Mortgage principle is basicly savings account

[Lsbcal]

I just realized that the principle part of our mortgage payments don't have to be considered as bills in our monthly budget because they are basicly a savings account that we don't get interest on. That should give us a little more spending money this year .

 

[twaddle]

Oh, no. You do realize that you've just spawned another "pay off your mortgage" thread, right?

Of course, a mortgage is a wonderful thing. It's a forced savings plan. It's a tax break. It's an inflation hedge. And it comes with a free put (i.e., you can pay it off whenever you like regardless of prevailing market rates). Everybody should have one.

 

[mathjak107]

well you still have to pay the same amount though monthly yes? regardless where its getting allocated to you still need to make the ful payment

 

[Lsbcal]

well you still have to pay the same amount though monthly yes? regardless where its getting allocated to you still need to make the ful payment

I do?

Just kidding. What I mean is that if you are retired you may have set up a monthly spending limit based on something like X% withdrawal rate plus inflation increases. Not having the mortgage principle in there helps us quite a bit. Since I've been doing this for about 5 years it was a Eureka moment.

Twaddle -- I herebye declare posters are not allowed to talk about "paying off your mortgage" on this thread .

 

[honobob]

I just realized that the principle part of our mortgage payments don't have to be considered as bills in our monthly budget because they are basicly a savings account that we don't get interest on. That should give us a little more spending money this year .

Smart, grasshopper! Now zen in a third party paying your principle. Then another. Now you're a effing real estate mogul!

Quick, take the rock from my palm.

 

[cute fuzzy bunny]

It's a forced savings plan. It's a tax break. It's an inflation hedge.

Aww, its none of those things to a lot of people.

For someone retired with significant investments, its not a savings plan...you're just moving money from one place to another.

Its not a tax break if you cant deduct the interest because you arent paying enough in income taxes.

And the inflation savings on the loan are offset by inflations equal weight on the money in your portfolio.

 

[EngineeringMyFinances]

I disagree with most of what you said.

You think the principal part of your payment is not a bill? Try not paying it and see what happens.

You think it's like a savings account? Try withdrawing your money. Means you have to sell your home to get it.

You don't get interest? Well, yes, you do. Sort of. Increasing the amount of principal you pay reduces the amount of interest you pay in the future. Which may tend to hurt your cash flow short term to the extent it reduces your tax deductions. So if anything it gives you less spending money this year, not more. Only way it increases your spending money is if you make your last payment.

 

[mathjak107]

the tax deduction is like spending an extra dollar over and above the cost of the house to get back .30 cents if you are lucky and do get to take it on your taxes. remember you are paying the interest so the deduction isnt a savings you spent the extra money

 

[Lsbcal]

You think the principal part of your payment is not a bill? Try not paying it and see what happens.

You think it's like a savings account? Try withdrawing your money. Means you have to sell your home to get it.

In our case we could pay off the mortgage easily (let's not get into whether I should or should not). If I pay it off then no more mortgage bill but I have to spend capital to do this. That capital will not be there to finance my retirement at my withdrawal rate.

So here is the math for our case. Have a mortgage that's $191k left in principle with monthly payments of $1148. If I'm withdrawing 5.5% until SS kicks in then by paying off the mortgage I will have to reduce spending by 5.5% X $191k / 12 = $875/mo. So the "savings" in reduced bills is 1148 - 875 = $273 per month. This savings is going to depend on (1) the interest rate on the mortgage, (2) the amount of principle left on the mortgage, (3) the withdrawal rate on your portfolio.

So now that I've actually done the math I guess it's not really the principle that I can deduct from spending but rather a number as calculated above. In our case this number is very close to the principle payments which I think is because our mortgage rate is almost equal to our withdrawal rate.

 

[Grizz]

I have a hunch that the mortgage tax deduction days are numbered. For one, I expect that the U.S. gov't may start to see that owners with some equity in their abode are less likely to default. That would take away an incentive to keep that mortgage high. The other reason is to help pay for the upcoming universal health care (or whatever they choose to call it).

I certainly don't think that the housing bubble was fully caused by people wanting a big tax break, but I suspect that it played a small part. In Canada we have no housing bubble or the ability to deduct our mortgages, but we do have universal health.

I just paid off my mortgage. If I were American, I might have had to think harder about doing that.

 

[Walt34]

Admittedly, math never was my strong point and perhaps I'm being overly simplistic.

But if someone in a 30% tax bracket pays $10K/year in mortgage interest, the deduction makes the interest payment "only" $7K - right?

The way I see it, that's $7K that they still don't have to use on other things, and it only works to advantage if that $7K is generating more than the loan interest rate to justify keeping the mortgage.

If not, what am I missing?

Then there's the intangible value of "not owing anybody anything" but that's a whole different issue.

 

[twaddle]

The way I see it, that's $7K that they still don't have to use on other things, and it only works to advantage if that $7K is generating more than the loan interest rate to justify keeping the mortgage.

Yup, you've nailed it. For example, let's say the bank gave us a loan for $100,000 at 5%.

Let's pretend it's an IO, and then we don't have to consider the principal payments and amortization.

So, you're paying $5000/year in interest. And after the tax break, you're paying $3500/year. Fixed rate. For, say, 30 years.

But you still have that $100,000 the bank gave you. So, your job is to invest that and make more than 3.5% per year over 30 years.

Everybody should have one, I tell you.

 

[RunningBum]

Wow, I'd be really careful not calling it an expense if this is your primary residence.

At some point are you going to tap into your home equity to pay your expenses? In other words, is your home equity part of your nest egg you are withdrawing on? If that's the case, you'll probably be looking at a reverse mortgage, or selling your home late in life to tap into that part of the nest egg. If not, then you're putting some of your income into a non-liquid asset.

It just doesn't seem right to me to not consider it an expense.

If it's not an expense, it seems to me that the income generated by the capital you are investing rather than paying off the mortgage isn't really income.

Put it this way:
If you have $1M in investments and a $1M personal residence paid off, and you got 8% on your investments, you'd have $80K in income.

If you decided to take out a $1M mortgage at 6% on that house, so now you have $2M to invest, you'd make $160K in income, and have $60K in mortgage payments. Did you really double your income with no new expenses? Of course not. You have a 60K expense. You netted $100K, not $160K. It's better than the 80K because your investment is getting a higher rate than your mortgage (but that's probably not guaranteed), but you can't ignore that 60K mortgage expense.

If it were a rental, of course you'd have rental income to offset the expense, but it's still an expense, in my opinion.

 

[nun]

I have a mortgage on a 2 family house and get $1500 a month in rent out of it, which is $300 more than my monthly interest and escrow payments. Now that's a savings plan.....

 

[Lsbcal]

But you still have that $100,000 the bank gave you. So, your job is to invest that and make more than 3.5% per year over 30 years.

IMO you are right as long as you add the proviso that the investment must make 3.5% after taxes return.

Of course, the situation is really more complicated. For instance, you borrow the money and get to use the tax writeoff at the marginal income tax rate. Then the invested money is taxed at the lower capital gains rate which this year is 0% if you are in the 15% or under bracket. Or is the invested money really in your IRA which is not taxed until you pull it out many years later -- it got to stay in the IRA because you didn't have to pull it out to pay off the mortgage. We could go on and on as this situation can really get complex with all the factors to consider.

In our case we have a 5 3/8% fixed mortgage and have not had any trouble so far investing the money at a higher return.

 

[kumquat]

In Canada we have no housing bubble

What planet is your Canada on?

See Housing inflation kicker
or
reportonbusiness.com: Homes in Edmonton, Saskatoon most overvalued
or
The Daily, Thursday, January 10, 2008. New Housing Price Index

Of course we have a housing bubble. It just hasn't popped yet.

 

[Lsbcal]

It just doesn't seem right to me to not consider it an expense.

It is an expense. The interest is definitely an expense but not the amount you are paying toward principle. In the last year of your mortgage almost everything is going towards principle ... and then in the next year the expense completely disappears. The mortgage (interest) expense does not go from full mortgage to zero in one year. When the last payment is made you get to call it the last one because you paid back all the principle the bank gave you (plus interest).

Maybe an accountant could do a better job of explaining this.

 

[nun]

It is an expense. The interest is definitely an expense but not the amount you are paying toward principle. In the last year of your mortgage almost everything is going towards principle ... and then in the next year the expense completely disappears. The mortgage (interest) expense does not go from full mortgage to zero in one year. When the last payment is made you get to call it the last one because you paid back all the principle the bank gave you (plus interest).

Maybe an accountant could do a better job of explaining this.

In my case the rent more than pays for the interest and escrow so it the mortgage an expense for me?

 

[mathjak107]

Admittedly, math never was my strong point and perhaps I'm being overly simplistic.

But if someone in a 30% tax bracket pays $10K/year in mortgage interest, the deduction makes the interest payment "only" $7K - right?

The way I see it, that's $7K that they still don't have to use on other things, and it only works to advantage if that $7K is generating more than the loan interest rate to justify keeping the mortgage.

If not, what am I missing?

Then there's the intangible value of "not owing anybody anything" but that's a whole different issue.

remember everyone gets the standard deduction anyway whether you have a mortgage or not so start your calculations after subtracting out the standard deduction from your interest payments

 

[Lsbcal]

In my case the rent more than pays for the interest and escrow so it the mortgage an expense for me?

Let's see, I could rent out the 2 extra bedrooms we now have and make the situation cash flow positive too. But my wife would kill me.

 

[RunningBum]

It is an expense. The interest is definitely an expense but not the amount you are paying toward principle. In the last year of your mortgage almost everything is going towards principle ... and then in the next year the expense completely disappears. The mortgage (interest) expense does not go from full mortgage to zero in one year. When the last payment is made you get to call it the last one because you paid back all the principle the bank gave you (plus interest).

Maybe an accountant could do a better job of explaining this.

If you were buying stock or putting it in a 401K, it's not an expense. You can easily use that for income.

If you bought a car or furniture with the money, that would be an expense. A capital expense since you'll still own the asset, but an expense, right?

A house used as your personal residence falls somewhere in between. It appreciates, but you still don't get any income out of it, unless your retirement plan includes eventually selling it. So I consider it a lot more like a car or furniture. I have something to show for it, but it doesn't give me any money. If my back is against the wall, I can downsize or sell it and rent, but that's not my plan.

That's why I consider it a capital expense, and I wouldn't say I could spend more money on other things because of this.

If you tried this through firecalc, how would you account for the cash outflow with the mortgage payment?

 

[dumpster56]

If you were buying stock or putting it in a 401K, it's not an expense. You can easily use that for income.

If you bought a car or furniture with the money, that would be an expense. A capital expense since you'll still own the asset, but an expense, right?

A house used as your personal residence falls somewhere in between. It appreciates, but you still don't get any income out of it, unless your retirement plan includes eventually selling it. So I consider it a lot more like a car or furniture. I have something to show for it, but it doesn't give me any money. If my back is against the wall, I can downsize or sell it and rent, but that's not my plan.

That's why I consider it a capital expense, and I wouldn't say I could spend more money on other things because of this.

If you tried this through firecalc, how would you account for the cash outflow with the mortgage payment?

Say you have a 1000 mortgage then have it paid off then the 1000 dollars would be new income.

 

[Lsbcal]

Runningbum, I think what you are missing is that when you take out a mortgage you are giving a piece of your real estate equity to a bank. When you pay it off (the principle) you basicly get it back and you now own the house 100%.

Real estate is considered an asset class in the equities world. Cars, kitchen tables, and other items are not really the same sort of thing. A bank will not generally loan you based on ordinary everyday items like toasters even if you have 1000's of them. But they will make you a home equity loan because the financial world considers real estate to have a marketable value in any normal investment environment. Today the asset may be worth 80% of what it was worth 2 years ago but that does not change the fact that your house is an asset.

 

[Grizz]

What planet is your Canada on?

See Housing inflation kicker
or
reportonbusiness.com: Homes in Edmonton, Saskatoon most overvalued
or
The Daily, Thursday, January 10, 2008. New Housing Price Index

Of course we have a housing bubble. It just hasn't popped yet.

I believe that Vancouver and area may be in for some turbulence, and as for the east, I haven't seen any bubble like gains in prices.

If oil, uranium, and natural gas are all in a bubble, then yes, the home prices in Alta and Sask are in a bubble as well. It is the natural resources that are abundant in these places that is causing a rise in prices, not idiotic lending practices. People want to move to Alta and Sask (I can't believe I just typed that) for the very real and lucrative economic advantages that exist by living near the resources and industries. Are there people flipping and building houses on spec? You bet, but so far there is a stream of actual families willing to move into the homes.

I have ridden the Alberta boom 'n bust rollercoaster all of my life. Real estate gains have always been very closely pegged to conventional oil and gas drilling activity. Now there's a new and very big game in town. There are a lot of multi-billion dollar projects planned and going on here presently in the oilsands and the upgraders that the big oil companies have already invested heavily in. Conventional oil and gas drilling is actually very slow here right now and yet the real estate prices have held reasonably steady.

Not everything that rises in price quickly is a bubble.

 

[nun]

R

Real estate is considered an asset class in the equities world. Cars, kitchen tables, and other items are not really the same sort of thing. A bank will not generally loan you based on ordinary everyday items like toasters even if you have 1000's of them. But they will make you a home equity loan because the financial world considers real estate to have a marketable value in any normal investment environment. Today the asset may be worth 80% of what it was worth 2 years ago but that does not change the fact that your house is an asset.

Yes, but its not a liquid asset. We all need somewhere to live so unless you sell your house and rent somewhere or buy a smaller place how much equity you have in a house is a nice ego massager, but of little practical value other than to let you borrow even more money and I don't see that as a good thing. That's why I bought a 2 family home so that I have an asset that produces income too. My house can make me money in 2 ways, appreciation and $18k a year rent.