Some opinions, please, re: mortgage prepayment

[sirion]

I just really need some opinions on this because I just keep going round and round in my head. Here is our situation as a 35 year old married couple:

Assets:
--Approx $1M in a well-diversified 80% stock/20% bond portfolio at Vanguard
--Emergency fund $20,000 in CD ladder
--$95,000 in 529 for our one nearly 4 year old daughter (no plans for more children)

Liabilities:
$295k on a 5.25% 30-year fixed mortgage with 29 years left

Income:
combined salaries: $94,000/yr
annual gift from parents: approx $47,500/yr

Contributions:
--Max out 401(k) - $16,500
--Fully fund Roth IRAs for me and hubby - $10,000
--Hubby has no retirement plan at work, unfortunately

We usually have about $10,000 annually "left-over." So my question is should I pre-pay the mortgage? Here are my thoughts:

Pros:
--If we prepay $10,000/yr, we will have it paid off by the time my daughter enters college, thus allowing us to supplement her tuition, if necessary, with cash flow.
--After daughter finishes college, we can think about retiring early (in our 50s) and with no mortgage payment. I don't like the idea of having to generate an extra $1,700/month in income from our investments until we are 65 and the mortgage is paid off.

Cons:
--We are 35 years old and our savings rate is still really important. That $10,000 will have about 20 years to grow if we invest it yearly in our taxable account.
--The rate on our mortgage is low (5.25%), but our tax bracket is also pretty low (15%) so we don't get too much savings from the deduction. Our itemized deductions are only about $9,000 more than the standard deduction,.

Any thoughts? From people who have been there/done that? Thanks so much for any input. Like I said, I am really stuck on this.

 

[REWahoo]

Sirion, this subject is one of the most frequently debated topics on the forum. See this FAQ for many threads on the subject.

My advice: do whatever makes you feel good.

 

[sirion]

Thank you for the link. I will get started by reading those threads. I suppose, like many things, there is no right answer.

 

[REWahoo]

I suppose, like many things, there is no right answer.

You got it.

 

[DblDoc]

Also a good summary here: Paying down loans versus investing - Bogleheads

DD

 

[sirion]

I'm trying to run the scenarios through FireCalc, as the threads suggest, but I can't figure out how to do this type of calculation.

I'd need expenses of $70,000 for the first 10 years of retirement, which drops down to $50,000 after the mortgage is paid off. Is there a way to do that?

******

Later, I figured out only to run for the first 10 years of retirement. I got 100% success both ways.

With mortgage: Avg bal $2,451,180
W/O mortgage: Avg Bal $2,303,322

Guess what?? It really doesn't matter much at all what I do.

 

[REWahoo]

I'd need expenses of $70,000 for the first 10 years of retirement, which drops down to $50,000 after the mortgage is paid off. Is there a way to do that?

Yes.

If you make a small donation to FIRECalc (click the "resources" link) you can sign in and take advantage of a couple of additional features. One of these is the ability to enter manual spending changes on the Spending Models tab.

 

[RockyMtn]

Sirion,

you two are certainly well on your way to an early FIRE date.

The debate rages on about prepaying a mortgage. On one side we have the peace of mind of not having a mortgage over your head during retirement. On the other side we have the math that basically says with the tax deduction (which gets your interest down to about 4%) you are better off not prepaying if you think that over the term you will have a better return investing the money (4% annual return average over 29 years is not a high hurdle).

A compromise which might give you some of the benefits of both....Pay an additional $400 per month out of your leftover $10k to the mortgage. Invest the rest. This would have the mortgage paid off by 2028 when you will be in early 50's just in time to FIRE!

 

[sirion]

Thank you all for your thoughts and for not beating me up for re-hashing a much hashed topic. I've been reading the old threads and thinking and thinking and I still don't know what to do. I'm glad FireCalc says it doesn't really matter.

 

[sirion]

Yes.

If you make a small donation to FIRECalc (click the "resources" link) you can sign in and take advantage of a couple of additional features. One of these is the ability to enter manual spending changes on the Spending Models tab.

Thank you for the tip. I will make a donation because I've been meaning to do that anyways!

****

Donation made!

 

[brewer12345]

Yes.

If you make a small donation to FIRECalc (click the "resources" link) you can sign in and take advantage of a couple of additional features. One of these is the ability to enter manual spending changes on the Spending Models tab.

Just a point of order:

Now that firecalc is owned by a profit-seeking organization rather than an altruistic individual, this is not really a "donation" any more. Lets call a spade a spade: this is fee for service.

 

[growing_older]

This seems to be a personal decision and everyone has their own opinion. So here's mine...

With the size of portfolio you already have, and the growth it will expect, your savings are in great shape. The biggest obstacle to you being FI is the monthly level of fixed expenses. Knocking off (or at least knocking down) the mortgage would be my first priority were I in your situation. With lower monthly costs, and the portfolio you already have, you will have lots of freedom in the future to do what you want - be that work, retirement, semiretirement, volunteer work, travel, etc, especially if you aren't tied to a big monthly payment.

 

[Andy R]

If you make a small donation to FIRECalc (click the "resources" link) you can sign in and take advantage of a couple of additional features. One of these is the ability to enter manual spending changes on the Spending Models tab.

All donations are still be routed to Dory. At some point in the early part of the New Year we will remove the donation option (sorry Dory) and open up all the features to everyone for FREE (because I am a profit-seeking organization rather than an altruistic individual).

 

[brewer12345]

(because I am a profit-seeking organization rather than an altruistic individual).

Presumably extra traffic drives more value than the piddling stream of "donations," so your self-characterization appears accurate.

Thanks for the clarification. Kudos on offering full functionality free of charge.

Signed,

One of your Content Generators (an altruistic individual AND profit seeking organization)

 

[Andy R]

Presumably extra traffic drives more value than the piddling stream of "donations," so your self-characterization appears accurate.

If that drives a lot of extra traffic, great. If not, no problem. Really, the truth is I am lazy and don't want to have to manually upgrade accounts after donations. I guess that would really make me a lazy individual who is being altruistic even though I own a profit-seeking organization. Isn't America great. A symbiotic relationship where lazy people can give away things free and still try to make a profit!

Thanks for the clarification. Kudos on offering full functionality free of charge.

You're welcome. Lots of people dislike the ad supported internet but it's been the catalyst for many innovations and free services for people.

One of your Content Generators (an altruistic individual AND profit seeking organization)

Thanks for your contributions. I hope you enjoy the stage.

 

[brewer12345]

Andy, FWIW, I am not really interested in pulling your tail. Happy that the donation issue is cleared up, since the appearance of calling something a donation when it is not bothers me. Ad supported internet is what it is, and has indeed spurred a lot of things on. Its a mixed blessing, like most things, but is hardly likely to go away any time soon so there is no point worrying about it anyway (much like the tax code). Keep up the good fight with the spammers and hackers.

 

[Walt34]

Basically the decision is an emotional one. We like being able to say "We don't owe anybody a damn thing!

That's worth a lot to us. YMMV.

 

[scrabbler1]

Sirion, if I can add two things which put me over the edge when I decided to pay off my mortgage back in 1998:

(1) I had a 1-year ARM and the interest rate was rising after I did a refi in 1992. It had not returned to the pre-refi years but had gotten about halfway there.

(2) As my mortgage interest deduction dropped in the mid-1990s, I saw that it was barely above the standard deduction for my state (not federal) taxes. This told me that paying off the mortgage would not cost me anything in state income taxes because the itemized deduction would replaced by the "floor" standard deduction. So the interest savings on the state side was pure.

 

[Texas Proud]

Sirion....

There is a two edged sword that I see.... you get over $47K from parents!!!

That either means they are rich, and you might be in line to get a big estate payment later in life... OR, they are spending a lot of money on you and will have nothing when they go...

But it also seems like most of what you have now is because of them (savings I mean)... If they have been doing this for 12 years, that is almost half of your savings... and I would assume the other half is from earnings...


SOOO, to my point.... what would happen IF you did not get this money Do you have enough to live on with your own salaries? It looks close to me... If so, then maybe paying down the mortgage NOW is easier with the extra cash you receive and if it stops and you are in a cash flow problem (because you don't want to touch savings), then you can refinance and spread out the payments...


But I still think your 'crisis point' is not the mortgage, but if your cash flow can be interrupted....

 

[SecondCor521]

One general comment:

Public opinion on this one wavers with the tides of the market. When the market was going up up up a few years ago, the reaction to "pay off your mortgage?" was "are you crazy?" With the recent downturn and job losses, the reaction is more along the lines of "hmmm, maybe it is a good idea to pay the thing down."

I'd tell you what I'm doing but I think the decision is very circumstance-driven, and mine don't match yours at all.

Good luck with the decision,

2Cor521

 

[youbet]

Public opinion on this one wavers with the tides of the market. When the market was going up up up a few years ago, the reaction to "pay off your mortgage?" was "are you crazy?" With the recent downturn and job losses, the reaction is more along the lines of "hmmm, maybe it is a good idea to pay the thing down.

Great observation!

POV's really swung around dramatically as the markets plunged and most of us got a dose of seeing our RE portfolios take a beating. In addition to the pay-off-the-mortages attitude change, I've also noticed that the fear of dieing with a lot of money left on the table or working longer than necessary of the pre-recession days has now been replaced with folks wanting the security of very low WR's and cushions and backup plans and all that.

To OP - As others have mentioned, there is generally little financial reason one way or the other concerning the pay-off or not decision with mortgages (assuming the mortgage is at a currently competitive interest rate). Do whatever feels good. Just remember that if you chose to not pay it off (or pay it down), invest that money prudently so it's available if you do need it for house payments sometime in the future.

 

[bow-tie]

I don't know if this will be of any value, but here's my input:

If I was sitting on that type of portfolio, coupled with this type of economic environment (and labor market funk), I would throw that 47.5k at your mortgage. The house would be paid off in 6-ish years. Meanwhile, I would still have the large portfolio, and I would still be contributing 26k per year to it. Once the house is paid off, I would have that peace of mind and, if applicable, I could use the 47.5k per year to continue to bolster the portfolio.

Unless the fit hits the shan in a major way, you guys are going to be sitting on a considerable portfolio by the time you hit age 50.

....my two cents. (and it probably ain't worth even that...)

 

[jIMOh]

I just really need some opinions on this because I just keep going round and round in my head. Here is our situation as a 35 year old married couple:

Assets:
--Approx $1M in a well-diversified 80% stock/20% bond portfolio at Vanguard
--Emergency fund $20,000 in CD ladder
--$95,000 in 529 for our one nearly 4 year old daughter (no plans for more children)

Liabilities:
$295k on a 5.25% 30-year fixed mortgage with 29 years left

Income:
combined salaries: $94,000/yr
annual gift from parents: approx $47,500/yr

Contributions:
--Max out 401(k) - $16,500
--Fully fund Roth IRAs for me and hubby - $10,000
--Hubby has no retirement plan at work, unfortunately

We usually have about $10,000 annually "left-over." So my question is should I pre-pay the mortgage? Here are my thoughts:

Pros:
--If we prepay $10,000/yr, we will have it paid off by the time my daughter enters college, thus allowing us to supplement her tuition, if necessary, with cash flow.
--After daughter finishes college, we can think about retiring early (in our 50s) and with no mortgage payment. I don't like the idea of having to generate an extra $1,700/month in income from our investments until we are 65 and the mortgage is paid off.

Cons:
--We are 35 years old and our savings rate is still really important. That $10,000 will have about 20 years to grow if we invest it yearly in our taxable account.
--The rate on our mortgage is low (5.25%), but our tax bracket is also pretty low (15%) so we don't get too much savings from the deduction. Our itemized deductions are only about $9,000 more than the standard deduction,.

Any thoughts? From people who have been there/done that? Thanks so much for any input. Like I said, I am really stuck on this.

My thoughts are as follows...

you answered your own question below (it depends)...

...And you have a decent idea on how to run various numbers. To retire early you need to have the means of paying off the mortgage, and at some point of retirement saving, it makes more sense to pay down the mortgage than it does to keep it. Peace of mind, return on investment and projecting what you want 20-30 years down the line all factor into the decision.

I am in same situation as you right now- do I pay down mortgage or invest... and I have chosen to invest for a short time. In my case I am attempting to get enough invested that I can project a 9% return from the investments and pick a retirement date. I am "close"- meaning within next 2 years I would expect all the money we have invested to be enough to retire on if it grows at the expected rate of return.

At that point some of the money we invest will be re-directed to mortgage to pay it off faster. In my case I want to direct only enough to pay it off the year our kids (twins) go to college. Will still invest after the inflection point, but that is more for cushion to build into the plan than it is because we need to invest.

 

[sirion]

There is a two edged sword that I see.... you get over $47K from parents!!!

That either means they are rich, and you might be in line to get a big estate payment later in life... OR, they are spending a lot of money on you and will have nothing when they go...

But it also seems like most of what you have now is because of them (savings I mean)... If they have been doing this for 12 years, that is almost half of your savings... and I would assume the other half is from earnings...

SOOO, to my point.... what would happen IF you did not get this money Do you have enough to live on with your own salaries? It looks close to me... If so, then maybe paying down the mortgage NOW is easier with the extra cash you receive and if it stops and you are in a cash flow problem (because you don't want to touch savings), then you can refinance and spread out the payments...

Thanks for your comments. We budget on our combined income of $94,000 and never include the annual gift. We live semi-comfortably in a HCOL area on that amount. However, our Roth IRA contributions currently come from the annual gift. I used to make about twice what I make now and took a lower-paying job so that I could continue to be near to home and not work a lot of hours (I stayed home for 3 years after my daughter was born.) I anticipate being able to find a higher-paying job if we need more cash. However, our lifestyle will not suffer if they cannot continue gifting, even if our savings rate would suffer. We use the gift money to spend on things we don't really "need" but would like to have. For example, we used some of the 2009 gift money to purchase a kitchen table and nightstands since we didn't have either. We were just using the dining room table and old tray tables beside our bed.

You are correct that my parents have been gifting us money for a long time and that a good chunk of my portfolio is due to them, however, I have also always been a huge saver. They have a portfolio of about $4M and figure they are better giving some of it away while we actually need it (every one of their grandkids had the benefit of a stay-at-home parent until age 3). They hope to leave us an inheritance, but it will depend on many factors, of course. So far, they have never given more than they have generated in income (between SSI, Dad's pension, and Mom's salary). My mother still works FT at age 70 and shows no signs of stopping (Dad FIRE'd at 55). I guess I expect to receive about $1M in about 5-10 years (but I never want them to die ). If I do receive an inheritance of that size, I will definitely pay off the mortgage.

I hear you about trying to pay the mortgage down so that if the gifting stops, our current income can get a boost if we refinance. That's definitely something to consider. It's hard to plan for every scenario, but even if I invest in my taxable account instead of paying down the mortgage, I can always take some out and refinance with a chunk of cash.

Thanks to everyone for the input...