Advice Needed - Taxable Invest vs Pre-Pay mortgage

[Trace]

I am 35 and currently save the maximum allowed by the Government in my 401K and Roth's (married). I am funding 529 accounts for my two children (age 9 & 5). I also will have a Pension that starts at age 55.

I am facing the decision on whether excess funds should go toward paying down my mortgage, funding a taxable account, or a combination of both.

I am currently in a 3 year ARM with a 4.25% rate. I chose the ARM because of the significant possiblity of relocating (I have moved several times with my employer). The only problem is that my family is now becoming more comfortable living in my current area. I have the option of staying here permanently (corporate headquarters located here).

I face the reality that rates are going to go up. If I focused my attention on reducing principal, the reduction in principal would offset any increases in the rate. This would keep my payment about the same if I refinance at the end of the 3 years.

Principal Balance of mortgage = $231,000, Home Value = $290,000. I am in an area in which homes have appreciated at a steady pace (5-6% a year). Only 1 down year in real estate in the last 55 years.

A lot of authors list several reasons to save vs. prepaying the mortgage. I would not be able to pay off the mortgage before ER if I go the savings route. However, I am currently leaning towards paying more toward the mortgage which would allows me to own my home free and clear for ER (target date is 50). It would also keep my required mortgage payment low which would allow me to divert some $ toward taxable accounts in the future.

I have ran the numbers both ways and it appears that ER at 50 is possible with either choice. However, the investment route projections show my net worth to be slightly more than the pre-payment route.

I would appreciate any thoughts that you may have.

[sgeeeee]

. . . I have ran the numbers both ways and it appears that ER at 50 is possible with either choice. *However, the investment route projections show my net worth to be slightly more than the pre-payment route.

I would appreciate any thoughts that you may have. *

Hi Trace,

How did you go about simulating the ARM using FIRECALC?

If you had a fixed rate mortgage with 15 or more years left to pay and a rate around 5.5% or lower, I would guess (based on a lot of simulations of my own) that FIRECALC predicts that keeping your mortgage makes more sense than paying it off. But I don't know how to account for an ARM using FIRECALC.

[brewer12345]

Assuming that you are planning on staying put, I would either refi now (since fixed rates are still pretty low), or start paying down the mortgage. There are really two considerations at work here. One is cash flow related (making sure you can handle the monthly payment if rates rise), and the other is investment related (maybe you can beat the cost of the mortgage money by investin, or maybe not). If you go the route of principal paydown, it is likely to be the lower risk, lower return strtegy, but that might be OK for you. If you go the investing route, you will have to make sure you have sufficient available cash to handle any rate spike effects.

If you refi into a fixed rate loan, you can pretty much set it and forget it, but I would only do so if you plan on staying in your ho,e for 10+ years.

[charlie]

Hey Trace,

It is really good not to have to pay a mortgage payment
out of savings when in ER. At a 4% SWR, you need
$25,000 in savings for every $1000 spent on the
mortgage. IMHO, you should take out a fixed rate
loan while the rates are still low ..... say a 20 yr loan
to coincide with your pension eligibility at age 55.

If you want to pull the trigger before 55, then prepay
the loan down to coincide with your ER goal. Invest
any excess after that.

Like Brewer said, this route has lower risk and possibly
lower return. However you can take comfort that your
home value will probably keep pace with inflation, at
least, and might be competitive with stock returns.

Cheers,

Charlie

[Trace]

Thanks for the advice.

I am probably going to take the route of aggressively paying down the mortgage. It is interesting how amortization works. The lower the interest rate, the higher the amount of money that goes toward your principal with each payment. The 4.25% interest rate plus additional principal payments is taking down my principal balance at a very nice speed. The conservative low-risk / low-return approach is OK with me. I hope to have the mortgage paid off by age 50. It the home appreciates 5% a year (I know, very low compared to our friends on the West Coast), it should double in value in 15 years. The home is brand new so I do not expect to much maintenance in the near term.

BTW, I did not use Firecalc in my comparison. I was looking at it from a pure net-worth perspective. However, it is excellent advice to run both options through the system.

Thanks again.

Good choice. We have almost paid off the house. Before the end of the year it will be a done deal. Whether we can make a few hundred extra $$$ in an investment account if we were not paying down the mortgage is not relevant to us. The peace of mind of being completely out of debt is very important to us.

We never bothered to refinance. I think we are at 7-7.5% or so. It is not very relevant. if you pay off quickly, the effect of interest is minimal.