Paying off the mortgage early grows in popularity

[Andre1969]

Thanks guys, for giving me a little insight into how the whole property tax/seizure thing works. Makes me feel a little better, that it's not as easy for the gov't to screw the little guy over as much as I thought!

 

[Alan]

And what about non-home owners? Freeloaders as well? Why should they get a free ride on the backs of people with the discipline to save enough to make a down payment and keep up with a mortgage?

And here's another thing; all those folks who do not own property are voters who vote to raise property taxes so they can have better public services. Sorry, voting on a tax that only someone else pays and you don't shouldn't be legal.

Their landlords pay property tax, which is incorporated in the rent. But hey, why let a small thing like fact get in the way of a good rant?

Yeah, come on. THINK. Non-homeowners also pay property taxes - it is include in their rent.

But renters have no skin in the game. Rent is determined by market conditions - supply & demand. The tax that the owner pays is just one of his costs, and is not directly reflected in the rent.

I'm a renter in a high property tax area, and I could rent much cheaper a few miles away, but prefer it here for all the extra amenities provided by those high property taxes. (150 miles of bike trails, 112 parks etc etc)

I have no doubt that the higher rent incudes the management company's contribution to the high property taxes here. I'm insulted at being called a "freeloader", or that I "have no skin in the game".

 

[Bestwifeever]

I'm a renter in a high property tax area, and I could rent much cheaper a few miles away, but prefer it here for all the extra amenities provided by those high property taxes. (150 miles of bike trails, 112 parks etc etc)

I have no doubt that the higher rent incudes the management company's contribution to the high property taxes here. I'm insulted at being called a "freeloader", or that I "have no skin in the game".

No kidding. And even in the other perennially unsolved yet still debated question, rent vs. buy, I don't think those who choose to rent have been called freeloaders or have touted "I don't have to pay property taxes!" as a reason to rent.

 

[Texas Proud]

Thanks guys, for giving me a little insight into how the whole property tax/seizure thing works. Makes me feel a little better, that it's not as easy for the gov't to screw the little guy over as much as I thought!

Don't get me wrong, they can still screw the 'little guy' if they do not pay their taxes... usually it takes a few years, but if the person does not pay the taxes they will sell the property... and if the little guy still does not do anything about it they WILL lose thier house...

But, the likelyhood of someone with a paid off house having this happen to them is slim... they can sell prior to the tax sale and pocket the money.... the person who has the biggest problem is one who lost their job and can not even make the mortgage payments... but the mortgage company will likely foreclose prior to a tax sale...

Edit...

Looked up some more info.... go to this link...

http://www.publicans.com/services/tax_sales.htm

It talks about the tax sale etc... I looked in my County and every one had a case assigned to it, so it looks like there is a legal judgement prior to any sale...

I am surprised how many I saw... but we are a big city...

 

[Hamlet]

Let's not even mention the massive federal tax subsidies that homeowners get.

I'm a renter in a high property tax area, and I could rent much cheaper a few miles away, but prefer it here for all the extra amenities provided by those high property taxes. (150 miles of bike trails, 112 parks etc etc)

I have no doubt that the higher rent incudes the management company's contribution to the high property taxes here. I'm insulted at being called a "freeloader", or that I "have no skin in the game".

 

[Alan]

Let's not even mention the massive federal tax subsidies that homeowners get.

Yes, let's keep away from politics. I just wanted to make the point that I pay property taxes as a renter and am not somehow cheating the system of local taxation.

Off to the gym now with my son.....

 

[RetireBy90]

But renters have no skin in the game. Rent is determined by market conditions - supply & demand. The tax that the owner pays is just one of his costs, and is not directly reflected in the rent.

I'm sure that others will pipe in and tell you how wrong I am, but being a real estate investor, monthly costs, including tax, are what makes all the difference in my investment. I can't unilaterally raise the rent if property taxes go up, or even if my income taxes raise, but if I'm not able to make a profit I either won't buy or will sell. So I would say the for me, the tax bill is directly linked to the rent I'll ask.

 

[ERD50]

Let's not even mention the massive federal tax subsidies that homeowners get.

Yes, let's keep away from politics.

Not a political comment, strictly financial.

Hamlet, if you are talking about the mortgage and property tax deductions for homeowners, I'm not so sure that is so much a 'subsidy' as it is just putting homeowners on equal footing with renters.

For the landlord, property tax and interest are a business expense, they offset income, so effectively is not taxed at the Federal level. In a competitive market, all or a portion of that 'savings' is passed on to the consumer.

But w/o a mortgage interest and property tax deduction for homeowners, they would effectively be paying a higher rate than that passed on to renters.

It seems to me it just levels the field. Capital gains treatment might be another story though.

-ERD50

 

[GRambler]

Not paying off your mortage when it's at a comfortable doable level is like taking a mortgage out on a paid for house at 3.5% in the hopes you can invest it and make 5%

I'll take my paid off house anytime over those odds in this market.

 

[Hamlet]

In practice though, I don't think it really works out that way.

In Minnesota, rental property has a much higher property tax rate than "homesteaded" property. Any rental mortgage typically has a higher interest rate as well.

If I were to rent a house similiar to mine, my costs would not go down much, but my taxes would be much higher.

Not a political comment, strictly financial.

Hamlet, if you are talking about the mortgage and property tax deductions for homeowners, I'm not so sure that is so much a 'subsidy' as it is just putting homeowners on equal footing with renters.

For the landlord, property tax and interest are a business expense, they offset income, so effectively is not taxed at the Federal level. In a competitive market, all or a portion of that 'savings' is passed on to the consumer.

But w/o a mortgage interest and property tax deduction for homeowners, they would effectively be paying a higher rate than that passed on to renters.

It seems to me it just levels the field. Capital gains treatment might be another story though.

-ERD50

 

[ERD50]

In practice though, I don't think it really works out that way.

In Minnesota, rental property has a much higher property tax rate than "homesteaded" property. Any rental mortgage typically has a higher interest rate as well.

If I were to rent a house similiar to mine, my costs would not go down much, but my taxes would be much higher.

Good points - it does get complicated, I don't think there is a 'pure' answer.

-ERD50

 

[ERD50]

Not paying off your mortage when it's at a comfortable doable level is like taking a mortgage out on a paid for house at 3.5% in the hopes you can invest it and make 5%

I'll take my paid off house anytime over those odds in this market.

I welcome someone to check my math, the result was a little surprising to me, but I guess it has to do with the declining balance interest payments:


I ran a $100,000, 30 year mort @ 3.5% on a calculator. Says total payments are $161,656. OK.

If I invest $100,000 and let the int/divs compound, I find I need only 1.61% returns to 'break even'. If I get 5% returns, I manage a profit of $270,538 at the end of 30 years.

EXAMPLE: 1.05^30 = 4.32194 times $100,000 - $432,194

Subtract the $161,656, and you have $270,538​

Taxes not taken into account, but a rough cut would be assume no deduction, and divide the returns by .85 for a 15% tax rate on earnings. That just bumps 1.61% up to 1.9%, and the 5% to 5.88%.

That 1.9% seems like a pretty low hurdle to me, over 30 years.

Any bad assumptions/calcs there? Inflation should not be a factor, as the mortgage is not adjusted for inflation, right? So I just need those numbers as simple returns, not in 'real' (above inflation) returns?

-ERD50

 

[Texas Proud]

I welcome someone to check my math, the result was a little surprising to me, but I guess it has to do with the declining balance interest payments:


I ran a $100,000, 30 year mort @ 3.5% on a calculator. Says total payments are $161,656. OK.

If I invest $100,000 and let the int/divs compound, I find I need only 1.61% returns to 'break even'. If I get 5% returns, I manage a profit of $270,538 at the end of 30 years.

EXAMPLE: 1.05^30 = 4.32194 times $100,000 - $432,194

Subtract the $161,656, and you have $270,538
​

Taxes not taken into account, but a rough cut would be assume no deduction, and divide the returns by .85 for a 15% tax rate on earnings. That just bumps 1.61% up to 1.9%, and the 5% to 5.88%.

That 1.9% seems like a pretty low hurdle to me, over 30 years.

Any bad assumptions/calcs there? Inflation should not be a factor, as the mortgage is not adjusted for inflation, right? So I just need those numbers as simple returns, not in 'real' (above inflation) returns?

-ERD50

I think you missed the earnings on the money you do not have to spend on the mortgage... IOW, your mortgage pmts are deemed to be invested under your calculation...

Or, another way to look at it is your invested balance has to go down to make the mortgage payments...

 

[rayvt]

Well, this is the thing. As has been implied in a few posts, people are making a decision to pay off the mortgage for short-term reasons. Like, "my investment portfolio only returned average 4.4% for [some particular] 6 years period." But for making comparison, you should look at the long-term, 25-30 years. Because when we're talking about a house/mortgage, that's the length of time under consideration.

In general, people who focus on the short term and ignore the long term are people who overall do not succeed as investors. Paying off a 4% mortgage sounds great, but you're giving up the opportunity to make avg 10%.

My portfolio's average returm from 2005 to 2011 was 4.4%.

Not paying off your mortage when it's at a comfortable doable level is like taking a mortgage out on a paid for house at 3.5% in the hopes you can invest it and make 5%

I'd take that in a heartbeat.
A simple strategy suggested by Jeremy Siegel of investing in the S&P500 stocks in the lowest P/E quintile made 17% average annual return in the 2001-2011 period, and 9.8% in 2005-2011. http://www.advisorperspectives.com/...l-Why_I_Changed_My_Mind_about_Index_Funds.pdf
Another simple strategy suggested by Jim O’Shaughnessy returned even higher (as in a LOT higher). P/B < 2, P/S < 2, P/E < 12, P/CF < 12. The top stock-market strategy of the past 50 years - Outside the Box - MarketWatch

Or, heck, just invest in a good set of preferred stocks. Currently paying about 7.5% dividend yield.

 

[ERD50]

I think you missed the earnings on the money you do not have to spend on the mortgage... IOW, your mortgage pmts are deemed to be invested under your calculation...

Or, another way to look at it is your invested balance has to go down to make the mortgage payments...

Yes, that's what I'm missing. Back to the drawing board (spreadsheet)! Thanks.

(edit) OK, now close to par required to break-even (slight delta probably due to exact timing of one annual payment, versus each month)

-ERD50

 

[Mulligan]

Rayvt said: In general, people who focus on the short term and ignore the long term are people who overall do not succeed as investors. Paying off a 4% mortgage sounds great, but you're giving up the opportunity to make avg 10%.

I admit that I fall into this camp, or better that I dont trust myself to be a successful investor, and take the sure thing. I am currently trying to pay mine down by doulbling the principal payment. While I believe there is no right or wrong answer, due to my committment to " driving fixed costs down" instead of " growing my assets" paying off the house early appears the best choice for me.

 

[ziggy29]

In general, people who focus on the short term and ignore the long term are people who overall do not succeed as investors. Paying off a 4% mortgage sounds great, but you're giving up the opportunity to make avg 10%.

Sure. But not *all* money management moves most of us make are intended to maximize expected long-term results.

There's also a "sleep at night" component to money management that definitely has some value that doesn't show up on the balance sheet. And in terms of asset allocation for retirement savings, the goal isn't always to maximize your "expected" retirement nest egg when it's time to hang it up (otherwise people 15+ years out would all be 100% in stocks or even leveraged)... sometimes the goal is to minimize your chances of falling short of what you need. You may have a higher expected nest egg with more equities, but you may also increase your chances of falling short if Mister Market throws a long tantrum right as you are getting ready to retire.

 

[Alan]

Rayvt said: In general, people who focus on the short term and ignore the long term are people who overall do not succeed as investors. Paying off a 4% mortgage sounds great, but you're giving up the opportunity to make avg 10%.

I admit that I fall into this camp, or better that I dont trust myself to be a successful investor, and take the sure thing. I am currently trying to pay mine down by doulbling the principal payment. While I believe there is no right or wrong answer, due to my committment to " driving fixed costs down" instead of " growing my assets" paying off the house early appears the best choice for me.

This was our approach as well. We didn't start paying down the mortgage until we were at the point of maxing out 401ks and IRAs. We didn't have the really low interest rates we have now, but I still think we still would have paid it down in order to be mortgage free by the time we ER'ed.

 

[ziggy29]

This was our approach as well. We didn't start paying down the mortgage until we were at the point of maxing out 401ks and IRAs. We didn't have the really low interest rates we have now, but I still think we still would have paid it down in order to be mortgage free by the time we ER'ed.

I tend to agree, though we've been mortgage-free since 2006.

Some people say they'd rather invest now and then, when it comes time to retire, they will pay off the mortgage to reduce the income they need for retirement. But what if they wanted to retire at the end of 2008? Would they want to sell stocks near their cataclysmic bottom to pay off the mortgage? And if they didn't pay off the mortgage, they might still need to periodically sell equities at a very low price in order to make up the cash flow shortfall that keeping the mortgage would produce.

The bottom line is that we all place differing values on certainty and security. And that will naturally influence our decisions in terms of asset allocation as well as our decisions on when (and whether) to pay off debts even before they are due.

 

[Alan]

The bottom line is that we all place differing values on certainty and security. And that will naturally influence our decisions in terms of asset allocation as well as our decisions on when (and whether) to pay off debts even before they are due.

Very well summarized.

 

[Sirka]

However, I understand the logic of less bills/debts in RE. If you sleep better knowing you don't have a mortgage, drive on. That income stream to pay the mortgage has gotta be solid as steel.

+1
I would not ER if I had to worry about mortgage payment every month. Everyone was telling me, that I was nuts paying the house off when I was still w*rking. What about the tax deduction? Well I get enough of that (deduction) with Medical Insurance we now have to pay after ER.

When we first retired, we rented for couple of years in the local mountains. I had to put aside large chunk of money each year to cover the rent - it was a painful. I can't see us renting again. We paid cash to build our retirement house, so there was no need for construction loan and no interest to pay. Same goes for buying a car, why pay interest.

Bottom line: interest that you pay is part of burn rate, it adds up!

 

[traineeinvestor]

I blow hot and cold on this question of paying off our mortgage before I retire:

The case for not paying off the mortgage:

Our mortgage is linked to HIBOR and is currently costing us about 1.1% pa. This is well below the average rate of inflation for the last few years and well below the yield on some longer term bonds or good quality equities.

Once I stop earning a salary, the ability to reborrow is significantly affected. Also, I would not be able to get such favourable terms again (probably).

The case for paying off the mortgage:

The mortgage interest rate is floating and gets reset every month. If interest rates rise our mortgage costs will go up as well. Rising interest rates would also (probably) reduce the value of the bonds and equities we invested in instead of paying off the mortgage meaning that we would take a hit if we change our minds later.

We have no pension, SS etc and will be funding all our bills from our investments. Although Mrs Traineeinvestor intends to continue working part time, I want this to be because she wants to work rather than because she feels she has to

Other factors

Although mortgage interest is tax deductable, this only useful if you have salary based income to offset it against. I'm hoping we won't.

Inflation out here has typically been above 3% pa in recent years and above 5% in a couple of them. Based on my amateur fumblings with a spread sheet, FIRECalc etc, inflation over a 40-50 year period is one of the greatest risks to the financial sustainability of our retirement.

We will also be carrying mortgages on some investment properties post retirement.

Right now I'm in the don't pay off the mortgage camp.

 

[pb4uski]

.....Although mortgage interest is tax deductable, this only useful if you have salary based income to offset it against......

Not really, the increase in deductions also allows you to do a larger tIRA>Roth conversion while staying in your target tax bracket. IOW, if you have 10,000 interest deduction and you are already itemizing then you can convert 10,000 more that you would be able to without the mortgage interest.

On this whole mortgage question, while keeping a mortgage is most optimal from a pure financial viewpoint since in most cases your earnings rate will exceed your mortgage interest rate, that there is no single "right" answer.

 

[traineeinvestor]

Not really, the increase in deductions also allows you to do a larger tIRA>Roth conversion while staying in your target tax bracket. IOW, if you have 10,000 interest deduction and you are already itemizing then you can convert 10,000 more that you would be able to without the mortgage interest.

On this whole mortgage question, while keeping a mortgage is most optimal from a pure financial viewpoint since in most cases your earnings rate will exceed your mortgage interest rate, that there is no single "right" answer.

My tax position is a little different as I am neither a US resident or a US person for tax purposes and will drop out of the US tax net when I retire.

I agree that there isn't a universally "right" answer. As others have said, it's not all about the numbers.

 

[Nords]

Wow, it's been a while since we've stirred up this mosh pit!

Most re-fi's are a new mortgage. Banks HATE to re-fi their own mortgages unless they have too.
Look at it from the Banks/business side of the deal...
The bank has lent your friend $370k at 4.25% why would they want to refinance that down to 3.5%? To do that would cost them $2,775 a year in interest. Would you do that out of the goodness of your heart?
The other banks do not want to offer your friend a $370k mortgage on a house worth less than that.
They other reason is the banks you are paying your mortgage to, in all likelihood, do not hold the mortgage note, they are just servicers. The collect the payments and distribute the proceeds to the bondholders of the Mortgage Backed Securities that the mortgage (with thousands of others) are part of.

I never knew that, that banks hated to refinance their own mortgage. I figured they'd rather refinance and keep their customer, and keep some money, rather than lose everything.
And no, if I was in the bank's position, I wouldn't let a customer refinance to a lower rate, just out of the goodness of my heart. But I'd rather refinance that customer, rather than have the customer do a strategic default. I guess I just don't think it's fair that someone can keep paying faithfully on their mortgage, and no concession is made for them, but if you decide to stop paying, then the banks might try to work with you. Or, if you do a strategic default and the bank takes it possession of you, they're going to end up selling it at a lower price, anyway.

I think most banks sell the mortgages as soon as they lend out the money, and I think they'd be happy to refi them every five minutes if they could-- they earn more from selling the loan and from the refi fees than they earn from collecting the interest.

I've never had a bank reluctant to refi when I asked them to. However they've always insisted on going through the FHA-endorsed due-diligence fee-paying refi process so that they could sell the loan after the closing.

The days of paying a small fee to drop the interest rate, as you used to do with the 1980s S&Ls, are over.

But renters have no skin in the game. Rent is determined by market conditions - supply & demand. The tax that the owner pays is just one of his costs, and is not directly reflected in the rent.

Maybe we should ask a few of the folks posting here who are landlords to chime in with their perspective...

I think the arguments to keeping a mortgage when you don't need to on a primary residence can be frequently sourced to not wanting to reduce consumption to pay it off early.

Renters have some skin in the game-- the hassle of finding a new place, the hassle of moving to it. There's also the hassle of kid's schools and pets. All of those have expenses as well as personal hassles. Those "hassle factors" are effective landlord rent-raising tools.

We set our rents high enough to be able to absorb the inevitable property-tax increases for a couple years. Around the third year, though, we know that we need to raise the rent by a few percent or by $50/month just to deal with inflation. Sometimes the tenant leaves by that point, but usually they're not gonna pick up & move over $600/year.

When we were tenants, we'd make sure we were valuable to the landlord. Sometimes we'd sign a 2-3 year lease. Other times we'd do repairs & improvements for the cost of the materials. Other times we'd help them keep an eye on the contractor or the pool cleaner or whatever they needed help with. We felt as though we had skin in the game.