Millionaires: do they pay off their mortgages?

[DRiP Guy]

Our society has this "mortgage debt is good" mentality - I think for a lot of people it is "spending a dollar to save 50 cents" logic

If you have a high AGI, the deduction reductions can be significant - around 30%.

So if a "high AGI" person had a $130,000, 30 year, 6% mortgage - they pay about $10,000/year in interest.

This gets reduced to $7,000 of deductions because of high AGI. Let's say they avoid 35% taxes -- so that's $2,450. So "using some else's $130,000" cost $7,550 per year cash-out-of-pocket.

So to make the mortage worthwhile, you gotta make (after tax - right ?) more than $7,550 on the $130,000 you have invested elsewhere.

That's 5.75%, after tax - and theoretically to compare should have the same risk level as holding equity in your house (low). That's tough.

There's a lot of things in life I don't understand - add "desireable mortgage interest deductions" to the list.

Also on the list: Day spas, Logarithms, SUVs, $4 lattes, and car detailing..............

I can't help you with gyms, Jimmies, Javas, or jalopies, but the logarithm thing is easy:

anti-exponentiation


(now, explaining e ... that is a bit more tricky)

 

[LOL!]

It is not necessary for mortgage interest to be deductible for it to make sense to keep a mortgage and invest money that could go to pay off the mortgage elsewhere.

I'm also sure that you don't have to claim every itemized deduction that you are allowed.

What seems to be important here is that many folks are rational and run the numbers. Some are not rational and do not run the numbers because they are right no matter what.

 

[JustCurious]

I'm also sure that you don't have to claim every itemized deduction that you are allowed.

You would be a fool, but you're right, you could choose not to claim a deduction that you are allowed.

 

[macdaddy]

Our society has this "mortgage debt is good" mentality - I think for a lot of people it is "spending a dollar to save 50 cents"

The way the last few years have gone, it's hard to convince people not to extend themselves and buy as much house as their exotic loan product allows them to. Couples who made foolish decisions to over extend themselves on housing were largely rewarded for it, until recently.

 

[Craig]

However ... good to adopt a cautious attitude about what is considered an "exotic" (aka dangerous) loan product. There are some useful tools out there.

For example, we refi'ed into a 30 year, fixed rate, interest-only option loan. Rate was 5.625%, and you have the option to pay interest only the first 10 years ... after that, it is a forced 20 year amort. Of course, you can pay any amount of principal you choose in the first 10 years. We paid principal down the first year, invested and used the cash elsewhere last year, and will pay down more principal this year. Having the option is nice, and with over 40% equity, we're cool with no principal payments if we so choose.

I just point this out because some folks have a knee jerk response to a product like this, and I believe it ignores some handy products that do provide great flexibility, while also fixing the rate exposure.

 

[firewhen]

We could have paid cash for our house a few years ago, but took out a maximum mortgage, while still avoiding PMI (80% of purchase). Here is why:

1) Rates were very low at the time--I got 4.75% for 15 years
2) I invest almost all in stocks, and I expect to beat that rate over the long haul
3) If I did not take out the big mortgage, I would have had to sell stocks, since I am not that liquid, which would have made paying capital gains federal and ordinary income to the state (I don't think most states have a separate rate for cap gains)
4) We get a deduction so the after tax interest is even lower and meanwhile the stocks I did not sell keep growing tax deferred. I still get about 2% dividends on the stocks we held, which could go to the monthly payment if need be. But even without the deduction, I would have taken out the mortgage.
5) My way of being "conservative" was going with the 15 year, since we are getting rid of the mortgage faster. If I truly wanted more leverage, I could have gone 30 years, but figured this gave some balance.

Luckily, the past few years, especially 2006, have been great, allowing me to do so much better than the mortgage interest rate.

What would I do after ER? Harder decision. Taxes would be less of an issue either way. I would still have to sell stocks, buy the cap gains rate would probably partially be at 5%. I do not know if I could stomach the big monthly payment then when just living off investments. I would hate to see some lean or negative equity return years while still paying a big mortgage.

 

[cute fuzzy bunny]

A prior poll from a different slant:

http://early-retirement.org/forums/index.php?topic=6046.0

No mortgage here, and even if we had one our itemized deductions wouldnt exceed our standard ones.

Without a huge monthly payment demand we shelter most of our "income" and pay less than 4% of what we generate in total taxes...including property taxes.

With the penfed differential between cd's and 20 year mortgages I did a back of the envelope calc. We'd make a couple of grand a year in float and pay an additional ~7000 in taxes as the extra income would bump us into a higher tax bracket and from 5% to 15% on qualified dividends and capital gains, which is where most of our money comes from.

No thanks.

"Conventional thinking" and fishbowling this argument make little sense for an early retiree.

Dang I missed this discussion...

 

[Cut-Throat]

Dang I missed this discussion...

Don't do it TH

 

[laurence]

My situation: When DW and I went from renting and taking the standard deduction to home ownership and itemizing, we reduced our taxes by about $1,500. This is in big mortgage San Diego. It's fun to throw around big numbers and say, "my tax deduction from the mortgage is 10 grand!" but that can translate into only $2,500 in actually dollars in pocket.

I waffled on this issue, we settled on a 20 year mortgage @ 5%, and will just run out of payments a few years before I can retire. So I would be disengenuous to model as if I took a stand on either side of the issue.

 

[Nords]

We'd make a couple of grand a year in float and pay an additional ~7000 in taxes as the extra income would bump us into a higher tax bracket and from 5% to 15% on qualified dividends and capital gains, which is where most of our money comes from.

That might be the way taxes used to be calculated (the infamous "tax-bracket creep") but I thought that nowadays moving into a new bracket would only apply to the income/dividends above the cutoff. IOW you'd still get 5% on your dividends/cap gains until you went above the limit, and whatever's above that limit would be taxed at 15%-- not everything, just the amount above the limit.

But I could be wrong.

 

[LOL!]

Sounds like a turbotax run is in order. Is "back of the envelope" a software package sold by Microsoft?

 

[cute fuzzy bunny]

That might be the way taxes used to be calculated (the infamous "tax-bracket creep") but I thought that nowadays moving into a new bracket would only apply to the income/dividends above the cutoff. IOW you'd still get 5% on your dividends/cap gains until you went above the limit, and whatever's above that limit would be taxed at 15%-- not everything, just the amount above the limit.

But I could be wrong.

No, you arent. However since i'm skirting the 5/15% boundary right now, any additional capital gains created to satisfy a debt instrument would be taxed at the 15% level and any addition ordinary income generated would get taxed at the usual income tax rates a bracket or two higher than what we're paying now.

I'd only get interest deductions to the extent that they exceeded the standard deduction.

As far as "the back of the envelope", its actually about six pages from last years tax return that I printed out and doctored up with the prospective numbers. I suppose those would make a fairly odd envelope. But i'm sure if they thought they'd make a few dollars off of it, microsoft would find a way to sell it.

Hell, the owner married the woman who brought us Microsoft Bob...

Back to the original question: do millionaires pay off their mortgages? I would imagine that someone that is well into the "millionaire" status would be a different scenario. If I had $5+M I might have one...cuz who cares? If I had a fairly small ER portfolio to work with...under $1M...I might HAVE to have one and take my chances.

One of the biggest concerns about ERing seems to be "what if I run out of money?" or "what if I have to go back to work in 10 years and my job skills are shot?".

In my mind (oh go ahead) you increase those risks in a linear fashion coupled with your monthly expense demand. Its great to have a larger port and arb a point or two out of it, but if you're carrying more lower return fixed income or easing off of the riskier, higher returning asset classes or frittering most of your gains away to income taxes...bad deal.

If you're still working and accumulating, you have a huge pot of cash such that any holes in the road wont screw you up, your "old job" has no special skills or knowledge that rots over time, you have a solid income stream that can cover the bills (cola'd pension) and/or you're already comfortable with carrying a high risk, high volatility portfolio...this decision makes sense.

Carving it down to "I can make xx% on a cd and pay yy% on a mortgage, so i'm making xx-yy" or "I can invest the money at an 8% average return while paying a 6% mortgage and make 2%!" is the greatest rationalization for someone who has already decided to carry a mortgage. For how it fits into a total picture open minded financial plan? Not so much.

I have to admit to feeling a good bit of pleasure in not paying very much to the feds and the state of california. Those seem to be poor returning investments for the most part.

 

[Nords]

However since i'm skirting the 5/15% boundary right now, any additional capital gains created to satisfy a debt instrument would be taxed at the 15% level and any addition ordinary income generated would get taxed at the usual income tax rates a bracket or two higher than what we're paying now.
I'd only get interest deductions to the extent that they exceeded the standard deduction.
I have to admit to feeling a good bit of pleasure in not paying very much to the feds and the state of california. Those seem to be poor returning investments for the most part.

Well, tax considerations affect our investing strategies far more than they should. I'd be happy to share my additional gains with wasteful politicians and Dory's server fund-- I'd still have more than I would by doing nothing. I guess it's human nature-- no matter how far ahead we are on points, we still hate to give up a touchdown. It reminds me of Covey's arm-wrestling for money analogy-- our competitive spirits can always get in the way of making more money for everyone.

I suppose those would make a fairly odd envelope. But i'm sure if they thought they'd make a few dollars off of it, microsoft would find a way to sell it.
Hell, the owner married the woman who brought us Microsoft Bob...

That just popped up a scary image. Maybe JG doesn't post anymore because he's locked in a focus-group conference room at Redmond testing the next-generation tablet machines-- the new "back-of-the-envelope" computers. They're probably trying to figure out a way to make the screen blank out when he uses the "pencil eraser" on it.

Bill Gates should stop appearing on TV with Melinda before everyone realizes that she's smarter than he is. Doesn't take much in the smarts department to marry a major babe with a brain, either, even if that's the only way he could kill off the funding for the "Son of Bob" project.

Carving it down to "I can make xx% on a cd and pay yy% on a mortgage, so i'm making xx-yy" or "I can invest the money at an 8% average return while paying a 6% mortgage and make 2%!" is the greatest rationalization for someone who has already decided to carry a mortgage. For how it fits into a total picture open minded financial plan? Not so much.

Guilty. It's not a question of "if" it should be done... only of "how much". And I agree with all the risks, other lower-interest-rate-earning assets, and "sleep at night" issues you've raised.

In addition to the portfolio distractions, another factor is the hassle. We could earn more by stoozing a half-dozen credit cards, with their attendant hazards of missing a deadline or having a lower FICA score jack up our insurance rates. Arbing a mortgage for a higher-paying CD is a safer hassle for a lower return, but it's still a hassle.

So, like prolonged unemployment, maybe ER just gives us more time to obsess optimize these crazy revenue-generating schemes...

 

[cute fuzzy bunny]

I agree completely on not selling yourself short in order to shortchange the government.

But i'm just playing legal three card monte with them. I'm living the lifestyle I want, making good money on my investments, and giving them as little of the proceeds as possible. Its a weird conjunction of having high assets, producing most of our income from qualified dividends and long term gains as possible, and minimizing regular taxable income.

Take the standard deductions, pay 5% on the dividends and capital gains, and nothing or nearly nothing on what looks like poverty level "ordinary" income on a tax form. I'm sure this construction is more meant to reward low income people that are trying to invest, or those on social security income taking some dividends and gains from their retirement portfolio...not for a pair of 45 year olds still working part time.

But i'll take it.

Throw 25-30k in additional gains and payments into the mix...icky.

 

[bright eyed]

California taxes keep getting manipulated and the speculators find new suckers. I've seen articles that say 70% of the people that own homes in California couldn't afford to buy them at the current valuations. Wages are not higher in California (overall) but property stays high. I wouldn't buy a house at the current prices in California and the other vastly inflated markets. I'd rent (and throw my money away and pay my landlords mortgage) until the next good old fashion recession. Then, the pickings will improve.

oh, you're making me feel better =D. we live in CA and have 3 kids so we are not likely to "buy" anything soon - where we live the houses cost $700k and up. My mom purchased her home for $240k and now it is worth (in 10 years) $750k+ and houses have sold in her neighborhood for more - these are 4 bedroom cookie cutter track homes in the suburbs.

i do think all the "creative financing" has gotten extremely out of control and they should put some ceilings on what is considered reasonable, i know most people can't afford these gigantic mortgages and living on the pipe dream that they can dig their way out on equity...while people like me are hoping this bubble will burst! which it did in the early/mid 90's!

i feel good about my $1500 rent (reality is geographically imposed)! we can't relocate to lower cost areas since our family is around these parts and not likely to all jump together to arizona, texas or oregon - CA expat locations of choice.

 

[work4beer]

The problem with examples like Edelman gives is that there's no warning of the risks involved. You get higher return by having a larger and/or interest only mortgage because you're investing in stocks (instead of the bond-like paying off the mortgage earlier). Stocks aren't a magic 8% flat rate return machine. If you did this in, say, 1966 or 2000 Brother B might be in a bit more of a pinch.

The other risk is that the leftover invested funds end up turning into new cars or other spending, instead of actually staying invested for the span of the mortgage. Probably the bigger risk for most people.

Having said that, I did end up taking the bet (equity-out refinance, invested in dividend stocks) a few years ago. So far it's worked out well. But I track those monies very carefully to make sure that I'm getting good value for the risk, and not spending it.

 

[clifp]

The problem with examples like Edelman gives is that there's no warning of the risks involved. You get higher return by having a larger and/or interest only mortgage because you're investing in stocks (instead of the bond-like paying off the mortgage earlier). Stocks aren't a magic 8% flat rate return machine. If you did this in, say, 1966 or 2000 Brother B might be in a bit more of a pinch.

The other problem is he is ignoring taxes on the value of his saving. I'll concede that 8% returns are not unreasonable (the Vanguard S&P is 8.3% over the last 10 years) in a taxed deferred account. However, 8% after tax even if he uses super-tax efficient fund (like VFINX) is another story.
Lets say he paid no taxes during the 15 years (a portfolio of non-dividend paying growth stocks) He has saving of $282,019, his contributions are 125K.
Even if the 15% dividend/cap gain tax rates remains in effect he will still owe ~20% (15 fed+5% state) on the 157K of profits. After paying taxes Brother B is left with a free and clear house and $60K in savings, vs Brother A's $30K. Brother B took considerable risk with a 100% stock market investment I am not sure the $30K is worth the risk. The 10 year after tax returns on VFINX is 7.12%. It is far from clear to me that borrowing money @7.42% (even with tax benefits) to earn 7.12% is a brilliant strategy.

That being said, when I had bought out my ex-girlfriends 50% share of the house we bought together, I elected to assume her mortagage rather than pay it off. But the mortgage was one of those old fashion 15 year 4.875% ones. If it had been even 1% higher I would have thought about it differently.

I think it is also important to distinguish between what is prudent for people in the accumulation phase and those of us retired. I don't like the idea of a 30 year old paying extra on his 6.38% mortgage if he doesn't have an emergency fund. On the other hand I think somebody who qualifies for conventional 20% down mortgage to elect to take a interest only mortgage with at 1% higher rate just so they can have some financial flexiblity is taking too much risk . However, for a 30 year old who is a good saver and investor the pontential to earn higher returns may make sense. For a early retired millionaire I can't think of any reason why taking this additional risk would make sense.

 

[dex]

I feel better that I'm with the people who paid off their mortgage.

The main reasons are that I have the security of a paid off home, and I don't have to think about investing to meet a mortgage payment.

I got the sense from taking with some people that I was going to pay for the house in cash, that I was crazy.

During the closing I asked the attorney if many people paid for their house in cash. He said that people either paid in full or took out the largest mortgage they could afford.

 

[W2R]

I paid off my house in November, and I sure don't regret it.

 

[bpp]

I have been by temperament in the pay-it-off camp, but am migrating to the maximize-endstate camp. With a fixed-rate mortgage at 2.6% (~1.6% after tax credits), I am finally starting to think, hmm, maybe it is worth the risk to let it be and invest instead. (Yes, I'm slow.)

My bank lets one make pre-payments in one of two ways: either shorten the remaining time on the loan, or reduce the monthly payments going forward. I think I will satisfy my irrational "pay-it-off" urges by making the second type of pre-payments occasionally, which at least frees up a bit of extra cash flow each month so it is not a total waste.

If I were in a position to pay it all off immediately, that would probably be very tempting anyway. Or maybe it would be less tempting, because then, who cares?

 

[spideyrdpd]

So how many lived in the house and it got paid down over time vs those that paid extra into the mortgage or paid cash ?

 

[scrinch]

So how many lived in the house and it got paid down over time vs those that paid extra into the mortgage or paid cash ?

Made normal payments for 17 years (with two early refi's: 11-3/4% down to 9-1/8% down to 7-1/8%) and then made a lump payment of $60K to pay off the balance with 6 years left on the mortgage. In 2002 that lump was 5% of networth, so it wasn't a huge decision to make. The house was worth about $450K, so I was deciding between paying it off and refinancing up to 80% and investing the rest in the stock market. I probably would have made more money doing the refi, but I'm still happy where I am.

 

[W2R]

So how many lived in the house and it got paid down over time vs those that paid extra into the mortgage or paid cash ?

I paid 20% down and lived in a minimalistic fashion ("like a student", in other words) in the house. Meanwhile I chucked every penny I had into it so it was paid off in four years.

I'm not saying that paying off my house was necessarily a great investment, or the right decision for everybody; but in my case it was something that gave me tremendous satisfaction that I wouldn't trade for anything. No matter what the market does, that house is paid off and as long as I pay my miniscule taxes it is all MINE.

Now, on the first of every month I have a big smile on my face that could be seen a block away.

 

[Craig]

OK, bpp ... we need your help. Check around in Japan, and see if you can find a mortgage lender for us at 2.6% fixed, in U.S. dollars, for all the great FICO scores on this board ... we'll even pay a couple points ...

 

[rs0460a]

So how many lived in the house and it got paid down over time vs those that paid extra into the mortgage or paid cash?

DW/me started construction in early 1994 on our current (e.g. retirement abode) and moved in the end of May. 30-year mortgage started at that time. Paid it off August 15, 1999 (a little over 5 years), through paying an amount of about 2.5 normal monthly payments (a lot of LYBM went to that contribution!).

While most folks were putting money into the market in the mid-late '90's, we put money into paying off our mortgage (e.g. note). Starting in September of 1999, after "retiring" the mortgage, we started putting an amount equal to our normal mortgage payment into the market (increasing our current IRA's/401K's). If you remember, this was a time of great "opportunities" (2000-02) to "buy cheap" (of which we did!!). The result was that we became mortgage free and had great results going forward in our retirement accounts.

Didn't plan it, but nothing beats "dumb luck". My wife (being a "bag lady") wanted to ensure that we paid off the mortgage ASAP (definitely before we retired). When you look at the raw numbers, we had $125K in interest we did not have to pay, according to our repayment schedule. At a 28% federal rate, we would have had to have $160K income to cover the interest alone (not including state/local income tax). For us, that was almost 2 years of normal gross income (e.g. we get to retire 2 years earlier).

Yes, you can debate alternatives. However, we're extremely happy with our decision, in this matter, to get rid of the mortgage and move on.

- Ron