Refi vs. Extra Payment vs. Invest

[mbnj77]

Hello all, perhaps I could impose on a bit of guidance.

We recently moved and are 1 year into a 30 year fixed at 4.375% with about $276,000 left. P & I are $1398. We are not 100% sure but we will likely stay in the house about 10 years. (The Mrs. & I are each 50 and when we are both retired, hopefully about 57-58), we will likely sell and find a smaller place by the beach soon thereafter).

As our income allows us to, we have budgeted an extra $1000 every month to either make an additional principal payment, refi to a 10-15 year loan and pay the higher monthly payment for that, or even take that money and invest in an after-tax account. (Note we also budgeted for a separate $1500/Month after-tax investement to help fund out future "gap").

Given our anticpated tenure in the house, where are we better off putting this additional $1000 or so? Given we each have very good paying jobs AND she is already collecting a pension after taking early retirement from a State job, we will never earn more than these next few years. So tax avoidance is a big issue for us. We are already maxing 401(k)s including the catch-up, and earn just a bit too much for a Roth.

Thank you very much in advance for any advice.

 

[Senator]

Every dollar you pay towards principal is like investing at 4.375%. You could pay the house down and at some point get a HELOC for emergencies. 4.375% is not a bad dividend stock, and yours is 100% safe. You will always have the principal in your home (unless RE prices drop…)

If you refinance to a 15 year loan, you will pay more in closing fees and likely not get much better interest rate other than the 15 vs 30 year difference. But you are obligated to make the higher payment, or lose the house. (or sell, if you can).

Paying the extra $1,000 per month makes sense, if it doesn’t hurt your life style. You can always cut back if you want too. Of you can put it in a higher yielding investment account until it reaches the entire principal balance and make a lump sum payoff.

I am in the process of paying one of my mortgages off that is at 5.5%, non-owner occupied. I have run through many of the same options as you.

 

[Meadbh]

I agree with Senator. In your position I would use your spare cash to pay down the principal. If you do this consistently, in 10 years you will have reduced the principal by an additional $120k, shortened the life of the mortgage, and saved yourself a bundle in interest. At the same time, you are keeping your options open just in case you need that extra cash.

Committing yourself to a higher monthly payment would not give you that flexibility and some of your increment would go to pay interest, therefore the principal would not drop as quickly in the early years.

Good luck finding a risk free investment with that yield in today's market.

Paying down principal has been my mortgage-killing method of choice for residential and investment real estate since 1991.

 

[rodi]

I agree with Senator. But there will likely be a big debate here about whether it makes sense to pre-pay a mortgage.

I'm debt averse - and I did exactly what you did - sent in extra principal payments for several years. We had a loan for $185k after the last refinance in 2009 - and with extra principal payments we paid it off this June. (I did pay a lump sum at the end - but only $38k.) Now we only have taxes/insurance and maintenance.

You don't mention where you are - but I'd also consider whether you're in an area that is likely to appreciate? If it's a high demand area (good schools, good employment centers nearby) then I'd totally pay extra, because you'll get it back when you sell to downsize. If you're in an area that is more stagnant, or has issues that might come into play when you sell... I might hesitate - knowing you could do a short sale if you're underwater when it's time to downsize. (Treating the mortgage more like rent.)

Also - if you're in CA (you mention beach - so this might be the case) be aware of the rules for transferring your prop13 tax rate if you're over 55. This requires transferring to a lesser $$ sales price - which might not be doable if you're moving to the beach. (I have friends who tried to move from a Mcmansion on the outskirts of Escondido to a coastal Carlsbad condo - and couldn't make the deal work because the price of the condo was higher than their more exurb McMansion, despite being smaller with no land.)

 

[racy]

...on the other hand, equities have returned better than 4.4% average. And, if you're figuring "about 10 years" you should be good in the market.
I believe the numbers will lead you to take the $1000 and put it in the market, but many sleep better having no mortgage. Pick your ride, buy your ticket and take the ride. Good luck!

 

[Animorph]

10 years is enough for me to go the investing route. I'd put the extra cash into my portfolio with the normal AA. The tax deduction is nice too.

A close second, or maybe first, would be to refi to the shorter time period if the interest rate deduction is enticing enough. Lower costs are always nice and you are still sort of prepaying. You'll have to run the numbers and see what makes sense to you.

 

[GrayHare]

Every dollar you pay towards principal is like investing at 4.375%.

But that's forgetting to account for inflation, of course. At 3.2% inflation, the long-term US average, that return drops to a mere 1.175%.

 

[mbnj77]

Thanks much all for the advice. I think maybe if had this choice before we moved it would have been more difficult but she was waiting to find another job in the private sector before she took early retirement and got her pension. We could afford it now but now there would be several thousands in closing costs that would just suck up most if not all gains realized by investing the difference. 15 year is about 3.5% vs. the 4.375% 30 year. Oh, and I am in NJ, about 4 miles from, (but not on), the beach. So i think prosepects are good for RE appreciation.

Now, what to do with her 457 Deffered Comp money that she can withdraw/move without the IRS 10% penalty? I'll save that for another thread.

Thanks very much again.