Paying down mortgage early?

[jnojr]

I've been paying "extra" towards the principle of my mortgage every month. I found a mortgage prepayment spreadsheet at The Mortgage Professor's Website and had a lot of fun playing with it. But someone on another forum brought up the point that every dollar you "save" is interest, which is all deductible. I figure that A) being debt-free earlier can't possibly be a bad thing, and B) it's better to "save" 100% of those dollars than to deduct them and save ~30% of the taxes.

What do you think?

 

[Nords]

I figure that A) being debt-free earlier can't possibly be a bad thing, and B) it's better to "save" 100% of those dollars than to deduct them and save ~30% of the taxes.
What do you think?

Welcome to the board, jnojr.

The decision has both an emotional and a financial component, and either component is a good basis for making the decision. The trouble starts when people attempt to compare them and somehow declare one superior.

I think you should search the old threads for the "pay off the mortgage" [-]question[/-] I mean [-]debate[/-] well [-]reciprocated diatribe[/-] worn-out thread. It's come up a number of times lately and I think we're all a bit burned out on it.

 

[maddythebeagle]

But someone on another forum brought up the point that every dollar you "save" is interest, which is all deductible.

yes...a bit worn out...but maybe a good one to get SG back in the game...

BTW mortgage interest isnt always fully deductible....you need to factor in what the standard deduction is vs. what you itemize...that esp. the case if your mortgage balance is smaller towards the end...Also AMT effects others...

 

[SecondCor521]

I would advise taking a big-picture, long-term view of the question. In my case, I will probably retire in the next 8 to 13 years, but I have 29.5 years left on my mortgage. For me it makes sense to consider whether or not I want to have a mortgage in retirement or not before I decide to pay mine down in advance.

In addition to what Nords said, I would add that everyone's financial and emotional circumstances are different, so what may work for one person may not be right for another. My circumstances are:

5.75% 30-year-fixed traditional mortgage
25% marginal FIT
not subject to AMT
regularly itemize

I am currently not pre-paying my mortgage. I may pay it off in a lump sum later.

2Cor521

 

[W2R]

everyone's financial and emotional circumstances are different, so what may work for one person may not be right for another.

Ultimately, jnojr, after you have gathered all the information you can and have thought about it, run the numbers, and so on, you will be making your own decision and it will probably be the right one for you.

In my case, I would have a hard time ER'ing with a mortgage to pay and I plan to retire in a couple of years. I funneled every spare cent I had into my house (principal) for four years and paid mine off. This has really made my day to day life so much happier! If half my expenses were my mortgage, this means I am half way to ER. Plus, I am saving so much more now that I don't have a mortgage to pay.

 

[jnojr]

Well, I guess I'm glad to hear that there's no single "right" answer. I just wanted to see if I was overlooking anything.

I intend to keep paying "extra", and maybe each year add another $50 or $100 "extra" to each payment.

 

[NinjaPigeon]

But someone on another forum brought up the point that every dollar you "save" is interest, which is all deductible.

That's a bit misleading. It's like when people say that you can donate money to charity to save on your tax bill. While this certainly is true, you're spending $1 to save 30cents.

So, if you pay it off early, no, you can't take a deduction on $X, but you also probably won't actually incur that much interest, since you paid off your mortgage early enough to reduce the interest you'd pay over the duration.

 

[W2R]

I see it that way too, NinjaPigeon.

By paying off my 30 year fixed mortgage in 4 years, I managed to pay only $17,401.08 in interest.

Had I taken the full 30 years to pay it off, I would have paid $159,478.00 in interest.

I rather like the thought of not handing 100% of that interest over to Chase mortgage, in order to get 28% of it back from the IRS.

Of course, I suppose I could have invested the principal I owed Chase (less than the interest I saved), and made simply huge profits - - or not!! You have to pay in lower interest for an investment that yields that interest with any degree of certainty. Paying off the mortgage has an appealing simplicity. Then, there is the emotional bonus.

 

[cute fuzzy bunny]

I rather like the thought of not handing 100% of that interest over to Chase mortgage, in order to get 28% of it back from the IRS.

You'd have really enjoyed making mortgage payments as a retiree.

You'd have the take the money out of your portfolio, pay 28% on it, then take the deduction (minus the standard deduction) to get most of "the savings" back.

You'd also probably have to keep an extra year of cash on hand and increase your bond holdings to keep the volatility monster from killing you in a downturn.

 

[Mach]

The general advice may be (comments/corrections welcome), assuming your mortgage rate is pretty low as most tend to be.

A. Close to retirement
- pay it off for simplicity

B. Not close to retirement but not interested in moderate/aggresive investment of that extra money
- pay it off

C. Not close to retirement, can effectively use that extra money for investments
- don't pay it off yet, invest that extra money
--------------------------------

Comments/corrections welcome

-Mach

 

[jumpstart]

I'd probably say work on paying it off if your only alternative investment option is a taxable account intended for retirement savings. But even then, its a close call. Yeah, maybe not paying Chase 160K over 30 years is nice, but "Janus" (or an equliviant) would have paid you 160K or more had you invested that money instead over 30 years. 6 in one, half-a-dozen the other, for the most part. I think in this case, paying the mortgage is the better bet due to the psychological benefits of not being in debt.

If you have any tax advantaged options not maxed (like an IRA for either you or a spouse, or a 401(k)) fully fund those first. Also, I'd recommend having a good-sized "emergency fund" in place first, and maybe even have a "car" fund going too, so you can buy an auto with cash when the need arises.

 

[donheff]

Why not put the extra money you would have paid on the mortgage plus the savings from the deduction into a diversified portfolio labeled "pay off the mortgage." Then when you are ready to ER you can decide whether to pay off the mortgage or not. In the meantime you will have the benefit of the larger deduction, plus access to the money you would have tied up.

 

[MasterBlaster]

Donheff:

Your strategy will outperform the pay-off the motgage stategy if the invested assets gain more on average than the interest rate on the loan. That will probably happen however it is not a sure thing and there are many time periods of which your strategy could backfire. So it goes without saying that the invest the money methods has more risk.

What you really want to compare is the risk-equivalent return of an investment relative to paying down the mortgage. In that case you may be limited to comparing investments like government or very highly rated corporate bonds to the mortgage payoff strategy. In that case the better use of house equity and "extra" payments versus investments is not so clear.

 

[Nords]

Your strategy will outperform the pay-off the motgage stategy if the invested assets gain more on average than the interest rate on the loan. That will probably happen however it is not a sure thing and there are many time periods of which your strategy could backfire. So it goes without saying that the invest the money methods has more risk.
What you really want to compare is the risk-equivalent return of an investment relative to paying down the mortgage. In that case you may be limited to comparing investments like government or very highly rated corporate bonds to the mortgage payoff strategy. In that case the better use of house equity and "extra" payments versus investments is not so clear.

"Risk" is such an imprecise word for what generally is implied to mean "volatility" and "loss of principal".

There could be plenty of both, but over the term of a 30-year mortgage a diversified portfolio of small-cap value stocks has never failed to beat all other investments. There's not much sense in comparing risk-equivalent returns if you're describing volatility or loss of principal because over all known 30-year periods neither has been relevant to the final results. That may be necessary for financial companies subject to regulatory oversight, but not us retail investors.

One question is whether the mortgage's interest rate is low enough to try to project this record into the future. Another question is whether an investor is willing to risk their ER on the results. Again, if ER depends on mortgage arbitration then it's probably best to keep working for a while.

Otherwise the whole debate is a personal decision with many independent emotional & financial factors that generally negate a blanket recommendation. In our particular case the factors seemed to tilt our way and, nearly three years later, even after last week's blip we're racking up 12.2% APY unrealized cap gains (after taxes on reinvested dividends) with a 5.375% APY mortgage. This isn't relevant to a 30-year record but it's close enough to the mean and we're far enough ahead of the game to not have to worry too much about reversion to the mean. We're certainly keeping ahead of inflation, which is my definition of the word "risk".

I just wish more posters would take the time to read the old mortgage threads before bringing it up again. This has to be one of the top 10 ER questions, not far behind "Whaddya DO all day?!?"

Moderators, how 'bout adding one of the gazillions of mortgage threads to the "Best of the Boards" forum?

 

[donheff]

Donheff:

Your strategy will outperform the pay-off the motgage stategy if the invested assets gain more on average than the interest rate on the loan. That will probably happen however it is not a sure thing and there are many time periods of which your strategy could backfire. So it goes without saying that the invest the money methods has more risk.

What you really want to compare is the risk-equivalent return of an investment relative to paying down the mortgage. In that case you may be limited to comparing investments like government or very highly rated corporate bonds to the mortgage payoff strategy. In that case the better use of house equity and "extra" payments versus investments is not so clear.

I have not run the numbers but it seems to me that if you are in a high tax bracket, and if the bulk of the mortgage payment is interest, (two big ifs) the save it scenario takes on a lot more weight. You could be adding as much as 30+% to your savings by banking the deduction savings.

 

[MasterBlaster]

Nords:

I don't disagree with anything that you have posted. And I agree that this topic has been beat to death on this forum and every other financial forum around. So in that spirit let me beat the undead one more time.

Let me point out that since we are talking about paying down the mortgage the loan term will be much less than 30 years. Over shorter time frames your stock beats mortgage pay down stategy does not always come out ahead. Your personal 12% gains were taken over a very favorable period for stocks. So (as you know) there is no guaranty of repeating that over the same time period. What is important is the after tax cash flow when you need it.

Donheff:

Tax write offs are good - I agree. However remember that your stock gains will eventually be taxed. If I were to bet I would think that capital gains will get less favorable tax treatment as the years and the deficits roll on. Are you certain that much higher tax rates on your gains will not be levied.

Also you have to worry about your home interest deduction being eliminated by the AMT. So the interest rate deduction is only good for loans that land you between the standard deduction and the AMT floor. Every year that band gets narrower since the AMT floor does not go up with inflation.

 

[jIMOh]

I've been paying "extra" towards the principle of my mortgage every month. I found a mortgage prepayment spreadsheet at The Mortgage Professor's Website and had a lot of fun playing with it. But someone on another forum brought up the point that every dollar you "save" is interest, which is all deductible. I figure that A) being debt-free earlier can't possibly be a bad thing, and B) it's better to "save" 100% of those dollars than to deduct them and save ~30% of the taxes.

What do you think?

The mortgage deduction is expensive. For every $10 you pay, you get ~$3 back. That's not good math. I'll double that offer for you... You pay me $10, I'll pay you $6. Send me $10 and I will send you a check for $6. If you wouldn't do that, pay off the house.

You also need to factor in what you would do with the extra money if you did not prepay (maybe invest it at a brokerage?).

 

[cute fuzzy bunny]

Here's a thought.

Pay down the mortgage per your current strategy, and reduce any ongoing bond investments you're making by the same amount.

Which of course depends on how old you are and how many years until you retire.

I see a lot of 20-30-40 year olds putting huge allocations into bonds because "thats what the book says". Pay your own 5.x% mortgage "bond" off first and then put money into FI.

 

[jumpstart]

I see a lot of 20-30-40 year olds putting huge allocations into bonds because "thats what the book says". Pay your own 5.x% mortgage "bond" off first and then put money into FI.

Per my comments earlier, I agree with this if we're talking about a "tax exposed" bond investment vs. a mortgage. But if we're talking tax-sheltered corporate/high-yield bond, I expect to beat 5.x% by at least a % point.

Also, for many, a 5.x% mortgage is effectively a 4.x% mortgage for those that can itimize (like me).

If one has a near 5% house loan, and can itemize, that's a pretty darn attractive margin loan.

 

[MasterBlaster]

Jumpstart:

Again.... High yield bonds are not risk-equivalent to paying down the mortgage. Apples and Oranges.

 

[jumpstart]

Jumpstart:

Again.... High yield bonds are not risk-equivalent to paying down the mortgage. Apples and Oranges.

A lot of people like to talk about risk from only one side, when there are usually two sides. You're speaking about the risk of volatility; volatility being greater with corporate/high-yield bonds. I tend to reflect more often on the risk of missing out on making the best of a given situation (meaning, not earning as much as I could have with a given pile of cash over a 30-year period).

Overall, the two-sided coin of "risk" tends to null itself out, unless we're talking about a short-time frame so I don't see the point of even discussing it. But we're not; we're talking about 30 years.

Now if you think you're one of the types to freak out and sell at bottoms, go to cash until a market peaks, then invest again, wash and repeat...... then, yeah, pay off the mortgage

For beginners/novices, one could do much worse than paying off any debt; Ala Dave Ramsey. I'd probably give different advise depending on my audience.

...........

Oh yeah, one other tip; If you're a married man, find something else to invest in rather than paying off the mortage.

 

[MasterBlaster]

No I was referring to the risk of default on the high yield bonds not their volatility.

We can all find an investment that will pay better than a mortgage rate. The question then becomes how much extra risk do I need to take on. You are right, if you don't quite grasp that risk concept then there is nothing to discuss.

 

[jumpstart]

No I was referring to the risk of default on the high yield bonds not their volatility.

I'm not near advanced enough to buy junk bonds in the individual market. Buy these through a mutual fund so that the occasional default is absorbed by the fund and will probably go unnoticed.

We can all find an investment that will pay better than a mortgage rate. The question then becomes how much extra risk do I need to take on. You are right, if you don't quite grasp that risk concept then there is nothing to discuss.

I don't want to get too hung up on junk bonds; I just threw that out as an example; besides don't invest 160K in these unless you have 2M plus! A diversified hybrid bond fund (having investment grade, junk, maybe zeros, etc) would probably be a better choice.

 

[MasterBlaster]

Jumpstart

Eureka - You have found "The Sure Thing", now go mortgage your parents house to buy it.

 

[jumpstart]

Jumpstart

Eureka - You have found "The Sure Thing", now go mortgage your parents house to buy it.

Its nice to see we can discuss this in a mature way.