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If you are planning on option 1 and pay it off early , go see if you can get a 3 year arm at no cost for 3%, don't borrow the closing cost, you wont save enough over the 3 years versus the 3.25% . You're not going to save a lot of money, but it is free money you're leaving on the table.
I put my money in a tax deferred retirement account where I get 100 free trades a year and buy Verizon stock that pays around 4% in dividend. If I had to pay transaction fees. I wouldn't do it. At some point when I'm in a lower tax bracket, I'll put it out and pay the taxes on it. If I pull it out before retirement , I'll have to pay penalties too. Chances are even with a 25% penalty, if I'm pulling out of my IRA early, I'd be hurting so bad, that my taxes + penalties are lower than my current taxes today. Verizon is just an example.
It's a 10 year mortgage....It does include taxes...so......Good point.
after i pay off the mortgage in 3-4 years (given option 1), i won't have 5100 to work with....i'll have 4700 or so each month as about 400/month would still be needed for taxes.
Putting the numbers in the equation with the 4700 instead of the 5100, i get an even wash given the 6.5% return. (Both options are around 392k now)
sort of a game changer.....at least i can say that i need to give it more thoughts.
Pros with option 1:
- peace of mind after 3 years
- guaranteed 3.25% returns
- i may not be able to even get 6.5% return over the next 7 years
Pros with option 2:
- more liquidity in stocks/mutual funds (we currently have about 1.5 years of liquid cash but the extra will still be considered liquidity as far as i'm concerned....)
- i may get much more than 6.5% return over the next 7 years
- tax benefits of paying interest....reducing that 3.25% rate to around 2.9%
Thank you again pcity! Good thinking!
I think option #1 is best. A guaranteed 3.25% return is nothing to sneeze at. Who knows how long QE will last to prop up the stock market?
I had a colleague who was recently let go that made 6 figures before. He is single and in his mid 40s. He used to brag at work that he could pay off his home but chose not to in order to keep the tax deductions. Well we had lunch with him a few weeks ago and he looked kind of down. He sold some of his toys like motorcycles and he talked about selling his home. I suspect he is coming under financial distress. Which is odd since he used to talk about how much money he had. He's only been unemployed for two months now.
There is something to be said about having the peace of mind in living in a home with no mortgage. Not sure you can put a price on that.
I'd call you a fool if you stopped investing to pay your home off. Paying your mortgage off is something you do in addition to saving and investing HEAVILY.
If you are investing in your future, saving for any and all expenses, emergency fund funded, retirement maximized and have plenty to spare then yes, throw $ at the mortgage and rid your self from the psychological prison, but only after you've covered the prior.
I'm a fan of being debt free but paid for house and being broke is a bad idea.
I'd call you a fool if you stopped investing to pay your home off. Paying your mortgage off is something you do in addition to saving and investing HEAVILY.
If you are investing in your future, saving for any and all expenses, emergency fund funded, retirement maximized and have plenty to spare then yes, throw $ at the mortgage and rid your self from the psychological prison, but only after you've covered the prior.
I'm a fan of being debt free but paid for house and being broke is a bad idea.
Thanks. I'm maxing out 401k. 1.5 to 2 years of Emergency fund on hand. I also invest about 1k a month in S&P. no other debt aside from the mortgage. To diversify, i think option 1 is best.
The math is off from not properly accounting for taxes.
The tax deduction makes a much larger difference than $2,500 because it materially reduces the opportunity cost of capital on the mortgage. Otherwise you compare the pre-tax results of one option with the after-tax results of the other, over-/under-stating respectively.
This is hard to see when using absolute numbers ($X/month) because we don't know the breakdown of the payments and each component is discounted differently. With option two, you capture annual tax savings that can be compounded, so you have to adjust the monthly investment upward to reflect that. Likewise, with option one you forfeit these savings, so you have to adjust the post-mortgage contribution downward. These adjustments keep your after-tax disposable income (i.e. standard of living) equal between the two options, thus making it a more fair comparison.
Also consider that investments are taxed lower than ordinary income, so a bonus with option two is that you play both sides of the tax code - you gain ordinary savings from the deduction while only paying unearned rates on the investments. Without doing the complex math, you can probably assume 4-5% as a rough break-even investment return.
The math is off from not properly accounting for taxes.
The tax deduction makes a much larger difference than $2,500 because it materially reduces the opportunity cost of capital on the mortgage. Otherwise you compare the pre-tax results of one option with the after-tax results of the other, over-/under-stating respectively.
This is hard to see when using absolute numbers ($X/month) because we don't know the breakdown of the payments and each component is discounted differently. With option two, you capture annual tax savings that can be compounded, so you have to adjust the monthly investment upward to reflect that. Likewise, with option one you forfeit these savings, so you have to adjust the post-mortgage contribution downward. These adjustments keep your after-tax disposable income (i.e. standard of living) equal between the two options, thus making it a more fair comparison.
His loan balance and interest rate isn't high enough to really benefit from the tax savings anymore. If he is already itemizing and he is in the highest effective tax bracket (40%) then he might save $2500/yr for the next few years or $9200 over 7 years. It seems like a wash to me. I can't say for certain without more details from the OP.
Quote:
Originally Posted by celcius
Also consider that investments are taxed lower than ordinary income, so a bonus with option two is that you play both sides of the tax code - you gain ordinary savings from the deduction while only paying unearned rates on the investments. Without doing the complex math, you can probably assume 4-5% as a rough break-even investment return.
This almost seems like a wash as well. Real estate and equities both enjoy tax advantages.
It's not about the raw tax dollars saved. It's about the compounded returns on those tax savings. If it increases his yearly contribution by 10%, over 7 years that will add a material amount to the option two result.
The true cost of the mortgage is 3.25% x (1 - tax rate), so at a 25% bracket that is 2.44%. That's your real return from paying down the mortgage, and your hurdle for investment returns. When you discount option two against this lower figure it increases the resulting present value.
To your second point, it is definitely not a wash because only option two takes advantage of both RE and stocks' tax features. With option one you are forfeiting most of the benefit so there is no counter-advantage to wash against. If he's not renting out his house, the interest deduction is really the only RE advantage applicable here. By deducting at a higher rate and paying a lower rate, he can capture a 10% tax arbitrage opportunity on the difference in rates, which is effectively free money.
The math is off from not properly accounting for taxes.
The tax deduction makes a much larger difference than $2,500 because it materially reduces the opportunity cost of capital on the mortgage. Otherwise you compare the pre-tax results of one option with the after-tax results of the other, over-/under-stating respectively.
This is hard to see when using absolute numbers ($X/month) because we don't know the breakdown of the payments and each component is discounted differently. With option two, you capture annual tax savings that can be compounded, so you have to adjust the monthly investment upward to reflect that. Likewise, with option one you forfeit these savings, so you have to adjust the post-mortgage contribution downward. These adjustments keep your after-tax disposable income (i.e. standard of living) equal between the two options, thus making it a more fair comparison.
Also consider that investments are taxed lower than ordinary income, so a bonus with option two is that you play both sides of the tax code - you gain ordinary savings from the deduction while only paying unearned rates on the investments. Without doing the complex math, you can probably assume 4-5% as a rough break-even investment return.
Are you telling me it would be wise for a home owner with no mortgage to mortgage it so you can write off the taxes and invest the equity? That is really foolish. If the OP has extra money lying around, pay the damn thing off.
I'm sick of hearing the tax advantages of being in debt. Pay $15,000 in interest so you can save 33% or whatever the OPs tax bracket is stupid. I agree that if you are putting off regular investments and retirement to pay down the mortgage is a bad idea but we aren't talking about that.
Mortgages are also secured by an appreciating capital asset and have low premiums to prime rates. It's not just the tax savings, but the big picture, and the compounded return on those tax savings over the life of the mortgage (you must assume the yearly tax savings are invested).
What's foolish is saying "all debt is bad, period" and thinking finance matters are that black and white. This is why real estate investors, and other wealthy people, despite having plenty of cash still buy houses with mortgages. They're not stupid.
I'm not saying it's best for everyone. But at least understand a potentially smart option before you decide to forfeit it.
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