Pay down Mortgage or Increase Taxable Account?

[rk911]

I am the exact opposite, I'm more of an increase overall wealth. Right now my rate is 3.0% I've got 185K left on my mortgage. no way am I pulling out that cash to pay off such a low rate. I guess I'm more of a "more" cash is a good thing believer.

all good, both approaches work

once debt, especially the mortgage, is gone cash builds up a lot more quickly. in the event of an medical emergency, job loss, etc. a mortgage can be a real drag on building wealth.

 

[RunningBum]

once debt, especially the mortgage, is gone cash builds up a lot more quickly. in the event of an medical emergency, job loss, etc. a mortgage can be a real drag on building wealth.

What did you use to pay off that mortgage, magic? In all of the cases you listed I'd rather have that $185K available to use rather than tied up in my house in home equity.

 

[EastWest Gal]

Do both. Put the money into a taxable account earning an average eight percent as equities until the balance equals the mortgage balance. Then pay off the mortgage.

This is a good idea. You will need to plan for some cap gains tax when you sell the equities to pay off the mortgage, but except for short term gains, it isn't that much. And you can adjust the amounts to each as life throws its usual problems at you. Having a taxable account is very helpful in early retirement.

 

[rk911]

What did you use to pay off that mortgage, magic? In all of the cases you listed I'd rather have that $185K available to use rather than tied up in my house in home equity.

magic? nope. it's called living beneath your means, on a budget and tossing excess dollars from the budget at debt. in our case we were debt free except the house. we refinanced the 30-yr mortgage to a 15-yr which we paid off in a bit more than 12, roughly 2-yrs before I RE and 3-yrs before my wife RE. discipline and extra principal payments were the keys. during that time we were also investing but if I had been smarter I would've tossed every non-budgeted dollar to the mortgage. if we had done that we likely would've had it paid off a lot sooner than 12-yrs. then all of the cash that had been going to the mortgage would've been used to invest. but as it is we have a NW in the low 7-figures.

your method ignores the risk of the mortgage when/if a medical or other emergency like losing your job upends your life. Ramsey is right about this but to each their own.

 

[njhowie]

magic? nope. it's called living beneath your means, on a budget and tossing excess dollars from the budget at debt. in our case we were debt free except the house. we refinanced the 30-yr mortgage to a 15-yr which we paid off in a bit more than 12, roughly 2-yrs before I RE and 3-yrs before my wife RE. discipline and extra principal payments were the keys. during that time we were also investing but if I had been smarter I would've tossed every non-budgeted dollar to the mortgage. if we had done that we likely would've had it paid off a lot sooner than 12-yrs. then all of the cash that had been going to the mortgage would've been used to invest. but as it is we have a NW in the low 7-figures.

your method ignores the risk of the mortgage when/if a medical or other emergency like losing your job upends your life. Ramsey is right about this but to each their own.

We paid off our mortgage 11 years ago, and I know that in our situation, it turned out to be one of the best things we've done. So I agree with you as far as the benefits.

However, your last thought, regarding risk of mortgage when/if a medical or other emergency arises...in that case you still have the cash which you did not use to pay off the mortgage. If anything, I see this argument much more often - that because the mortgage rate is so low and there is no place else you could borrow at that kind of rate, should an emergency situation arise, you have the cash available. If the emergency happened soon after using the money to pay off the mortgage, and you were short on funds, what would you do then? Quickly get a home equity line of credit? Start using credit cards? Remortgage the home?

The threads on this subject always get contentious. We just need to see it as a personal preference, and leave it at that.

 

[RunningBum]

magic? nope. it's called living beneath your means, on a budget and tossing excess dollars from the budget at debt. in our case we were debt free except the house. we refinanced the 30-yr mortgage to a 15-yr which we paid off in a bit more than 12, roughly 2-yrs before I RE and 3-yrs before my wife RE. discipline and extra principal payments were the keys. during that time we were also investing but if I had been smarter I would've tossed every non-budgeted dollar to the mortgage. if we had done that we likely would've had it paid off a lot sooner than 12-yrs. then all of the cash that had been going to the mortgage would've been used to invest. but as it is we have a NW in the low 7-figures.

your method ignores the risk of the mortgage when/if a medical or other emergency like losing your job upends your life. Ramsey is right about this but to each their own.

You're not getting it, but that's your business. Telling someone else that it's better to have money tied up in the equity of your house than in investments in case you lose your job is wrong. I can easily tap my investments to keep up my mortgage payments and pay other bills if I lose my job. You'd better hope you got a HELOC in place before you lost your job, because nobody is going to loan you money without a job and you might have to do an emergency sale of your house to put food on the table.

Blindly following Ramsey's advice is risky.

 

[rk911]

We paid off our mortgage 11 years ago, and I know that in our situation, it turned out to be one of the best things we've done. So I agree with you as far as the benefits.

However, your last thought, regarding risk of mortgage when/if a medical or other emergency arises...in that case you still have the cash which you did not use to pay off the mortgage. If anything, I see this argument much more often - that because the mortgage rate is so low and there is no place else you could borrow at that kind of rate, should an emergency situation arise, you have the cash available. If the emergency happened soon after using the money to pay off the mortgage, and you were short on funds, what would you do then? Quickly get a home equity line of credit? Start using credit cards? Remortgage the home?

The threads on this subject always get contentious. We just need to see it as a personal preference, and leave it at that.

not trying to come across as contentious but there may be lurkers in the forum who have not yet FIREd or are in a situation where they're trying to make a decision on which way to go. Sure, it's a personal preference but to us the risk of substantial debt is real which is why we did what we did.

 

[rk911]

You're not getting it, but that's your business. Telling someone else that it's better to have money tied up in the equity of your house than in investments in case you lose your job is wrong. I can easily tap my investments to keep up my mortgage payments and pay other bills if I lose my job. You'd better hope you got a HELOC in place before you lost your job, because nobody is going to loan you money without a job and you might have to do an emergency sale of your house to put food on the table.

Blindly following Ramsey's advice is risky.

nothing blind about it. we listened, evaluated and made a decision. not everyone in your, or our situation at the time, may have investments to pull from.

 

[RunningBum]

Just make sure you are not leaving yourself cash poor and house rich when trying to pay off or pay extra on the mortgage.

 

[MarieIG]

I also don't like the ARM because you just don't know where it will be going. I would look at your different options for fixed rates to reduce your monthly payments to the lowest possible fixed monthly payment; as this would reduce your monthly obligations and give you more flexibility if needed. (This is not absolute if you're looking at selling.) Please note, you can still make additional payments towards the principal when you so choose, i.e on your own schedule.

While I am a huge proponent of paying off a mortgage (I am not saying it's they way to maximize income, rather I see it as a bit of risk management); I don't see that you have enough cash/ money in a taxable account.

Also, the percentage of your expense covered by your pension effects your ability to whether downturns, i.e. don't cash out when markets drop.

 

[Dtail]

I'm a "no-debt-is-a-good-thing" believer. eliminate/reduce risk whenever possible.

Same here.

 

[Rambler]

Logic seems to tell me that if you can earn more than the cost of the mortgage (currently 2.85%) then you should keep the mortgage (for now, and reassess as rates go up...you can always pay it down with what you set aside in taxable accts).

My personal emotions tell me to pay it off. I really don’t like having personal debt, even if I could make make money on the arbitrage. That said, I had enough to have a nice sized taxable acct AND a paid off mortgage. If that isn’t you, then I’d find ways to make more money and keep the mortgage, and don’t forget the tax advantage of the mortgage either.

 

[rayvt]

I'm a "no-debt-is-a-good-thing" believer. eliminate/reduce risk whenever possible.

Paying down a mortgage does not reduce your risk. Only paying it off eliminates the risk.

 

[rayvt]

You'd better hope you got a HELOC in place before you lost your job, because nobody is going to loan you money without a job.

Doesn't matter if you already have a HELOC in place. The banks can and will freeze your HELOC if they know (or suspect) that you are out of a job.

A HELOC is not cash --- only cash is cash.

Every HELOC I've seen forbids you from using the HELOC to make a mortgage or HELOC payment.

 

[W2R]

I've elected to increase my taxable accounts AND pay down the mortgage at the same time.

That's what I did when I was preparing for retirement.

1) I paid off my mortgage in 4 years (would have been 3 except for Hurricane Katrina ).
2) Meanwhile I *always* maxed out my TSP (=401K) and Roth IRA, and
3) I put several times that much in taxable investments.

I figured it all counted and called it "money for my future" in my financial spreadsheet. It didn't really seem to matter whether I put it into the mortgage or into my taxable investments, but it really mattered a lot that I allocated as much as possible for the future. I had a five figure salary but no dependents so that helped, plus (like nearly all of us) I was highly motivated to retire.

 

[ERD50]

I'm a "no-debt-is-a-good-thing" believer. eliminate/reduce risk whenever possible.

Paying down a mortgage does not reduce your risk. ...

Agreed, you still have that monthly payment to make, and less in your stash to do it with (what if you lose your job?).

... Only paying it off eliminates the risk.

Well, maybe reduces risk, it certainly doesn't eliminate it (you still have property tax, maint, utilities, etc). There is some risk that the market acts worse than at any time in the past, as long term returns have historically way outpaced the current mortgage rates on average, and I think have never, ever (historically) been less than current mortgage rates.

-ERD50

 

[rayvt]

(you still have property tax, maint, utilities, etc).

Well, the government taxes are something that you can't avoid, so that doesn't count. The other things are just the cost of living.

Really the only risk of a mortgage is if you don't or can't make the monthly payments. If you dump $150,000 into paying down (not off) the mortgage that's $150,000 that you don't have to make the payment if you lose your job. And you can make a lot of monthly payments with $150K.

I have seen houses go into foreclosure with as little as $5000 mortgage balance.

as long term returns have historically way outpaced the current mortgage rates on average, and I think have never, ever (historically) been less than current mortgage rates

.

True that. Which makes an even stronger case to not pay off your mortgage. Heck, if you refi'd recently to 2.25% or 2.5%, you are basically getting free money, since that's just about the rate of inflation.

 

[Iggysmom]

I'm 59 1/2 and plan on retiring at 62 or earlier. Nearly all of my investment savings is is in my 401k and pension, so I will owe taxes on withdrawals. I recently became concerned that I don't have enough in a taxable account that I can draw from for spending to lower my income in retirement and hedge against pulling money out in a downturn. I started putting additional $1200 a month cash aside in my emergency savings to build up the taxable account.

Our only debt is 13 years remaining on a 30 year ARM mortgage (balance is about $120K and current rate is 2.85%). So the question is, should I continue to put cash aside, or pay down the mortgage, or perhaps split the two?

Given how low interest rates are, and assuming your mortgage interest is deductible, I would add to your taxable account. It's nice to have liquidity and options of places to draw from for income.

 

[FlaGator]

I'm 59 1/2 and plan on retiring at 62 or earlier. Nearly all of my investment savings is is in my 401k and pension, so I will owe taxes on withdrawals. I recently became concerned that I don't have enough in a taxable account that I can draw from for spending to lower my income in retirement and hedge against pulling money out in a downturn. I started putting additional $1200 a month cash aside in my emergency savings to build up the taxable account.

Our only debt is 13 years remaining on a 30 year ARM mortgage (balance is about $120K and current rate is 2.85%). So the question is, should I continue to put cash aside, or pay down the mortgage, or perhaps split the two?

Contrary to most comments so far, I think you should build the cash. Building up $25K or so in the next few years gives you flexibility, especially if most/all of your living expenses are coming from 100% taxable sources. I had paid off my prior residence (that had an ARM), so I understand the opinions of those who say pay it down or refi to a fixed.

As to potential mortgage rate increases-if your rate jumps the full 2 points (typical ARM maximum annual rate change), that's $2400 additional for the next year ($120,000 x .02). If you used the $1200/mo to pay to pay down the mortgage and your rate increases 2%, it would be an additional $2120 for the year (($120,000-14,000)x.02). Not a big difference. Not obvious to me the half of either that you get by splitting the difference is really meaningful. You'll have to calculate the taxes on pulling $14,000 from your 401k to see the tax cost and include that in your calculations.

I'm now carrying a substantial mortgage (~60% LTV) and sleep well. May do something different in a few years, but I'll make sure I sleep well then. Suggest you run the numbers and make a decision that works best for your situation.

 

[ERD50]

Quote:
(you still have property tax, maint, utilities, etc).

ell, the government taxes are something that you can't avoid, so that doesn't count. The other things are just the cost of living. ...

Regardless, my point is that these are still risks to home ownership. If you can't pay utilities, can't pay for a new roof (a major leak could make it uninhabitable), or can't pay property tax or insurance, those could cause you to lose the home. Not much difference between having to sell a paid-for home at a loss to pay those bills and a foreclosure.

And having more of your savings tied up in the house means it's not available for those repairs. And being behind on these payments may make it tough to get a mortgage at that point.

I'm just countering the idea that some say that having the home paid off somehow makes you "bullet-proof" - there are still bills and those are tougher to meet if you are house-rich and cash-poor (which is the point you make in the rest of your post).

-ERD50

 

[timeismine]

Build up taxable- difficult to borrow when retired

To second some of the other comments, building up your taxable account helps you control your income level until you are 65. This is important if you plan on using “Obama” care for medical insurance. Once you go over around $57k per year, your premium starts to rise quickly, from hundreds of dollars per month to $1200-$1700 per month.

Plus with lower income loans are harder to get, so you need cash on hand to make larger purchases.
I should have taken out a mortgage in my last couple of years of working, as an income cushion.

 

[RetiredAt55.5]

Lots of opinions. I'll add my 2 cents, but I don't think there's a right or wrong answer, unless a person is bad at managing money and will blow through any money sitting in a bank account (then by all means listen to Dave Ramsey).

We've been in our house for 30 years. Had the mortgage paid off. It felt good but the feeling wanes with time. Fast forward some years, we bought a vacation property and paid for it using a new mortgage on the first house. I have the liquid money to pay off the mortgage now (~ $75k), but I don't and I sleep like a baby because the monthly payment is low (~$475 per month) and the $75k would cover the mortgage payments for the next 13 years. Or the $75k would cover both the mortgage payments and my real estate taxes for the next 6 years. Or the $75k would cover the mortgage payments, the RE taxes, and a new roof for the next 5 years.

Point being, there's lots of ways of looking at this. Some will argue it's important to pay off a mortgage before retiring. I don't completely understand that logic as it's just another bill. I don't attach any more importance to it than other bills, like real estate taxes and home repairs. There is some advantage to having liquid assets (i.e., money in taxable accounts) for various situations. Some banks don't care how much money you have in retirement accounts if you no longer have a weekly paycheck and aren't yet drawing from a pension or SS. So don't count on being able to do a get a new mortgage or a HELOC for that paid off house. When the SHTF, that's why banks get stingy and particular with lending out money.

 

[karen1972]

I'm not sure why people think there is more risk in not paying off the mortgage, at least in my case that is not what the numbers say.

So we just refinanced, 30 year 2.875% fixed

Running it through firecalc, I have a 5% better chance of never running out of money if I don't pay it off early. Using the investigate button, it says I have $1300 extra I can spend every year for the rest of my life if I don't pay it off early.

So as much as I feel like paying it off should be the better choice in the end the numbers prevailed.

In your case, with an adjustable rate mortgage, I'm not sure how I would model that, probably by assuming at least 1-2% increase in the rate and then the numbers may not work in your favor.

 

[Markola]

I'm not sure why people think there is more risk in not paying off the mortgage, at least in my case that is not what the numbers say.



So we just refinanced, 30 year 2.875% fixed



Running it through firecalc, I have a 5% better chance of never running out of money if I don't pay it off early. Using the investigate button, it says I have $1300 extra I can spend every year for the rest of my life if I don't pay it off early.



So as much as I feel like paying it off should be the better choice in the end the numbers prevailed.



In your case, with an adjustable rate mortgage, I'm not sure how I would model that, probably by assuming at least 1-2% increase in the rate and then the numbers may not work in your favor.

Wow, that’s a terrific rate. We are in a similar situation with a new 30 year mortgage but at last spring’s 3.68%. I use the Personal Capital retirement calculator and get a similar boost in monthly spending by keeping the mortgage. I get even more spendable with the scenario of refinancing again in 15 years, thus lowering the P&I payment by about 1/3. Of course, interest rates at that time are unknowable.

 

[TheWizard]

...Every HELOC I've seen forbids you from using the HELOC to make a mortgage or HELOC payment.

Some years ago, I re-fied my home mortgage from a conventional bank to a HELOC at my credit union, making the CU the primary lienholder.
It worked out fine...