The Simple Life vs Mortgage Payoff

[thegarman]

I'll try to make this as short as possible.

We live in a small, rural area. Things are simple here. The cost of living is low, but in return so is the average wage. A nice living here is $35,000- $45,000. Many houses are bought and sold for less then $100,000, with the average monthly mortgage at $500 or so.

Here is my personal situation:

I am married, both of us have decent income. We are 42 years old, with one grown child. With eyes fixed on early retirement, we have over the last 3-4 years worked hard to eliminate all our credit card debt, and both car payments. Both are currently ZERO. We have a combined $150,000 in IRA / 401K through our work. We have a few "toys" , but for the most part, we stay home, save money and work hard.

Our last real "debt" is our mortgage. Today, the payoff is about $41,000, at 5.5% fixed. We have (over the last two years or so) worked very hard, and saved EVERY POSSIBLE PENNY, and now have exactly $41,000 in our savings account. (I know that may not seem like a lot, to you high earning city folks, but its a figure we are very proud of).

If you were us, do you:

a) Write that check TODAY and begin living life debt free? (Temporarily we would be broke. Happy, but broke.)
b) Continue to save, and write the check in say 6 months, after saving a few grand for "emergencies"?
c) Invest some of the money, in hopes of obtaining higher returns, and carry the mortgage a few more years. (I rarely see any sort of tax break from my mortgage interest, as the standard deduction almost always wins out)

Either way, it will be very difficult to see all the money disappear, but we are looking forward to the day we are debt free. From there, we should be able to reestablish a very high savings rate, and rebuild the "heap" rather quickly, with hopes of ER.

Thoughts ? Advice?

 

[Sue J]

I vote for option (b)-
b) Continue to save, and write the check in say 6 months, after saving a few grand for "emergencies"?

While your heart may be telling you to pay it off now, we all know that life tosses you a surprise every now and then. You don't want to be without an emergency fund. Having a paid off mortgage is a glorious feeling, but so is having a hunk of money in the bank, just in case.

How much are you saving a month currently while you still have the mortgage payment?

 

[brewer12345]

I would either keep the cash in savings or invest it as you see fit. More importantly, I would refi ASAP. I believe that Pen Fed will do a no cost 10 year home equity loan at 2.99%.

 

[easysurfer]

IMHO, it sounds like you are leaning towards the satisfactory feeling of owning your place outright. Still, if you want that, I'd pick option b, to build up some emergency first. You don't want to bring your savings down to zero, then have something come up like your car or furnace breakdown.

Six months isn't that far away. In the meantime, if you haven't already so something like create a budget and think/dream about how you are going to save and invest all the extra money that would have gone into mortage payments.

 

[Ed_The_Gypsy]

How about making double payments? That would seriously accelerate your payoff and still leave you with an emergency pot--that would still be growing in the meantime. I would not 'invest' the cash in anything but short-term (otherwise, it would not be an emergency fund, would it?) cash equivalents at the moment. I learned the hard way that anything less than 10 years is short-term and subject to market losses unless in CDs.

 

[Nuiloa]

Unless your savings are generating 5.5% interest, I'd say put a push on paying off your mortgage. However, I agree that there should be an emergency fund first.

Once you have paid the mortgage, continue to pay it to yourself. It's amazing how fast it grows!

 

[Andre1969]

How many years are left on your mortgage? On a 30 year mortgage, I think the tipping point of 50/50 principal/interest is something like 23 years into it. So once you get towards the end of the mortgage, most of your payments are principal anyway. So while you're at 5.5%, if your outstanding balance is only $41K, you might be paying mostly principal.

Owning your home outright, I imagine, is a nice feeling (I wouldn't know yet). But, with such a small outstanding balance, and the fact that your payment is probably mostly principal at this point, I don't think I'd rush to pay it off early.

One thing you should do though, is check the amortization tables and find out what percentage of your monthly payment is interest at this point in time.

 

[Animorph]

Given that you seriously want to be debt free, (b) sounds right to me. You could do a zero-cost refi if it looks like you might want to take longer than 6 months to pay it off. I'm happy to carry a low-cost (and deductable in my case) mortgage and invest the amount in equities, but probably not at 5.5% these days.

 

[thegarman]

How much are you saving a month currently while you still have the mortgage payment?

Good Question. We normally have at least two (of four monthly) paychecks "free and clear" every month that go right into savings. Probably about $2000 a month dumps right into savings, even with paying the mortgage.

Keep in mind though, that this is a fairly recent development, as previously we were paying off credit cards, and cars, and paying for our sons college. Its only been 8 -12 months that we have really been saving.

Its funny, the more bills you pay off, the faster your savings can add up!

And yes, some sort of Option "B" is probably the way we will go...

 

[ronocnikral]

refi into a 5year ARM (if possible).

 

[clifp]

My guess is that without the mortgage payment (or possibly even with it) you would not need to itemize deductions. Thus you aren't getting the tax benefits that people with higher mortgage balances and incomes get.

So I would be certainly inclined to pay it off. There is no law that say you have to pay all of it so paying $30,000 to 35,000 and leaving the rest as emergency fund, I think would be the right approach. Then make extra payment on your mortgage, and 2012 will the year you will be DEBT FREE!. Congrats.

Given the low mortgage balance I certainly would not bother with a refi.

 

[l2ridehd]

I like option c. Yes I know, you didn't list an option c. So here is what option c should be. Set aside 10K for you emergency fund now. Pay off 31K on the mortgage, then make double payments until it is gone. With this option you save a lot of 5.5% interest payments, you maintain an emergency fund, and you get the balance paid off in about 6 months by paying mostly principal and very little interest. And no gap without an emergency fund. The best of all worlds. Accomplishes exactly the same objective with lower risk and minimal cost.

 

[GrayHare]

Option c, plus refinance to a term with, say, a 3.5% rate. If inflation runs 2%, that drops your effective rate to 1.5%, and you can probably earn more than 1.5% via investments.

 

[pimpmyretirement]

I like option c. Yes I know, you didn't list an option c. So here is what option c should be. Set aside 10K for you emergency fund now. Pay off 31K on the mortgage, then make double payments until it is gone. With this option you save a lot of 5.5% interest payments, you maintain an emergency fund, and you get the balance paid off in about 6 months by paying mostly principal and very little interest. And no gap without an emergency fund. The best of all worlds. Accomplishes exactly the same objective with lower risk and minimal cost.

+1

You should have X months living expenses in liquid reserves, where X is determined by your job security and tolerance for risk. This is not an all or nothing proposition.

Determine X, keep it in the bank, put the rest towards the mortgage.

Yeah, the numbers would probably say do a refinance, invest the $41k.. blah blah blah. The reality is it's $41k. If you net an extra 1% return on that over having used the money to pay off the mortgage, you'll clear a whopping $410 dollars a year. No thanks, I'd rather have the peace of mind that comes with owning the home.

 

[pb4uski]

First and foremost, congratulations in putting yourself in a situation where your only debt is mortgage debt and you have savings equal to your mortgage balance. Doesn't it feel good?

Totally agree with others that you should keep an emergency fund of 6-12 months of expenses.

Do you have and fund any Roth IRAs? If not, I would divert some funds towards the Roth IRAs (you can do $6K/year each IIRC).

Since you don't itemize deductions, I would favor paying down the mortgage since in a it is a "guaranteed" 5.5% return (avoiding paying 5.5% is similar to earning 5.5%) and you will sleep better at night. I wouldn't normally suggest that but the fact that you don't get a tax benefit from your mortgage interest makes it seems best in your situation.

 

[ChadR]

Option B is my vote.

yes you could probably refi your mortgage and get a lower interest rate. The pay off mortgage vs earn better returns on investments will never die. Just keep in mind that at the end of the day while a mortgage may be the cheapest borrowing you can ever do, if you make the decision to invest instead of paying off, you are effectively borrowing money to put it into the stock market.

If you honestly think you can get better returns by not paying down your loan, then go ahead and REFI the house for a better rate but why not cash out as much equity as possible and invest it in the market. Some people are confident that they can generate superior investment returns compared to today's mortgage rates. No problem, maybe you are one of those people. Just recognize that on a macro basis you are effectively borrowing to invest, not the simple what should I do with existing cash.

Finally, because your not getting a tax benefit on your mortgage interest you have to consider your incremental (not effective or marginal) tax rate on those investment gains to establish what sort of investment gain you need to achieve for it to make sense. If your incremental tax rate would be 15% lets say and you obtain a mortgage of 3.5%, Your gains need to be 4.12% for example.

 

[W2R]

It all depends on what YOU want to do, of course. Get out your spreadsheets and try all of the various scenarios discussed above to see what the results might be.

Were it me, I'd pick option B. But that's just me.

 

[Bestwifeever]

It's so awesome not to have a mortgage payment, no matter how much more financial sense it might make to keep a mortgage. Knowing you don't have to make those payments is just priceless. So I'd get it paid off by the end of 2012 , when you'll have $25K more in the savings account to keep you covered.

 

[FUEGO]

I'll go contrarian and say option A - pay it all off now. You are living on only 1 paycheck right now, so you'll have the other paycheck to live on should one of you lose a job. And if you are saving $2000 a month, you'll have $2000 in savings at the end of the month (plus what you were paying on a mortgage each month). Having a credit card or HELOC would be a good back up plan. Penfed and others allow you to get no closing cost HELOCs and that would act as your emergency fund short term if you need some quick cash (at a very low interest rate). Regardless of the HELOC, in 4-5 months you'll keep saving and have a tidy five figure savings account and probably not need to tap your HELOC.

Not having any debt payments at all reduces your need for monthly cash outlays.

 

[Meadbh]

It's so awesome not to have a mortgage payment, no matter how much more financial sense it might make to keep a mortgage. Knowing you don't have to make those payments is just priceless. So I'd get it paid off by the end of 2012 , when you'll have $25K more in the savings account to keep you covered.

+1

 

[dessert]

You could do a zero-cost refi if it looks like you might want to.........

Animorph, what is meant by a "zero cost refi"? I'm thinking about a re-fi myself but the only way I see to have zero costs is to just throw all of the costs into the loan amount. All that means is that you don't have to pay up front now but do so later. Could you help with an example of what is zero cost in a re-fi situation?

 

[brewer12345]

Animorph, what is meant by a "zero cost refi"? I'm thinking about a re-fi myself but the only way I see to have zero costs is to just throw all of the costs into the loan amount. All that means is that you don't have to pay up front now but do so later. Could you help with an example of what is zero cost in a re-fi situation?

Many lenders will offeryou a true no cost refi in return for a higher note interest rate.

 

[growing_older]

My vote is C.

Figure what is a comfortable emergency cash cushion (say $10,000) and plunk the rest on the house. Blast the remaining mortgage for a few months until it is paid off, meanwhile you still have your $10,000 cash cushion to cover unexpected events.

With a mortgage balance of only $10,000 you are unlikely to find any refinance options. You may find no cost Home Equity or HELOC with attractive rates, so if you really want to get rid of your 5.5% you could. If it's only for a few months it likely doesn't matter much. You might find you want a HELOC with so much tied up in your home equity. You might decide you don't want the temptation.

 

[FreeAtLast]

Option B sounds better. You need to have an emergency fund.

 

[Tif7]

You could pay off about 30k, leaving you some cash for an emergency. Then dump the 2k a month you are clearing into the remaining balance and you will be done in 5 months or less.

T