invest money or pay downmortgage?

[MedicalDoc]

I have about 5 years left in my 15 year mortgage (5.75% rate) and have some money that I can use either to invest towards retirement (about 12 years away) or pay down my mortgage.  I'd appreciate any thoughts about whether to take the money and put it in the stock market or use it to reduce the outstanding balance of my mortgage.  I have no other debts and am in the highest tax bracket.

 

[2B]

This is pure personal opinion.  The conventional wisdom is spilt between "be debt free" and "you can get a better return in the stock market than 5.75%."

IMHO --- Look at what you have outside of tax deferred accounts.  You should have enough to cover you to 59 1/2 which would allow you to move money to a Roth in the interim.  Also, you should have enough to cover your expenses should you suddenly lose your job for at least a couple of years.

The other consideration is whether the home you are currently living in will become your "retirement home."  If it is, the bias is toward paying off the mortgage.  If it isn't, the very strong recommendation is to pay it off as slowly as possible because at some point you will need the money you're saving to pay cash for your real retirement home or to make a large down payment.

Remember that cash is king.

 

[rs0460a]

Since you don't feel strongly, either way (or else you would not be asking the question  ), why not split your available cash and do both?    :

- Ron

 

[scrinch]

I had the same decision to make a few years ago...5 years left on a 15-year mortgage. I opted to pay off the mortgage, and it was a sweet feeling when that letter of reconveyance from the mortgage company came in the mail. I missed the dot com run-up with that money, and then also the dot com bust, and the subsequent recovery. I have never given a second thought to the decision. The feeling of owning the home outright has been satisfying enough that I've never even tried to calculate if I would have been better off investing the money in the stock market. It is definitely a personal decision, though. 8)

 

[cute fuzzy bunny]

This ones easy. Pay off your mortgage and put the rest into 90-95% equities, the rest in cash in a cd ladder. You dont need the 'ballast' of any bond holdings...your house is your ballast. You can draw from a heloc, a reverse mortgage or sell it if you desperately need the cash.

Over a 10-20+ year period, your high equity portfolio of smaller stature will (if historic returns hold) whomp the larger portfolio's returns minus the costs of the mortgage if the larger portfolio is held in a prudent 50/50 or 60/40 balance.

Should we have a lousy run in the market, so what? Your needs to withdraw from the portfolio with no mortgage to pay is pitifully small. You could mow lawns and make enough to pay the monthly bills.

A great run in the market and you're making a killing.

Or if you're worried about the future of the stock market, invest in a wellesley or target retirement income fund, take the stability and low volatility, and live off the dividends...because you dont need much money to pay the bills every month.

A lot of people do this calculation in the absence of tax implications, the standard vs itemized deduction difference, or do it as a 30 year ROI against a 30 year mortgage. Few people stay 30 years in a house. Most stay less than 7. What rates are you going to get when you move in 7 years? Will that short term return on your 50/50 or 60/40 portfolio be positive during that 7 years?

Someone investing the mortgage money over the last 5 years in any vanguard balanced fund barely made money if they didnt lose money vs paying off the debt. From 2000-2005 they all lost money.

For someone with an income to pay the bills (say, working spouse, COLA pension), a manageable tax situation, the willingness to stay put in the house for over 10 years, and perhaps the willingness to trade a riskless debt payoff transaction for a higher risk sector fund play (like energy, precious metals, reits)...maybe rolling the dice makes sense and you'll come out ahead.

By poll here, the vast majority of board members have paid off their debt or plan to by the time they retire. Theres a reason for that, and its not just "feels good". Run the numbers. You can retire earlier with less money with no debt and a 90-95% equity portfolio than with a 200-300k mortgage and a portfolio invested in a 50/60 or 60/40 blend. With less risk. With a lower withdrawal amount. With most likely lower taxes. With a good probability of being able to live off of just interest and dividends from your portfolio.

 

[LOL!]

This ones easy. Do not pay off your mortgage and put all of it into 90-95% equities, the rest in cash in a cd ladder.

Over a 10-20+ year period, your high equity portfolio will (if historic returns hold) whomp a smaller portfolio's returns as well as give you tax savings in your high tax bracket if the mortgage if the larger portfolio is held in a prudent 50/50 or 60/40 balance.

Should we have a lousy run in the market, so what? You have income to cover your needs.

A great run in the market and you're making a killing. And your home should appreciate in value as well. Plus you will be paying your mortgage with future inflation-ravaged dollars.

Or if you're worried about the future of the stock market, invest in a wellesley or target retirement income fund, take the stability and low volatility, and live off the dividends...because you dont need much money to pay the bills every month.

By poll here, the vast majority of board members have paid off their debt or plan to by the time they retire. This is because they don't run the numbers, are fearful of debt and don't seem to have much of an income.

The "feel good" feeling is just plain bunk. You should feel just as good that you can pay the mortgage whenever you want and you have two assets that are going up in value: your home and your investments.

 

[audreyh1]

At some point we noticed that our mortgage interest deduction fell well below the standard deduction.

We paid off the mortgage with money we gained by selling some company stock after a big run up.

It felt great!

Yes, the company stock went higher, and we could have done better if we had held on to the company stock for a few more years. Some of our peers were a little shocked at our move - they were holding on to every last bit of company stock waiting for the big payoff. But we only sold a portion, so it wasn't like we used it all. And it was a really good excuse to diversify some of that single stock ownership.

And the feeling of not having to worry about a mortgage was just incredible. We slept better knowing that no matter what happened, we owned our own home outright. Just felt like our options really opened up, and that we had more choices in life.

It's really a psychological thing. Which will make you feel more secure financially? We love the debt-free feeling.

Audrey

 

[tryan]

Let's see... a 5.75% in the highest tax bracket (33% federal, no state tax?); that's like really paying 3.8% (5.75 - (5.75 X .33)).  Minus inflation (3% is customary) equals FREE money (emotions aside)!

I'ld say keep the mortgage.

 

[jdw_fire]

I have about 5 years left in my 15 year mortgage (5.75% rate) and have some money that I can use either to invest towards retirement (about 12 years away) or pay down my mortgage.  I'd appreciate any thoughts about whether to take the money and put it in the stock market or use it to reduce the outstanding balance of my mortgage.  I have no other debts and am in the highest tax bracket.

This really is a where can you get the highest yield question since either way your house will be paid off by the time you retire.  If you do decided to pay it off make sure you keep making the mortgage payment, just make it to your portfolio (over and above what you currently add).  If you don't plan on immediately increasing your amount saved by the mortgage payment amount then don't pay off the mortgage because if you do you will be cheating your portfolio out of the mortgage payoff amount.

 

[donheff]

Let's see... a 5.75% in the highest tax bracket (33% federal, no state tax?); that's like really paying 3.8% (5.75 - (5.75 X .33)). Minus inflation (3% is customary) equals FREE money (emotions aside)!

I have been thinking about this exact question but come out more comfortable buying it off. $175K to go, 5.75% - $15700/yr. Me retired, DW to go in a couple or three years. Still in a high bracket now. But after she retires the tax advantage won't be there any more. I figure that the SWR on that mortgage requires almost $400K. So I plan to pay it off. But that means the $175K is a short term planned expense now since I need to spend it within a couple of years. Soooo - I plan to pull the $ out and either pay off the mortgae or leave the $ in safe investments until the tax advantage evaporates. If the market does great I will have missed a bit, but if there is a big downturn I will be a lot happier without that extra debt over my head.

 

[wabmester]

Let's see... a 5.75% in the highest tax bracket (33% federal, no state tax?); that's like really paying 3.8% (5.75 - (5.75 X .33)).  Minus inflation (3% is customary) equals FREE money (emotions aside)!

I'd say keep the mortgage.

Agreed. There are many threads on this topic, but it seems like a no-brainer to me.

1) You are borrowing at a 5.75% rate.

2) You can get 6% risk-free return from a CD (PenFed, for example).

What do people have against free money?

 

[Gone4Good]

Agreed.   There are many threads on this topic, but it seems like a no-brainer to me.

1) You are borrowing at a 5.75% rate.

2) You can get 6% risk-free return from a CD (PenFed, for example).

What do people have against free money?

Well, I'm paying down my 15 year mortgage prior to retirement in ~3 years despite the fact that I might earn a higher return elsewhere.  I'm doing it simply to maximize my financial flexibility post retirement.  I plan to trade the fixed monthly mortgage payment for discretionary expenses (mostly travel).  I feel I'm taking more than enough market risk already by retiring early that I do not need to accentuate that risk by leveraging my investments.

To that end, "expected" returns are always enhanced through the use of leverage.  That is not to say that actual returns will be.  Also keep in mind that you will be making constant fixed mortgage payments for the life of loan.  Annual payments on my 15 year mortgage total about 12% of the outstanding balance . . . you wouldn't advise a 12% withdrawal rate for your retirement portfolio because it is too risky.  There is similarly ample risk of losing money by borrowing against your home to invest in financial assets with higher "expected" return. Incidentally, I doubt the 6% CD rate lasts for the duration of the mortgage or has a similar amortizing feature . . . so if you were to make that trade to capture 25bp, you are taking reinvestment risk on the back end of the transaction.

There is no such thing as a free lunch.   

 

[Gone4Good]

I just ran a scenario on FIRECalc where you used a starting portfolio of $150,000 invested entirely in equities to amortize a 15 year, $150,000 mortgage (annual payments of $15K non-inflation adjusted at 5.75%). The success rate is 61% with a terminal value range from $-178,592 to $444,523, and an average of $66,850.

Although the transaction has a positive expected return ($66,850 non-inflation adjusted), it amounts to a compound annual return of 2.5% and has considerable volatility with a terminal value range of $600K. I imagine the monthly amortization required by most mortgages would lower the expected return. To my surprise, a 30 year mortgage resulted in only slightly higher success rate of 62%, and lower average annual expected returns of 1.7%. According to FIRECalc the same scenario (using a 30/yr mortgage and 6% interest rate) resulted in a terminal value of $-852,281 to $1,007,014, with an average of $100,680.

So unless I calculated this incorrectly (which is completely possible), holding the mortgage and investing in equities is a marginally positive NPV transaction which carries a large amount of risk.

I think I'll pay down the mortgage.

 

[Nords]

I just ran a scenario on FIRECalc...

This thread keeps coming back to life like Glenn Close in "Fatal Attraction". 18 months and who knows how many revivals since then.

http://early-retirement.org/forums/index.php?topic=1390.0

3YTG, maybe you & SG need to have a little FIRECalc conclave...

 

[Martha]

When looking at keping a mortage and you are high income, some people forget that itemized deductions are phased out as your income increases.

For 2005, you begin to lose some of your itemized deductions when AGI reaches $145,950.

Your itemized deductions phase out at the rate of 3% of additional income. In other words, for each $1,000 of adjusted gross income above the phase out limits, you lose $30 of itemized deductions. You can never lose more than 80% of your itemized deductions.

 

[Rich_by_the_Bay]

When looking at keping a mortage and you are high income, some people forget that itemized deductions are phased out as your income increases.

For 2005, you begin to lose some of your itemized deductions when AGI reaches $145,950.

Yikes - didn't realize that. What's the AGI limit if filing jointly?

Makes me rethink the mortgage thing.

 

[Martha]

Here is a great chart for deduction phase outs for 2006: http://www.taxguideonline.com/ContentPages/ID_PhaseOut.html

 

[cute fuzzy bunny]

I just ran a scenario on FIRECalc where you used a starting portfolio of $150,000 invested entirely in equities to amortize a 15 year, $150,000 mortgage (annual payments of $15K non-inflation adjusted at 5.75%). The success rate is 61% with a terminal value range from $-178,592 to $444,523, and an average of $66,850.

Although the transaction has a positive expected return ($66,850 non-inflation adjusted), it amounts to a compound annual return of 2.5% and has considerable volatility with a terminal value range of $600K. I imagine the monthly amortization required by most mortgages would lower the expected return. To my surprise, a 30 year mortgage resulted in only slightly higher success rate of 62%, and lower average annual expected returns of 1.7%. According to FIRECalc the same scenario (using a 30/yr mortgage and 6% interest rate) resulted in a terminal value of $-852,281 to $1,007,014, with an average of $100,680.

So unless I calculated this incorrectly (which is completely possible), holding the mortgage and investing in equities is a marginally positive NPV transaction which carries a large amount of risk.

I think I'll pay down the mortgage.

Ding ding ding!

The biggest distraction with this decision is trying to make it simple. It aint. The loss of six figures of debt, dropping a withdrawal rate by 40-60%, ignorance of the full tax implications, making a 5-10 year decision into a 30 year one without knowing all the parameters, and the total change of risk profile have to be incorporated.

I love free money. My favorite kind is when I can take on more portfolio risk for higher long term returns than a piddly half or quarter percent.

Another favorite discussion distraction is comparing cd rates you can barely get with interest rates that you cant get easily. Current 30 year rates are over 6.5% with a half point, according to freddie mac. Reinvesting cd interest on the highest paying current cd from penfed can get you 6% APY, before taxes on the interest.

 

[2B]

Ding ding ding!

I love free money.  My favorite kind is when I can take on more portfolio risk for higher long term returns than a piddly half or quarter percent.

I've found a place that will lend me money at 2%. I've found another place that will pay me 8%.

I'm buying Italy tomorrow. I'm throwing a big party for everyone on this board in Milan next week. Look me up in the most expensive hotel. Everything will be on the house.

I agree with you CFB!!!! 8) 8) 8)

 

[scrinch]

If you want the historically highest returns and don't care about risk, take out the highest dollar, longest-term, lowest rate mortgage you can on the house, dump the money into the stock market, and leave it there as long as you can. We all know that long term stock market returns exceed mortgage interest rates, regardless of taxation subtleties. :

But that's not the answer to the question you asked. You asked whether you should pay down your 15 year mortgage which has 5 years remaining on it. I assume that by you asking it, you plan on paying off the mortgage in 5 years even if you don't pay it down now. You'd be smart after the mortgage is paid off to make that same mortgage payment into savings. So the question boils down to: should you invest a lump sum in your home equity now and then make time payments into the stock market, or should you put the lump sum into the stock market and keep making time payments into your house? If you're comfortable with the extra risk of the stock market at this point, that's where statistically your money should stay parked for the highest return. If paying off your house is going to give you a warm cozy feeling, then realize that it is a conservative thing to do, but go ahead and do it. Asking this question is like asking whether you should have 20% or 40% of your money in bonds. You can make a quantitative analysis of the choices, but eventually it is a personal risk/reward analysis that tells you what the right thing to do. If stock market returns are 4% higher than your mortgage rate, then you will be out about 4%/yr x 2-1/2 yrs x mortgage balance, minus taxes by paying down the mortgage.

If you make this into a complicated, long term decision and try to answer it comprehensively and knowing all tax implications, you will end up frustrated and without an answer, or with an answer that is largely an artifact of the assumptions you make about risk, return, and taxes. When I paid off my mortgage early I agonized for months over whether it was the right thing to do, then I decided that the mortgage-burning feeling was worth the potential loss of return. After 5 years you're going to end up in the same spot, one way or the other, so don't sweat it too much. Do what feels right.