Should I keep or pay-off, part of or all of, new mortgage?

[MdaPetralia]

I recently bought a new primary residence for my DW and I and just sold the old one. I took out a 15 year $500K conventional mortgage at 6% on new home (with market value of $700K). I now have $940K in liquid cash after closing on old residence and cashing in some matured bonds and T-bills. Should I now keep or pay-off, part of or all of, new mortgage?

Background: My wife and I are both 56 and retired. No other debt besides the new mortgage. Our net worth (excluding $200K equity in new home) is around $5.5m (50/50 in qualified and non-qualified accounts with AA approx. 50/50) with a 2.8% SWR (includes all expenses, mortgage, taxes, healthcare, etc.). If we pay-off entire mortgage, our net worth would drop to $5m and then looking at a 2.05% SWR (no more mortgage payment and $500K goes into new home equity).

I would like to keep a few years worth of living expenses in cash or cash equivalents (T-bills, CD's, etc) but not looking to invest in the stock market with this money.

My DW says to pay off entire mortgage and I'll thinking of paying off maybe ½ ($250K or $300K).

Your thoughts please?

 

[pb4uski]

Not paying 6% is the same as earning 6%. Do you have any fixed income that is yielding less than 6%? If you sell those and use the proceeds to pay off the 6% mortgage wouldn't you be ahead?

Let's say that the lowest yielding part of your fixed income allocation is yielding 4%... so if you sell $500k yielding 4% and used the proceeds to avoid payng 6% then is seems to me that you are ahead by $10k a year.

 

[daylatedollarshort]

The only scenario I can think of for keeping it is that if interest rates go up enough 6% might be a good deal in the future. I think our first couple of mortgages were 12%.

So you can pay it off as pb4uski suggested or eat the extra cost over bond yields for a year or two and see what happens with inflation / interest rates.

 

[MdaPetralia]

Do you have any fixed income that is yielding less than 6%?

Yes, all of it (is there any new fixed income investments earning more than 6% today?). Currently waiting for all the funds to clear then will put any of the money not used to pay-off mortgage to work. Expect to earn between 3% and 4% if I invest in CD's and T-bills over the next few years.

If you sell those and use the proceeds to pay off the 6% mortgage wouldn't you be ahead?

Yes, but shouldn't I hedge and not pay mortgage all off now to see if rates go higher in a few years and cash equivalents earn more than 6%?

 

[MdaPetralia]

The only scenario I can think of for keeping it is that if interest rates go up enough 6% might be a good deal in the future. I think our first couple of mortgages were 12%.

So you can pay it off as pb4uski suggested or eat the extra cost over bond yields for a year or two and see what happens with inflation / interest rates.

Both you and pb4uski make valid points. That's why I'm thinking of splitting the difference (pay off 1/2 now and then wait and see what interest rates due in next few years). Rather be half right than 100% wrong.

 

[pb4uski]

Yes, all of it (is there any new fixed income investments earning more than 6% today?). Currently waiting for all the funds to clear then will put any of the money not used to pay-off mortgage to work. Expect to earn between 3% and 4% if I invest in CD's and T-bills over the next few years.


Yes, but shouldn't I hedge and not pay mortgage all off now to see if rates go higher in a few years and cash equivalents earn more than 6%?

I prefer to base investment hypotheses on assumptions that have some reasonable real-world possibility.

It's possible that a spaceship from Mars will land in our parking lot tonight too... only a slightly lower probability than earning 6% on cash equivalents anytime soon especially given that inflation is moderating and the Fed is committed to reigning in inflation... don't fight the Fed.

Did you have a mortgage before this recent house purchase? I'm guessing not and that the mortgage was principally to facilitate buying the new house before selling the old house. If you had a 3% mortgage from a similar swap a couple years ago then it would be an entirely different conversation.

 

[SnowballCamper]

Pay off the entire mortgage, for the reasons mentioned above, e.g. not paying 6% to the bank. In my mind paying off the mortgage does not result in a reduction in net worth. It would increase net worth by the future interest payments that are avoided. Good Luck.

 

[daylatedollarshort]

I prefer to base investment hypotheses on assumptions that have some reasonable real-world possibility.

Check out the chart in this link. If you look at federal funds rates historically at the years where they were the same rate are today, they didn't always go down and stay down for years afterward - https://www.macrotrends.net/2015/fed-funds-rate-historical-chart. The ensuing years are all over the map. Interest rates today don't tell you what rates will be over the next several years. In 1976 the federal funds rate was similar to today's rate and then went to 19% by 1980.

 

[Koolau]

I guess if your interest rate were 3 or 4%, it would be a tougher decision. But at 6% I'd pay it off UNLESS you believe inflation will continue well beyond 6% for quite a while. Under that scenario, being in debt has advantage of paying back with money that's worth less. But, again, you gotta have something to invest that borrowed money in that earns 6% or more now IMHO. Your choice and YMMV.

 

[FLSUnFIRE]

I'll leave the tea leave reading to the others.. only time will tell if maintaining leverage will be profitable. Although it looks like you have plenty regardless, I'd consider liquidity vs cashflow needs. There are days I wish I took out a mortgage (lower than 6%) as I would have come out ahead in the market (although that has been trimmed a bit recently) but having no mortgage lowers my cash-flow needs which makes the current market so much less scary to me. If I had a mortgage, my cash flow needs would be considerably higher and I'd have to realize more income (and also pay more taxes including reduced ACA PTC).


Going 50/50 IMO is the worse of both worlds... if you believe leverage costing 6% is a good deal then go all in! 50/50 halves the funds you can benefit from using the leverage while not reducing your cash flow needs (still got to pay that payment each month even if you've paid extra principle unless you refinance or are allowed to re-amortize the remaining balance).

 

[DrRoy]

Not paying 6% is the same as earning 6%. Do you have any fixed income that is yielding less than 6%? If you sell those and use the proceeds to pay off the 6% mortgage wouldn't you be ahead?

Let's say that the lowest yielding part of your fixed income allocation is yielding 4%... so if you sell $500k yielding 4% and used the proceeds to avoid payng 6% then is seems to me that you are ahead by $10k a year.

+1.
Waiting on changes in rates is a bit like market timing.

 

[MdaPetralia]

I guess if your interest rate were 3 or 4%, it would be a tougher decision. But at 6% I'd pay it off UNLESS you believe inflation will continue well beyond 6% for quite a while. Under that scenario, being in debt has advantage of paying back with money that's worth less. But, again, you gotta have something to invest that borrowed money in that earns 6% or more now IMHO.

I don't have a crystal ball as to what inflation will do in future and less of an idea where to earn 6% on the borrowed money relatively safely over the next few years.

Did you have a mortgage before this recent house purchase?

No, had paid off 30-year mortgage on prior home early (originally at 6.5%, later recasted to around 4 1/4%) in 14 years (and that was about 10 years ago).

Now leaning towards paying off the entire thing for many of the reasons stated above. I also ran some numbers that shows by reducing my cash flow if I paid it off now would still leave me with just about 4 years of safe cash (for MM, T-bills, CD's etc.) for living expenses/emergencies versus 6 years if not pre-paying anything with the increase cash flow. So basically would be paying the bank 6% on the borrowed money for cash I wont need until 4-6 years from now. Doesn't make sense.

But perhaps the most compelling reason to pay it all off now would be that is what my wife wants to do!

Thanks for everyones thoughts!

 

[pb4uski]

Yeah, happy wife, happy life sort of thing.

 

[mrfeh]

Pay it off.

 

[finnski1]

When mortgage rates were 2.5 to 3 % and the market was all happy it might have been fine to not pay it off.
@6% I would pay it off. A guaranteed 6% right now is pretty darn good IMHO.

 

[MarieIG]

I would pay this off so fast I would make the Roadrunner look like a slug.

I could understand the wavering if you had a 2.5 rate - in which case I would have recommended paying of half due to your DW's expressed desire - but I'm not seeing the benefit under your current circumstances. IMHO, you have locked in a 6% earnings. Moreover, if you pay income tax (perhaps you do not?) you would have to account for that in any money earned. Moreover, brownie points with DW.

 

[COcheesehead]

Just for fun and to spur on thought, I’ll take the other side.
Just FYI, your net worth won’t change no matter what you do.

Reasons to not pay it off
1. You are putting funds into an illiquid asset. HELOCs are not guaranteed in retirement and you may have to sell or do an expensive reverse mortgage to get money out.
2. Your payments in real value will go down over time - the time value of money principle.
3. There are investments today that yield over 6% that keep the funds liquid and make it a wash.
4. You likely be able to refinance within 1-2 years.
5. Verify that there are no prepayment penalties.
6. If you itemize, there may be tax benefits lowering your real interest cost.
7. Debt is a tool, not something to fear. Having cash in the bank is safer than cash in the house. Something DW may not see clearly.
8. Money made in real estate is based on the leverage of home value appreciation vs equity invested.
9. Real estate values could decline.
10. Is having too much cash in today’s investing environment really a problem?



I wish the OP health and happiness in 2023 no matter what you decide.

 

[pacergal]

Based on what you posted, no matter which you choose, you will have less than 3% WD rate, so Win-Win.
Why does your DW want it paid off? If she feels more comfortable knowing there is no mortgage, why not pay it off and put the other 440K in T bills, CDs and use for living expenses for the upcoming years? That hits at what both of you want.

 

[ERasap]

I would suggest your tax situation is a big consideration. With a $500k loan at 6% interest, thats $30k per year in expense, lets say you then invest the $500k at 6%, so its a wash, but the $30k income is taxable. The $30k in interest could push you over the $24k standard deduction, depending on what else you can deduct, lets say a total of $40k in deductions. Thats a pickup of $16k in deductions for $30k in income, so you have another $14k in taxable income at whatever your marginal rate is. If you pay 1/2 the loan, now you have $15k in income and $15k in expense, so now you have $25k in standard deduction ($15 income + $10k in other deductions), so a pickup of $15k in income vs an increase in deduction of $1k. So again you pickup $14k in taxable income at your marginal rate. I am not a tax expert, so maybe this is slightly off, but nevertheless finding a 6% tax free income (low risk??) is pretty hard.

I personally would pay this mortgage off. I paid mine off in 2020 at a 4% rate. And it makes me feel really good to not owe anyone anything.

 

[Jerry1]

I’d pay off the mortgage but maybe not all of it. My driving consideration would be making sure I had enough liquid investments to live off of. I think OP said he’d have a couple years. I would want three and maybe up to five. I’d decide on that number first and pay the rest on the mortgage. Hopefully, that will allow it to be paid off entirely.

 

[MdaPetralia]

I’d pay off the mortgage but maybe not all of it. My driving consideration would be making sure I had enough liquid investments to live off of. I think OP said he’d have a couple years. I would want three and maybe up to five. I’d decide on that number first and pay the rest on the mortgage. Hopefully, that will allow it to be paid off entirely.

I figured I would have a good 4 years of living expenses if I paid-off mortgage in full now.

Why does your DW want it paid off? If she feels more comfortable knowing there is no mortgage, why not pay it off and put the other 440K in T bills, CDs and use for living expenses for the upcoming years? That hits at what both of you want.

Yes, that would be the plan, put the 440K in MM, T-bills, CD's etc. It's an emotional decision for my DW, she doesn't want to owe anything (she's more frugal than me!).

Reasons to not pay it off
1. You are putting funds into an illiquid asset. HELOCs are not guaranteed in retirement and you may have to sell or do an expensive reverse mortgage to get money out.
2. Your payments in real value will go down over time - the time value of money principle.
3. There are investments today that yield over 6% that keep the funds liquid and make it a wash.
4. You likely be able to refinance within 1-2 years.
5. Verify that there are no prepayment penalties.
6. If you itemize, there may be tax benefits lowering your real interest cost.
7. Debt is a tool, not something to fear. Having cash in the bank is safer than cash in the house. Something DW may not see clearly.
8. Money made in real estate is based on the leverage of home value appreciation vs equity invested.
9. Real estate values could decline.
10. Is having too much cash in today’s investing environment really a problem?

1. Yup, it would be an expense to borrow my own money/equity in the event I need it before selling.
3. Can you name a few?
5. No prepayment penalties although I might tick-off the underwriting team.
6. I would then itemize but I don't have much income except for ROTH conversions (although interest income has grown the past year).
10. Right, it's a good feeling knowing that you don't have to care what the markets are doing for the next 4-6 years but I will need to tap into investments eventually (something I have not had to do since retiring almost 3 years ago). If I pay off mortgage in full now, it will just shorten that time.

I wish the OP health and happiness in 2023 no matter what you decide.

Thanks, and same to you!

 

[pb4uski]

....Our net worth (excluding $200K equity in new home) is around $5.5m (50/50 in qualified and non-qualified accounts with AA approx. 50/50) with a 2.8% SWR (includes all expenses, mortgage, taxes, healthcare, etc.). If we pay-off entire mortgage, our net worth would drop to $5m and then looking at a 2.05% SWR (no more mortgage payment and $500K goes into new home equity). ...

... Just FYI, your net worth won’t change no matter what you do. ...

+1 if you pay it off you will have $500k less financial assets but $500k more home equity... or $500k less assets but also $500k less liabilities... so your new worth will be unchanged.

 

[COcheesehead]

I figured I would have a good 4 years of living expenses if I paid-off mortgage in full now.


Yes, that would be the plan, put the 440K in MM, T-bills, CD's etc. It's an emotional decision for my DW, she doesn't want to owe anything (she's more frugal than me!).


1. Yup, it would be an expense to borrow my own money/equity in the event I need it before selling.
3. Can you name a few?
5. No prepayment penalties although I might tick-off the underwriting team.
6. I would then itemize but I don't have much income except for ROTH conversions (although interest income has grown the past year).
10. Right, it's a good feeling knowing that you don't have to care what the markets are doing for the next 4-6 years but I will need to tap into investments eventually (something I have not had to do since retiring almost 3 years ago). If I pay off mortgage in full now, it will just shorten that time.


Thanks, and same to you!

As to number 3, I invite you to read the Golden Period thread on here. So much good info on fixed income.

 

[daylatedollarshort]

Right now real interest rates are negative, which usually gets corrected by The Fed in order to fight inflation. So within a couple of years, the likely scenarios are that either mortgage rates will drop and you can refinance, or mortgage rates will increase and you will be happy you have 6%. We always keep a mortgage and refinance every time rates drop with no cost, no point loans and it seems to work out well. Last year we had an under 3% mortgage and TIPS making around 10%. When inflation is high, we actually come out ahead partly because of TIPS and a low, fixed rate mortgage, even though when we refinanced last year fixed income investments were generally paying less than the mortgage rate. Look at the historical Federal Funds rates in the previous chart and think long term probabilities and scenarios. Many posters here are worried about inflation and many also believe you shouldn't have any debt. However, low cost, fixed rate debt is a great inflation hedge, and by long term historical standards 6% mortgage is a pretty low rate. If we are in for an extended period of high interest rates, you may not be able to ever get that rate again.

 

[qwerty3656]

Here is recent youtube video on the subject.