My Second thoughts on Prepaying Mortgage

[stephenandrew]

I have seen lots of discussion here about the pros and cons of pre-paying a mortgage. For the past several years I have been paying an extra $1000 a month on our 5.25% mortgage so that we would own our home free and clear by May 2010. I always thought that while this might not make the most financial sense (e.g. I could borrow at 5.25% and hopefully invest the money at a higher rate) that it would provide me with peace of mind, etc. In addition, while I never put pen to paper, I didn't think the financial benefits of "investing the difference" were that much more than prepaying.

In retrospect, I think I screwed up. Our family income prevents us from contributing to a Roth IRA. We currently max out our 401-K contributions ($31,000 per year total), and I stopped continuting to regular IRA (e.g. putting post tax money in) a number of years ago. Obviously, a lot of the money that could have gone into the IRA went into the house. I now understand that in 2010, I have the ability to convert a regular IRA to a Roth IRA (no income limitations--assuming the current law does not change. Making this conversion would create a tax liability which I understand I can spread out over 2 years.)

Had I been smart enough to recognize this opportunity a few years ago, I think I would have come out way ahead in the long run by taking the money I was using to pre-pay the mortgage, putting it into a regular IRA and then, in 2010, converting it to a Roth IRA. Under the current law, this would have been my chance to create a Roth that could grow tax-free, and when withdrawn, would never be taxed. This may be an opportunity I will not get again. (My employer does not offer, nor do they currently plan to, offer a Roth 401-K.)

I am not trying to make this out to be a horrific financial tragedy, but it did give me pause to more clearly see the potential financial benefits of carrying a mortgage that some of you have spoken about in the past.

 

[Bestwifeever]

Other people on this board will give you their educated and reasonable financial response but I say don't second-guess your decision to pay off the mortgage at this point. IMHO you will end up in the same place. Once it's paid you will have the monthly payment plus the additional $1,000 you've been able to put toward it to now put into savings and that will add up quickly. And your 401ks must be pretty healthy--you did not forego contributing toward those.

 

[retire48in2018]

Don't fret over it.

IMO - you want both - paid off mortgage and fully funded IRAs. It's great that you already maxed the 401ks out.

We did an analysis to determine whether we should payoff mortgage earlier or put more into retirement accounts.

For an unsheltered taxable account, it was really close to break-even at an 11-year payoff point with our tax bracket.

Ultimately we decided to set our mortgage-free date to be before the first child starts college. Max out IRAs and 401ks. Rest of money into taxable accounts with low turnover index funds. That allows us to cash flow college (to the extent that we choose to assist the kiddos).

We're just under 4 years left to payoff mortgage - and we're really looking forward to having all that extra money (mortgage and extra mortgage payoff $s).

 

[maldini]

As someone who also paid off his house early, do not worry about your decision. The difference in which way you went is negligible IMO.

You can also find many articles online that will caution people against blindly doing the Roth conversion in 2010 as it is not the right choice for everyone.

I myself have a lot of money in traditional IRA's and will not be making the conversion. I want my money to be tax deferred for as long as possible to maximize compounding.

 

[Patrick]

Just think of that huge chunk of mortgage interest that you WON'T be paying and smile.

 

[honobob]

I have seen lots of discussion here about the pros and cons of pre-paying a mortgage.

In retrospect, I think I screwed up.

Had I been smart enough to recognize this opportunity a few years ago, I think I would have come out way ahead

I am not trying to make this out to be a horrific financial tragedy, but it did give me pause to more clearly see the potential financial benefits of carrying a mortgage that some of you have spoken about in the past.

Hey, join the club. A few years ago I refinanced two mortgages into 15 year mortgages chasing after the rate. Looking at the small picture and not looking at the big picture plus ingrained midwest debt adversion caused me to not make the best financial choice.

Still again, 15-20 years from now I'll probably be throwing extra money at a couple of 30 year mortgages just because the inflation adjusted payments are so small that they are more nuisance than financial concerns.

 

[donheff]

If you have a few bucks laying around you still have a couple of days to toss in $4K each for 2007 ($5K if you are over 50 or maybe 55). But be careful, when you convert, all IRAs are treated as one single source for tax purposes. DW and I have a real traditional IRAs with pre-tax money in them. The whole amount is taxed as income. If we toss a few thousand after tax dollars in now, we will still pay income tax on 90% of the what we convert. Not worth while at high brackets.

 

[Nords]

It sounds to me as if you made the mortgage decision based on sleep-at-night peace of mind (an emotional perspective) and you're re-evaluating it from a financial perspective. Had you originally made it from a financial perspective, would you have been able to sleep at night?

Had I been smart enough to recognize this opportunity a few years ago, I think I would have come out way ahead in the long run by taking the money I was using to pre-pay the mortgage, putting it into a regular IRA and then, in 2010, converting it to a Roth IRA. Under the current law, this would have been my chance to create a Roth that could grow tax-free, and when withdrawn, would never be taxed. This may be an opportunity I will not get again. (My employer does not offer, nor do they currently plan to, offer a Roth 401-K.)

Well, consider this opportunity.

I ER'd at age 41 with nearly 30 years left before having to take RMDs from my conventional IRA (which was largely funded by non-deductible contributions). We didn't even start Roth IRAs until 2002, the year I ER'd (spouse still has some earned income as a drilling Reservist).

When you ER your earned income will drop precipitously, and almost certainly below the AGI limit for Roth conversions. You'll also probably have a few years left before you reach RMD age. That gives you a chance to convert your conventional IRA to a Roth a little each year, up to the top of the 15% tax bracket. Even if you're executing a 72(t) you'll be able to shelter some of the IRA to continue growing tax-free at a time when taxes rates are likely the lowest they'll be for decades to come.

I say the 15% bracket because when you hit RMD age with a conventional IRA, while also drawing Social Security, you will almost certainly be in the 25% marginal tax bracket. Your SS will be subject to a lot more tax, too. Even converting while executing a 72(t) will save you money. Paying the taxes from taxable accounts (again during a time of extraordinarily low cap-gains rates) will shelter even more of the new Roth to compound tax-free.

So while you may have "missed" one opportunity with a mortgage, there may still be time for the other.

 

[W2R]

Nords made some really good points, as did others.

I have learned that there are many paths that lead to FIRE. No matter which you decided to do first, you will be SO FAR AHEAD of the vast majority of Americans, and when you are FIRE'd, it won't much matter which you did first, really.

You don't have to be perfect. You just have to keep making good progress towards your goal. It sounds like you are doing that, nicely. Don't say you "screwed up". You didn't and you are doing wonderfully.

(Personally, had I been you I would have done exactly what you did, even after hearing your misgivings. I cannot tell you how rewarding it is to come home each day to my own home, and to know that THIS IS MINE, and to pay nothing for rent or mortgage ever again. But really, that is neither here nor there.)

 

[Midpack]

We paid extra every month and finished paying our mortgage last Nov. Like you, it gave us both a feeling of satisfaction to own our home outright. We haven't had any other debt for almost 20 years, so getting out from under the mortgage felt great.

And I can always get a home equity loan if I want to put some debt back in your financial picture, so can you. But I'm not planning on it...

 

[spideyrdpd]

You could refinance that money back out and still do the roth's

 

[jIMOh]

I think the Roth ship for you has sailed in terms of getting only 10k or 14k in before 2010 conversion- relative to years worth of 401k contributions and compounding, probably not much.

I started in the invest the difference camp, and am seeing my risk tolerance change as time passes. I doubt I will keep my 30 year fixed to 30 years, it will probably get paid off in 20 or so. I am in year 2 now (age 35).

I see your situation as quite positive- you have a decent amount of taxable investments, a paid off house, and a much larger 401k.

The question I would ask is do you have an ER withdraw strategy thought out?
Consider:

The taxable account will not be "taxable income", it will be long term gains. Meaning if you sell $1 M worth of taxable investments, my understanding is they are taxed at 5% right now because you would have no "earned income" to make that rate be 15%.

So an ER withdraw strategy to consider:
1) take income needed from taxable accounts
2) convert a portion of 401k to a Roth which caps out 15% tax bracket ($66100 this year)

So from ER age to age 70.5, you can convert $66100 to a Roth and pay less taxes on it then than you would if you converted to a Roth in 2010 (I am assuming your current earned income puts you in 25% or 28% tax bracket).

If you ER at age 50, 20*66.1k=$1.322 M in Roth at 15% tax bracket. That is much better than you could do in 2010. The better question is do you have enough in taxable accounts to last you 20 years?

 

[Walt34]

Purely emotional to pay off the house. "I don't owe anybody anything!" Didn't bother to do any math.

 

[stephenandrew]

Thank you

Thanks for some of the suggestions. It had not occurred to me about doing the IRA to Roth conversion later when, presumably, my income will be lower, and I would be elligible to do so. And with regard to the coment on not having to be "perfect" but continuing to make forward progress toward my goals---I think keeping that in mind might be beneficial to me as I conitnue on my journey to FIRE. Maybe the details are really less important than just LBYM and saving. Again, thanks!

 

[DAYDREAMER]

I wouldn't fret about paying down the mortgage. Take it from somebody who has paid off the mortgage debt anchor- Life is good! I don't concern myself how the silly market is doing, because I didn't gamble my house.

 

[Rich]

stephenandrew :

I wouldn't beat myself up too badly over this. I submit that you really can't make a "mistake" by paying off the mortgage early. As other posters have mentioned, living in a home that is debt free permits you to live with a whole new mindset.

Best of luck,

Rich