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I notice a lot of people have paid off their mortgages ... and, normally I would think it would be a great thing since people say it's key for a comfortable retirement. But I have doubts about it and I would like some input to see if I'm missing something that I haven't thought of.
First of all ... our payment is pretty low, especially by Calfironia standards ... only $1200 a month including insurance and taxes (the mortgage payment itself is $900). And the interest rate is fixed so, no issues there. We only paid $155K for the house and, when we retire in 20 years at age 65 ... we'll owe about $60K on it at that point with our current 30 year amortization schedule.
The interest rate is only 5.875 percent so ... I'm not sure I'd save that much money by it paying down. Especially since here's the kicker ...
We're in a high tax bracket ... nearly 35 percent when you include state and federal taxes between the two of us. So I'm thinking we should be putting as much money as possible in our 401Ks. We are government employees with 457 plans also so, between the two of us we could put away up to $60K a year tax deferred between the two of us.
I'm thinking it would be much better to put that 35 percent of tax money into the retirement accounts and invest it over the next 20 years ... rather than paying down the mortgage after 35 percent is deducted for tax ... only to save 5.875 percent.
It's just that when I run different investment scenarios with the 401K plans, etc. ... even with conservative investments ... being able to invest the tax money over 20 years makes the retirement accounts grow so much faster ...
So I'm not inclined to pay down the mortgage but ... I'm wondering if there's something else I haven't thought of.
I know that paying down the mortgage brings a lot of peace of mind but, I also want to make the best financial decisions so ... any input would be appreciated.
I agree that you do not want to pay off that loan. When you consider the tax breaks the effective rate is below 5% and your money will earn more than that.
Put your loan data into a spreadsheet and do the math to tally up the actual interest you will be paying month by month. Add a column for the actual tax deduction you get on the interest you are paying. Then another column subtracting the tax deduction amount from the interest paid amount. Do the same for the investments but don't forget to subtract out all the fees you pay. Run these out to your retirement date or even to the planned for end of lifetime. At the bottom, tally up the interest paid and the interest/dividends earned.
Then run different scenarios, including a bear market for several years like we just had. This way, you can actually see in real dollars which would be more advantageous for your situation.
You can talk theory up one pole and down another and still not see what you will really have. Putting it in concrete numbers lets you do apple to apple comparisons in something we all can understand - real dollars in hand. You can find all the math you need and even some sample spreadsheets by searching the web.
If the numbers work out, there is always the option of paying down the loan at the end when you get little tax deduction anyway.
Another advantage to NOT paying it off, is that the $1200 a month that you send to the mortgage company has less and less buying power each month becasue of inflation. $1200 today is likely to buy the most it will ever buy. Next year it will buy less, 10 years from now...much less. I think we all know that the real inflation % is significantly higher than the official government number, that doesn't include most of the things that we actually buy. It makes no sense to pay it off with todays dollars. The interest you would save probably pales in comparison to the loss of buying power via inflation. Let the mortgage company take the inflationary hit. They can afford it much better than most of us. Like Tesage wrote, you might want to run the numbers to get a clearer picture.
blessings....Franco
Last edited by CosmicWizard; 11-19-2007 at 12:55 PM..
Then run different scenarios, including a bear market for several years like we just had. This way, you can actually see in real dollars which would be more advantageous for your situation.
You can talk theory up one pole and down another and still not see what you will really have.
True but, isn't trying to predict the length and duration of bear markets also theory? Not much precision there either.
I don't have 401K money in stocks right now ... I put it in bond funds because I figured the market was gonna tank. I'll get back into stocks when it looks like we've finally hit bottom.
Granted, right now the bonds aren't paying much ... about 6 percent. But at least I'm not losing money on stocks. And, even with that low rate of return you still do better than paying down the mortgage.
To use a simple example ...
$10000 before tax at 6 percent earns you $600 of investment income.
$10000 after tax nets $6500 to pay down the mortgage ... and saves me only $325 in mortgage interest (my real interest rate with the tax deduction is about 5 percent)
So even with low yielding bonds in the bad years, you're still ahead by nearly 3 percent because you're at least earning some investment income on those tax dollars.
Of course, when the market comes back, the differences would be substantially greater in the good years. At 12 percent ... I'd be earning nearly 9 percent more on my money than I'd save by paying down the mortgage.
Pre tax investment income: $1200
After tax mortgage savings: $325
With $10,000 that's an extra $875 ... or an 8.75 percent rate of return.
But, again, if I'm missing something ... let me know.
I recently did the spreadsheet analysis and it became very clear that I am better off not paying off my mortgage. Even in a credit union money market account I am earning more in taxable interest income than I am paying in deductible mortgage interest. I have a 15 year very-low-interest fixed rate mortgage and the market value of my home is five-to-six times my mortgage balance, so I feel pretty secure. I simply don't believe the interest I earn is ever going to be less than what I pay on this mortgage.
Of course I remember years ago when my mortgage was 11.5% and I paid it off quickly, then started investing, and it worked out very well indeed.
That said, I am selling my home anyway, and will buy something just as nice but smaller, and without a mortgage, NOT because I want to pay off the mortgage, but because I really want to relocate.
I recently did the spreadsheet analysis and it became very clear that I am better off not paying off my mortgage. Even in a credit union money market account I am earning more in taxable interest income than I am paying in deductible mortgage interest. I have a 15 year very-low-interest fixed rate mortgage and the market value of my home is five-to-six times my mortgage balance, so I feel pretty secure. I simply don't believe the interest I earn is ever going to be less than what I pay on this mortgage.
Of course I remember years ago when my mortgage was 11.5% and I paid it off quickly, then started investing, and it worked out very well indeed.
That said, I am selling my home anyway, and will buy something just as nice but smaller, and without a mortgage, NOT because I want to pay off the mortgage, but because I really want to relocate.
You reach a point where that security becomes important. We are like you retiring to the Triangle and will have no mortgage. We could have done it differently but we will be comfortably retired with other investments intact. With the threats of inflation and illness tentatively covered by other investments there is a security in knowing that if something happens to me my wife is good and financially will not miss a beat.
What is always missing in the math calculations that will be revealed in actually calculating it in a spreadsheet with ALL the costs factored in and that none of the subsequent posts took into account is the tax hit on your interest earned or the fees you pay in almost every investment vehicle. These are real dollars spent.
I'm not saying that it always pays to pay down your mortgage - just that if you don't do the numbers so that every step is actually understandable to you (the beauty of doing it month by month in the spreadsheet), you are making assumptions or missing costs that are going out of your pocket or comparing apples to oranges. I was amazed when I put my numbers into the spreadsheet. For me, it was more advantageous over the last 7 or so years. It also fits my overall life plan and is one of the keystones to a soon to be comfortable and secure retirement. Your mileage may vary.
Look carefully at bonds. I did the numbers on my bond fund over the last 7 years and found out it was actually increasing by less than 1% in real dollars over all that time. And this was when bonds were supposedly doing well. My actual dollars earned in 7 years came no where near the reported return. Heck a passbook account does better than that over that time period. Needless to say, I dumped that fund.
Also, I have a S&P500 indexed fund that I unfortunately bought in 2000. It has taken until last summer to finally break even in real dollars despite the market index actually being higher than it was when I bought it. You just don't have a realistic grasp until you put all the costs and earnings side by side to see what the real dollar increase is. All the rest of it seems to me to just be smoke and mirrors to get you to buy into something.
My rule of thumb is: If I can't understand how they arrive at the numbers, then it is probably bogus. After all, it really is just simple arithmetic. Dollars in and dollars out.
What is the Triangle? Are you talking about North Carolina?
The Triangle area of North Carolina is the area around Research Triangle Park, namely Raleigh, Durham, and Cary, maybe even including Chapel Hill and Wake Forest.
In contrast with the Triad area of North Carolina which is the area of Greensboro-High Point-Winston-Salem. Also referred to as the Piedmont Triad.
For me, a great place to retire to ( no income tax on state or federal retirement ) and a good quality of life ( very modest cost of living compared with the DC area ).
And, by the way, I did include in my spreadsheet income tax on interest income and additional income tax due to no mortgage interest deduction.
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I agree
