180k left on a 200k mortgage we took out about 5 years ago with 100% financing (when that was still possible).

I had already planned to pay off our secondary mortgage, which is near 8% interest, in the next few months so we will do that. Our primary mortgage is about $150k with 4.875% interest, and I wanted advice on whether it makes sense to completely pay this off immediately. It seems a kind a gray area these days whether I can invest and make more that 5% returns with confidence. We have student loans which are between 1.5-2.5% interest, which I can't justify paying off early. We will also be padding our emergency fund a bit and getting rid of my clunker of a car

Thanks!
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Old 12-24-2011, 10:24 AM   #2
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Mortgage rates are at all-time lows. Why not refinance and capture one of these 3% or so mortgages?

Probably more important is what are you going to do with the rest of the money?
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Old 12-24-2011, 12:25 PM   #3
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Whatever you do, take your time and think about it carefully. I think paying off the second is a no-brainer. After that, I would just bank the cash somewhere that you cannot access it on a moment's whim (a few different online savings accounts would be ideal) and spend a few months noodling on your total financial picture and plan. This is a big change for you financially and you want to make the most of it in a considered way. No point in rushing.
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Old 12-24-2011, 12:37 PM   #4
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Whatever you do, take your time and think about it carefully. I think paying off the second is a no-brainer. After that, I would just bank the cash somewhere that you cannot access it on a moment's whim (a few different online savings accounts would be ideal) and spend a few months noodling on your total financial picture and plan. This is a big change for you financially and you want to make the most of it in a considered way. No point in rushing.
+1

It's unlikely you'll ever see a windfall like this again in your lifetime. When it's gone, it's gone, so consider very carefully before you spend a dime of it on anything.
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Old 12-24-2011, 12:58 PM   #5
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What a great opportunity to solidify your financial future and become FI at a young age!! Agree with Brewer that you shouldn't rush into anything other than paying off the 8% second mortgage and trading the clunker .

I would consider refinancing at today's low rates (3-4%) since I think that in the long run you can invest and earn total returns that will exceed the mortgage rate you would pay. Fully fund 401k if it is available to you, Roth's, HSAs, etc and invest the rest.

You can always payoff the mortgage later if you want. Continue to LBYM and stash the windfall.
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Old 12-24-2011, 01:07 PM   #6
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Agreed that paying off the second is an easy decision.

As for the first mortgage, this is a common question and I tend to answer it this way: If you owned your home free and clear, would you take out a $150,000 mortgage and invest the proceeds? If not, why wouldn't you pay off the mortgage? It's pretty much the same thing; you either have another $150K in investments and a $150K mortgage or you have neither one. But for some reason, our philosophy often changes depending on whether or not you already have the mortgage. People tend to be hesitant to mortgage their home just to invest the proceeds, but have no qualms holding the mortgage when they could pay it off.
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Old 12-24-2011, 01:15 PM   #7
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ziggy29, there are some sunk costs that one has to pay if they take out a new mortgage that one probably does not pay if they keep an existing mortgage. There are some muni bonds that pay more than some mortgage interest rates, so one can get close to risk-free return. Remember also that the option to do something else besides paying off the mortgage is worth something, so add that the value of that option into the equation.

Also note that when mortgage rates are low, investment returns are low. One has to grab a low-rate mortgage and wait for investment returns to increase. That's an argument for not paying off the mortgage.

coalcracker, although it does not appear that you have the money yet, you may wish to think about making sure your 401(k) plan contributions are at the maximum possible for 2011. If not, then you may have one more paycheck to make contributions. If you all do have paychecks and have not reached the max, you may wish to talk to payroll on Tuesday the 27th and see if you can increase your contribution on those last paychecks.
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Old 12-24-2011, 01:20 PM   #8
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ziggy29, there are some sunk costs that one has to pay if they take out a new mortgage that one probably does not pay if they keep an existing mortgage.
True, but I don't think the people who would NOT take a mortgage to invest the proceeds would change their minds and do it just because the mortgage was zero-cost, zero-fee and at prevailing market rates. So I think it's fairly irrelevant even if technically true.
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Old 12-24-2011, 01:22 PM   #9
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You have convinced me to go to the bank on Tuesday and explore taking out a mortgage on my paid-off home.
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Old 12-24-2011, 01:33 PM   #10
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Last year I was in a similar situation, but not at the 600K level. During my last days on the job I got a 4.5% 30 yr refi with some cash out. I piled that plus the the windfall funds into equities. OK my risk level is probably greater than yours, but to date the equities have yielded (growth + dividends) about 15%. The dividends pay for the new mortgage more than 2X over so for the last year I'm dramatically ahead.

So coalcracker, the moral of this is if you can stand the risk, refi the 1st to as low a rate as you can get for as long as you can get and put enough of the 600K into equities to at least pay the new mortgage PITI and invest the rest to generate income you can live off.
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Old 12-24-2011, 01:34 PM   #11
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Last year I was in a similar situation, but not at the 600K level. During my last days on the job I got a 4.5% 30 yr refi with some cash out. I piled that plus the the windfall funds into equities. OK my risk level is probably greater than yours, but to date the equities have yielded (growth + dividends) about 15%.
Of course, had you done this in late 2007...
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Old 12-24-2011, 01:45 PM   #12
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Of course, had you done this in late 2007...
Although I dont profess to be an investment expert and would never pretend to be, but I second your conservative, practical thinking. You dont hear too many financial " horror stories" on the net by people paying off all their debt.
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Old 12-24-2011, 02:05 PM   #13
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You have convinced me to go to the bank on Tuesday and explore taking out a mortgage on my paid-off home.
The problem with that, as you probably know, is that the tax deductability situation is not as good with a mortgage that wasn't used to purchase a home or refi such a mortgage. The first $100k is usually deductable no questions asked (except for AMT). After that you've got to make sure you can deduct it as an investment loan, with some additional hassle. It's nice to preserve that initial purchase balance if you can.

I've still got half my HELOC money invested. The rest goes in if the market really goes south in 2012 or 2013. Plus I took out $100k cash from my 2009 refi at 4.375% and invested that. So I'm maybe a little over 80% LTV on the house and invested in just about all equities with that.
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Old 12-24-2011, 02:11 PM   #14
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I agree with Ziggy.

Pay off both mortgages and build up an emergency fund by investing at least some of in a short-term or intermediate-term muni bond fund. The risk is fairly low and the return (federally tax-free) beats what you can get in bank CDs.

As I learned when I paid off my mortgage in 1998, losing the mortgage interest deduction was not as severe for my taxes as I thought it was going to be because the standard deduction guarantees a deduction even if the mortgage disappears.
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Old 12-24-2011, 02:13 PM   #15
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Whatever you do, take your time and think about it carefully. I think paying off the second is a no-brainer. After that, I would just bank the cash somewhere that you cannot access it on a moment's whim (a few different online savings accounts would be ideal) and spend a few months noodling on your total financial picture and plan. This is a big change for you financially and you want to make the most of it in a considered way. No point in rushing.
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+1

It's unlikely you'll ever see a windfall like this again in your lifetime. When it's gone, it's gone, so consider very carefully before you spend a dime of it on anything.
+2 Conventional wisdom is to put it in a MM account and wait for around 6-12 months while investigating what you might do with this windfall and working very hard on developing a plan.

A temptation that can arise is to buy everything you ever wanted with it right away. I'd suggest buying something <$100 with it to get that urge out of your system, but nothing more than that right now.
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Old 12-24-2011, 02:20 PM   #16
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Keep your money and never payoff a long term mortgage. You need the money more than the bank.
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Old 12-24-2011, 03:46 PM   #17
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There are some muni bonds that pay more than some mortgage interest rates, so one can get close to risk-free return. Remember also that the option to do something else besides paying off the mortgage is worth something, so add that the value of that option into the equation.
Here's two opposing viewpoints.

On one side:
Suze Orman advised a lottery winner to (1) pay off all her debts, (2) blow 10% of the winnings any way she wanted without guilt, and (3) invest the remainder in munis. Of course Suze has the majority of her assets allocated to munis, so she might be biased.

On the other side:
If you'd never received the $600K then you'd still be able to pay off the mortgage and save for retirement and carry out the rest of your original financial plan. So if this is a windfall, then perhaps it's worth risking a percentage of it in the stock market. One "hedge" option would be to pay off half the mortgage and put the rest of the money in the market. Another "hedge" option would be to put the mortgage balance in long-term CDs and put the rest of the money in the market.

The essential question is what you do with assets that you don't need. Do you save them to pay off your debts or because "you might need them some day", or do you take extra investing risks with them because you don't need them in the first place?

I still don't have a good answer to that question.

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You have convinced me to go to the bank on Tuesday and explore taking out a mortgage on my paid-off home.
Yeah, but assets don't count in the lender's eyes. You might not have the cashflow to convince the bank that you can pay it back.
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Old 12-24-2011, 04:23 PM   #18
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Thanks guys, really helpful replies and some things to contemplate. I have already maxed out 401(k)'s for the year, and I have an additional tax sheltered account that I have through work.

I plan to put the bulk into a money market fund for the time being and do some more research before I decide where to invest. As for the primary mortgage, I will have to chew on that a bit. I was already able to refi the primary mortgage down to 4.875% from 6% about 18 months ago, but I haven't considered trying to refi again.

I've read "The Bogleheads Guide to Investing" and a few other books that have been a great start. I'm anticipating many visits to this forum for advice in the future!
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Old 12-24-2011, 05:07 PM   #19
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I'm anticipating many visits to this forum for advice in the future!
It's the consensus in the advice here that's worth every penny you pay for it.
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Old 12-24-2011, 06:20 PM   #20
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Of course, you could invest the whole thing in a new business if money is the only thing that has been holding you back from launching your startup company. But I didn't hear any mention of that.....
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