I think I know, but...

[firemediceric]

I've read the multiple threads indicating it is generally wiser financially to carry a mortgage and invest money elsewhere which could otherwise be used for paying down the mortgage. I grasp the counter argument that the psychological benefit of having your home paid for brings a peace of mind for some which eclipses monetary returns.

Although I may lean towards being in the latter group, my desire to maximize my funds could have me very content to carry a mortgage if that's the course of prudence.

My story is I recently closed on home. I had earmarked $220K to use towards the purchase between down payment and closing costs. Any significant pressing repairs would also need to come from that pot of money. As fortune would have it, I landed on a home which had an assumable FHA loan at 3.125% interest. In assuming the loan, I had to take the terms as they were. That meant rather than going with a 15-year mortgage as I had planned, I had to take on the 28 years the previous owners had remaining on the note.

On the upside, I used only $120K of the $220k I had set aside. I am also fortunate that the house needs very little. Furthermore, now that the loan is closed, I am permitted to pay it down as I choose with small additional monthly installments or with a lump sum.

My confusion comes from the way I perceive interest being figured differently on an amortized mortgage versus the compounding interest on an investment.

Do I take the $100k, which I have over & above my emergency fund, sitting in a money market account earning 5.17% currently and pay that towards reducing the mortgage or is the financially smarter move to pay the minimum monthly mortgage payments at 3.125% on the 28-year mortgage and let the cash keep earning at the higher interest rate?

Perhaps an elementary question but I'm thrown looking at how much of the monthly mortgage payment at the beginning of the loan goes to just interest and not principal.

 

[Dash man]

One of many reasons I paid off my loan years ago.

 

[SevenUp]

Do I take the $100k, which I have over & above my emergency fund, sitting in a money market account earning 5.17% currently and pay that towards reducing the mortgage or is the financially smarter move to pay the minimum monthly mortgage payments at 3.125% on the 28-year mortgage and let the cash keep earning at the higher interest rate?

Look at the after-tax returns and cost.

E.g., if your marginal tax rate (combination of federal + state + local) is 25%, you are earning 5.17% * (1 - 25%) = 3.88% after tax. If you don't itemize, then your mortgage is costing the full 3.125%. If you do itemize, it would be less, but how much less would depend on what fraction of the interest takes you above the standard deduction.

Perhaps an elementary question but I'm thrown looking at how much of the monthly mortgage payment at the beginning of the loan goes to just interest and not principal.

In a home mortgage, you are always paying 3.125% on the remaining principal, so the comparison described above is fair. For you, given the assumptions listed, paying the minimum on the mortgage in the situation you describe is financially smarter - and that's even without discussing liquidity issues.

 

[street]

I can't be much help, but I wanted to comment on one thing. There are many tips given to people retiring and one on the list has always been to be debt free. It has always been interesting to me that is always makes the list. I also have heard the same about carrying a loan is a wise choice.

I for one like to build equity as early as possible in whatever I buy as an investment home, land etc...

So, in my honest opinion having a loan during ER isn't my plan of attack. I'm not saying it is better to have things paid off, but in my goal and plan to the end point, is too own not owe.

Again, I got to where I am at today doing it the unorthodox way from what others have said to do and from which way is the best way.

Good luck and hope you find the best way going forward.

 

[Koolau]

I'm certain that if you sharpen the pencil, you can determine whether it's better to carry a mortgage and invest or not. I just never much liked being in debt. YMMV

 

[COcheesehead]

If you take emotions out of the decision, it’s just a math equation.
My mortgage is well under 3%, tax adjusted. I am earning 5%-6% reliably on any funds I would use to pay it off. It’s just arbitrage.
Being debt free in retirement is one of those half truths. It really depends on your total expenses and your cash flow. If your mortgage rate is low and your cashflow secure, you’re golden. The only reason to pay off a mortgage is an emotional one. I can’t say that is wrong, but it’s one I would not chose. I basically live in my house for free, yet still have all the funds I would pay off the mortgage with earning me interest AND, more importantly, I have quick and easy access to. Houses are pretty illiquid. HELOCs are not a given in retirement.

 

[Gumby]

I walked the same path as street, ensuring that my mortgage was paid and that I entered retirement with no debt. And I have been happy with that decision. SevenUp is on point with the calculation as things currently stand. One thing you can count on is that your mortgage rate will be 3.125% over the next 28 years. The other thing you can count on is that your money market rate will vary. I think that, in 2024, it will likely drop from the current 5.17% Also, paying down debt is risk free, but investing is not, even in a money market fund.

One thing you might consider is just making extra principal payments each month if the risk adjusted after tax return on your money market drops below your mortgage rate. You could pick any comfortable amount you want.

 

[Jerry1]

In the current interest rate environment there’s no way I would pay off a 3.125% mortgage. Take the money you would put on the mortgage and save it in some very low risk investment, like a CD. Things may change and it may make sense to pay it off, but with CD’s paying more than your mortgage rate, now is not the time.

 

[Ronstar]

Personally I like to be debt free. But going by your sheer numbers, math says to pay minimum mortgage payments and keep the $100k.

But I think the analysis should go further than just numbers. You don’t mention if you’re retired or not. I suspect not. Will keeping the extra $100k or putting it toward the mortgage now make a difference in future retirement decisions? Any anticipated needs for more liquidity down the road? Or any anticipated investment opportunities?

I think if you put together a solid financial plan for the next 20 years or so, I think the answer will become more clear. But it doesn’t hurt to make minimum mortgage payments until such time that you become totally satisfied that paying $100k toward the mortgage is the right move.

 

[gamboolman]

We paid off our home many years before I retired.
For us, the sleep good at night feeling from having no debt was worth it.

 

[Texas Proud]

Look at the after-tax returns and cost.

E.g., if your marginal tax rate (combination of federal + state + local) is 25%, you are earning 5.17% * (1 - 25%) = 3.88% after tax. If you don't itemize, then your mortgage is costing the full 3.125%. If you do itemize, it would be less, but how much less would depend on what fraction of the interest takes you above the standard deduction.

In a home mortgage, you are always paying 3.125% on the remaining principal, so the comparison described above is fair. For you, given the assumptions listed, paying the minimum on the mortgage in the situation you describe is financially smarter - and that's even without discussing liquidity issues.

Or if you tax rate is zero you earn over 5% and are paying about 3%... easy decision...




Edit to add... you can buy a long term bond or bonds that pay in the 7 to 8% range that mature in 20 plus years.. sue, a default risk buy you can minimize that... even go A rated at 6% or so... you do not have to keep it in MM accounts..


Debt is not an enemy if you do it right...

 

[pb4uski]

In the current interest rate environment there’s no way I would pay off a 3.125% mortgage. Take the money you would put on the mortgage and save it in some very low risk investment, like a CD. Things may change and it may make sense to pay it off, but with CD’s paying more than your mortgage rate, now is not the time.

+1 If you want simple, put the money in a money market fund and then set up an autopay of your monthly mortgage payment from the money maret fund.

If/when the yield on the money market fund ever declines to less than 3.125% and looks like it is not a temporary dip, then use the money to pay it down.

 

[W2R]

Do what you want. It's your choice, after all.

Personally I wouldn't touch a mortgage (or any other loan) with a 10 foot pole in retirement. But that's me, based on my own life experiences, and you need to make your own choice about this. We can't do it for you.

 

[Montecfo]

I think you have gotten good comments here.

One further comment I would add is that net of inflation, the mortgage is free. I would not pay down any debt I did not have to in an inflationary environment.

And I practice what I preach: retired, small mortgage at 2.49%.

It is an ARM so maybe it will rise someday. I have had it for about 15 years.

 

[chris2008]

IMO inflation makes the morgage free only if
- you sell the house at an inflated price - but wouldn't you buy elsewhere at an inflated price, too?
-your income rises faster than inflation - but you would still have to pay the morgage each month.

So I do not really get the argument that inflation is good for debt.

 

[SevenUp]

-your income rises faster than inflation - but you would still have to pay the morgage each month.

If your income goes up, the constant mortgage payment becomes a smaller fraction of that income.

 

[FLSUnFIRE]

I've read the multiple threads indicating it is generally wiser financially to carry a mortgage and invest money elsewhere which could otherwise be used for paying down the mortgage. I grasp the counter argument that the psychological benefit of having your home paid for brings a peace of mind for some which eclipses monetary returns.

Although I may lean towards being in the latter group, my desire to maximize my funds could have me very content to carry a mortgage if that's the course of prudence.

My story is I recently closed on home. I had earmarked $220K to use towards the purchase between down payment and closing costs. Any significant pressing repairs would also need to come from that pot of money. As fortune would have it, I landed on a home which had an assumable FHA loan at 3.125% interest. In assuming the loan, I had to take the terms as they were. That meant rather than going with a 15-year mortgage as I had planned, I had to take on the 28 years the previous owners had remaining on the note.

On the upside, I used only $120K of the $220k I had set aside. I am also fortunate that the house needs very little. Furthermore, now that the loan is closed, I am permitted to pay it down as I choose with small additional monthly installments or with a lump sum.

My confusion comes from the way I perceive interest being figured differently on an amortized mortgage versus the compounding interest on an investment.

Do I take the $100k, which I have over & above my emergency fund, sitting in a money market account earning 5.17% currently and pay that towards reducing the mortgage or is the financially smarter move to pay the minimum monthly mortgage payments at 3.125% on the 28-year mortgage and let the cash keep earning at the higher interest rate?

Perhaps an elementary question but I'm thrown looking at how much of the monthly mortgage payment at the beginning of the loan goes to just interest and not principal.

As far as the math, as other's have said if the after tax cost of the loan is less than a risk free (or riskier if you are so inclined) after tax return it would be optimal to keep the mortgage. Similarly, if you can borrow from a credit card or margin account the same math applies as it is all leverage but many would not recommend those options!


My perspective is that I'd keep the mortgage and use the leverage while working. One can always pay it off with the invested funds but one can't easily borrow cheaply and HELOCs are variable rate. This also gives you greater liquidity to take advantage of opportunities or deal with emergencies. Once FIREd, I personally like having no mortgage. Not having that relatively large payment reduces my cash flow needs giving me more control over my realized income (I don't *have* to withdraw the amount/realize taxable gains) to cover the mortgage payment. There is also the psychological element of owning free and clear. As long as I can make my HOA and taxes I have a place to live no matter what else happens.

 

[firemediceric]

Great replies looking at it from several angles. Thank you all.

 

[Koolau]

IMO inflation makes the morgage free only if
- you sell the house at an inflated price - but wouldn't you buy elsewhere at an inflated price, too?
-your income rises faster than inflation - but you would still have to pay the morgage each month.

So I do not really get the argument that inflation is good for debt.

You pay back your debt in less valuable dollars. That's the idea about being in debt during inflationary periods (assuming a fixed rate of interest.)

 

[DrRoy]

You are financially ahead to keep the mortgage.

 

[Badger]

We paid off many years ago before retirement. We even made extra payments on the principal each month. The original mortgage was $50k at 8.75 interest for 30 years. We were paid off in 10 years. After that we continued paying those same dollars in our 401k(s), Roth, and taxable MF until retirement. Was it a good idea for us and our situation? I don't know but I sleep better at night knowing all we have to afford is around $2500/yr in property taxes to have a place to sleep.
Everyone has their own way and this is what has worked for us.

Cheers!

 

[arcyallen]

Something to keep in mind through all of this: Rejoice in the fact that you are choosing between two great choices! I paid off my 3.25% mortgage a few years ago and don't regret it, but I know we likely would have ended up with more money if we hadn't.

Having said that, try this mental exercise: If you owned the home free and clear, would you take out a HEL at 3.125% and invest it? Why or why not? You don't have to answer here, but your answers might give yourself more insight.

 

[Andre1969]

Perhaps an elementary question but I'm thrown looking at how much of the monthly mortgage payment at the beginning of the loan goes to just interest and not principal.

The short answer is, not much. However, it's going to vary by how much your interest rate is. The higher the interest rate, the more of it goes to interest right from the get-go, although the up-side to that is there's more to write off if you itemize.

To throw out a few examples...
1) My first mortgage, on a condo back in 1994. $79,800, 9.625% fixed, 30 years. Monthly payment (principal/interest) $678.58. First month breakdown: $640.40 interest, $38.19 principal. So, a whopping 5.63% of the first payment went to principal.

2) Current mortgage on my house, refinanced in 2020. $468,000, 2.875% fixed, 30 years. Monthly payment (principal/interest) $1941.70. First month breakdown: $1,121.25 interest, $820.45 principal. So in this case, 42.25% of it went to the principal, right off the bat.

In my case, the emotional side would like to see the mortgage paid off, but the logical side says just let it ride. Plus, thanks to the ravages of inflation, that $1,941/mo becomes less and less painful over time.

Speaking of inflation, that $678.58 payment that started in 1994 would be akin to around $1,397.06, adjusted for inflation. So in real dollars, I'm really not paying that much more now, for a mortgage that's 5.9x bigger. And, if I had kept that original mortgage, even at that high rate, I'd still only be paying $678.58/mo now, almost 29 years later. And it would have been paid in full at the end of next year.

In reality though, I had refinanced that mortgage in 1999, to something like 7.25%, another 30 year. And then in 2002 I refinanced to a 15 year fixed at something like 5.5%, so it would have been done sometime in 2017, if I had stayed in that condo.

 

[MarieIG]

When we bought our home - I printed out an amortization schedule. That allowed me to see how much time and interest pre-payments would save me.

Regular payments made in the beginning of the mortgage went mostly to pay the bank interest. Regularly scheduled payments towards the end of the life of the mortgage went mostly towards paying principal.

Pre-payments made early in the life of the mortgage seemed to cut the most years (and total cost out of pocket) off the mortgage - in other words, I got the most bang for my buck by making those early pre-payments of principal.

I also enjoyed crossing off years (and payments) on that schedule.

If I were you, I would print out the amortization schedule and "play with it." You could, if you choose, create your own 15 year mortgage - if that's want you want. Locking in a low rate - is a "good" problem to have.

Congratulations on your new home! You have options.

 

[CRLLS]

Clearly, the financial answer is in keeping the FHA mortgage. Unfortunately, very few people can follow the financial answer and emotions come into play. This is why many pay off the mortgage early. The good news is that you can carry the mortgage today and prepay the mortgage down at any time you choose. You could pay extra every month, or do a big one-time payment.

In our case, we followed the financial answer for years. Interest earned was greater than the mortgage interest so we, kept on keeping on. When mortgages went below 3% we looked for refinancing to keep more $$ to ourselves. What I was wanting was to refinance for the number of years left on our original loan so that our monthly payment was reduced, not extending the time for another30 year mortgage. I just was not happy paying 4.6% while others were paying <3%. Refinancing at the published low rates was not available for our sub-100K balance. Even though our mortgage interest was still lower than what we were earning in investments, we chose to pay off the existing mortgage. Like I said, emotions do come into play even when you think they don't.

One thing seldom mentioned is that paying down or paying off a mortgage has another financial benefit; it lowers one's non-discretional monthly expense thus lowering any amount necessary to hold in a low interest-bearing emergency fund if one keeps an EF.