pay off home or not?

[tmitchell]

Hi all

Hypothetical question here. I'm not quite ER yet and still hope to grow my stash a bit more, but I'm nearing 1MM net worth and have a 470k mortgage on a condo (crazy I know but I live in SoCal!). Wondering, would it be smarter to

A) pay off the mortgage and live on the $20,000/yr (assuming 4% SWR), or
B) keep the mortgage and live off $40k?

Either way it's a squeeze in a high cost of living area, but I would seem to come out about equally on a monthly basis. Is it foolish to carry that much of one's net worth in a primary residence? Or is it smarter financially to pay off the mortgage and save the interest? BTW my interest rate is 3.375% and I anticipate moving to a cheaper area in the long run (maybe in 5 years).

Thanks!

 

[Bamaman]

Your question's a little general, and info a little scant. Is the condo's value going up appreciably right now? What's your time frame to retirement? Do you intend to stay in an ultra expensive place in retirement or move somewhere affordable? Will you have the income in early retirement to keep up such an expensive residence?

 

[panacea]

Yes, your info is a little sketchy.

However, based on the information you provided it doesn't seem to make sense to pay off your mortgage. Aside from having a low interest rate, it sounds like you'd be shifting a very large portion of your overall net worth into a single piece of property. And where would that money come from? Would you have cap gains? Would you have ordinary income tax? What about the potential growth on those investments over the next 5 years until you sell? And if your property value declines in the short-term, that wouldn't be good.

Also, if you're not retired why would you be living off your portfolio at all? How close are you? If you're so close that you're not expecting to accumulate much more and will only have $500k to draw $20k if you pay off your mortgage, why pay it off? Sounds like a move sooner than later might make more sense?

I kind of feel like I'm guessing here, trying to put the puzzle pieces together. Anyway those are my thoughts.

 

[kitesurfer2]

you should stay there! too many reasons not to.

 

[exnavynuke]

If you're planning on moving in 5 years anyway, I'd keep the money invested instead of paying off the mortgage with that interest rate (assuming the money is invested in the market and not, say, sitting in a savings account).

If you don't need to be withdrawing money, I would be letting it grow instead of taking any money out of your investments as well.

 

[Yachi]

I see two different questions:

Should I pay off my mortgage if I'm still working?
I would say no, the interest rate is lower than you can make in the markets, and you have a job to support your expenses. You don't have to worry about a 4% withdrawal rate yet.

Using a 4% withdrawal rate, is it better to pay off or keep my mortgage?
Usually this calculation favors paying off the mortgage because the yearly mortgage payment is more than 4% of the balance owed. I ran your mortgage through some calculators and the payments should be $24,936 for a 30-year mortgage. This is higher than the 20k you mentioned, do you have a longer-term loan? If you're going to withdrawal $20,000 at 4%, it implies you'll have 500k left after paying off the 470k mortgage, so we're looking at a $970k nest egg*
If so you, actually have this scenario:
Keep the mortgage: $38,800 - $24,936 = $13,864 for living expenses
Pay off the mortgage: $20,000 - Use all of it for living expenses

*others have mentioned taxes. In order to have 500k left, you'll need to start with more than 970k in order to pay taxes on the withdrawal.

 

[Montecfo]

Speaking very generally, you should consider pay off or pay down of your mortgage if the funds available for doing so are invested at a rate that is less than the after tax cost of the mortgage.

And you should only do so when you have appropriate alternative emergency funds, and appropriate life, medical and , if earning an income, disability insurance in place.

Also, having a standby HELOC in place is wise for most folks with substantial home equity.

 

[FiveDriver]

In my Opinion, the gating item is -- when will you lose access to the Interest Deduction at Tax Time??

How far into this Mortgage are you ?? Is your monthly payment mostly Principal now ??
Or is there a sizable Interest portion ?? Once your Annual Interest Payment is less than the Standard Deduction......you'll probably not be able to use Schedule A (and all it's associated extra deductions).

I will say from Personal Experience, that being Mortgage Free in Retirement is good for your Cash Flow. You will still have your HOA Fees, but Housing Expense will be greatly reduced.

 

[GrayHare]

It's rarely mathematically wise to pay down a low-interest mortgage because inflation negates at least part of the interest. If your rate is 3.375% and inflation runs 2%, your actual rate becomes 1.375%, which is a some very inexpensive money. If a few years down the road inflation spikes to 4%, you're actually earning money by having the mortgage!

 

[Bruceski44]

Fed policy penalizes savers and zero-debtors

The Fed's recent near-zero interest rate policy has penalized savers but created opportunities to wisely use debt to enhance returns. Mortgage loan rates are so cheap now, it's foolish in my opinion to pay them off early. Besides the low cost of the loan, you get a tax deduction on the interest paid (if you itemize) and can earn greater returns on investments. Not necessarily in the stock market, which is not your only choice.

I recently refinanced my house and pulled cash out, resulting in 50% LTV on the house and about 14% debt to net worth ratio. After investing the cash, it pays returns at twice the mortgage's interest rate in the first year and this is projected to increase over time. The portion of my income devoted to paying the mortgage actually went down.

 

[rodi]

I hear you on the crazy home prices/values here in Southern CA. I live in coastal San Diego and home values are ridiculous... But the quality of life is awesome! I walk my dog on the beach in La Jolla most mornings.

One of the things I played with when figuring out when I could retire and what my retirement budget would be was the mortgage payment. DH and I decided to make extra payments to our mortgage while we were still working and had some cash flow going. We made between $1k and $2k extra in payments each month. We also continued to max our 401k/retirement savings and the kids 529's. We'd successfully gotten our mortgage down to $40k-ish when I realized we were no longer getting a tax benefit... We did a lot of analysis and decided to pay it off. Not so coincidentally - my work became less pleasant and I decided to quit/retire at age 52. Having no mortgage in retirement allows us to manage our income streams to be low enough to qualify for ACA premium tax credits - which definitely helps our budget.

One benefit to paying extra payments while you're still working is you get used to spending less (since there is less money available to spend)... The lower spending rate becomes a new baseline for what you'll need in retirement.

If your mortgage is variable - I'd definitely look at socking as much towards it now as you can... If it's fixed rate, it's less clear cut.

 

[Trawler]

With a fixed 3.375% rate I vote not liquidate assets to pay off mortgage but rather pay down out of current cash flow after meeting 401K or other savings plans.

 

[Gotadimple]

You have to ask yourself, what you are currently earning on the money you would use to pay down the debt? If your investments (specifically the bond portion) is earning 4%, then paying off the mortgage means you are forgoing those earnings.

See the mortgage professor website: Mortgage Prepayment (Paying Off Early) - The Mortgage Professor

He has several articles that can help with the planning process if you are planning an early payoff.

- Rita

 

[daylatedollarshort]

Beside the pros and cons already mentioned, one other pro to having a mortgage is possibly cheap asset protection. California doesn't have very high exemption limits compared to average home prices for personal residences, so if you have the option of keeping money in places like an ERISA covered 401K instead of paying off a mortgage, that's something to consider.

 

[ShokWaveRider]

Schools out on this but I say Yes, if you can afford it. We paid ours off in 1995 and that alone helped us to Fire in our mid 50's.

 

[bclover]

With a fixed 3.375% rate I vote not liquidate assets to pay off mortgage but rather pay down out of current cash flow after meeting 401K or other savings plans.

That's pretty much my thinking. I owe 250K on my mortgage. My house is assessed at about 800K. My rate is 3.75% fixed. I love the house but may sell mainly because it's a 4 level townhome and I'm probably going to need knee replacement very soon.

anyhoo, I'll let the mortgage ride until something change,

 

[tmitchell]

Your question's a little general, and info a little scant. Is the condo's value going up appreciably right now? What's your time frame to retirement? Do you intend to stay in an ultra expensive place in retirement or move somewhere affordable? Will you have the income in early retirement to keep up such an expensive residence?

Hi. Sorry for the scant info. Partly it's because I'm not sure yet. I work in entertainment so I need to be in LA or NY as long as I'm working the career, which I foresee doing for about 2-5 more years. After that I'm just not sure. I want to at least go part-time to enjoy life, or even FIRE. I guess I'm trying to figure out how little I can get by with if I were to FIRE in LA. If I do so, I would need another few hundred thousand invested in order to keep the mortgage. Whereas if I pay off the place, I reckon I could at least get by, albeit very tight.

Probably I need to keep working or just move! Thanks for your question.

 

[tmitchell]

I see two different questions:

Should I pay off my mortgage if I'm still working?
I would say no, the interest rate is lower than you can make in the markets, and you have a job to support your expenses. You don't have to worry about a 4% withdrawal rate yet.

Using a 4% withdrawal rate, is it better to pay off or keep my mortgage?
Usually this calculation favors paying off the mortgage because the yearly mortgage payment is more than 4% of the balance owed. I ran your mortgage through some calculators and the payments should be $24,936 for a 30-year mortgage. This is higher than the 20k you mentioned, do you have a longer-term loan? If you're going to withdrawal $20,000 at 4%, it implies you'll have 500k left after paying off the 470k mortgage, so we're looking at a $970k nest egg*
If so you, actually have this scenario:
Keep the mortgage: $38,800 - $24,936 = $13,864 for living expenses
Pay off the mortgage: $20,000 - Use all of it for living expenses

*others have mentioned taxes. In order to have 500k left, you'll need to start with more than 970k in order to pay taxes on the withdrawal.

Hi. Yes your math is about right, which is why I was wondering if paying it off would be better. However I wasn't considering the cap gains required from selling my investments.

It IS possible for me to shift my current savings into the mortgage though. Currently I park it in index funds with every paycheck. If I did that I'd at least save the cap gains...

 

[tmitchell]

In my Opinion, the gating item is -- when will you lose access to the Interest Deduction at Tax Time??

How far into this Mortgage are you ?? Is your monthly payment mostly Principal now ??
Or is there a sizable Interest portion ?? Once your Annual Interest Payment is less than the Standard Deduction......you'll probably not be able to use Schedule A (and all it's associated extra deductions).

I will say from Personal Experience, that being Mortgage Free in Retirement is good for your Cash Flow. You will still have your HOA Fees, but Housing Expense will be greatly reduced.

Great point. Yes I'd be selling investments and incur that gain! I suppose that would destroy the benefit. Thank you!

 

[tmitchell]

Very thoughtful & helpful information everyone. Thank you!

I have a secondary question: given that I may move out of state once I do FIRE (in say 2-5 yrs TBD), would it be better to stop putting my savings in index funds and park it in a savings account instead? That is, if I decide to sell the condo I'd have a certain amount of equity but probably not enough to buy a property outright, even in a cheaper market.

Or since I'm "undecided" is it better to just keep investing and deal with it later?

 

[Walt34]

I have a secondary question: given that I may move out of state once I do FIRE (in say 2-5 yrs TBD), would it be better to stop putting my savings in index funds and park it in a savings account instead? That is, if I decide to sell the condo I'd have a certain amount of equity but probably not enough to buy a property outright, even in a cheaper market.

Well, you're going to want to have enough ready cash to make the move and find a place to live without having to sell in a down market. It doesn't need to be enough to buy a home though, most will advise renting in the new location for at least a year anyway in case you find you don't like it.

 

[Yachi]

You can buy index funds in a Taxable Investment Account, 401(k) or IRA. I would not put funds in the 401(k) or IRA that you want to use 2-5 years from now, as you might get hit with penalties for withdrawing them.

If you want to buy index funds in a Taxable Investment Account, realize you can gain or lose money in a 2-5 year period. If you're very flexible and don't mind delaying the move due to a down stock market this would be OK. Don't let capital gains taxes scare you from having those gains in the first place.

I would not put these funds in a savings account, because your mortgage rate is higher than what you get in a savings account. If you don't want your plans to be subject to what the stock market does in 2-5 years, putting your savings into paying off your mortgage may be better.

As Walt mentioned, you want enough money accessible to fund the move without tapping the equity in your condo. This should be enough to move furniture and cover the mortgage on the condo for as long as you think the condo will be up for sale and vacant. You can always list the condo before moving out if it looks like selling takes a long time in your area.

Your 2-5 year plan is subject to what happens to the housing market in your area. If you don't like that, and despise the area you live in, you might consider selling now and renting in your current state.