Quote:
Originally Posted by LoriBee62
Scenario: A couple is 55 with the goal of retiring in 10 years at 65. Currently paying $1,500 a month mortgage on a single family home with no HOA. Interest rate is 3.75% They have excess cash to work with each year. Should they:
1) Put that cash toward their mortgage with the goal of paying it off completely by the time they retire.
2) Put that cash in investment accounts while making the regular mortgage payments and then, the year they are planning to retire, refinance the balance of the mortgage back out to 30 years (assume the same or better interest rate), reducing their mortgage from $1500 a month to $500 a month.
3) Put that cash in investment accounts, leave their mortgage alone and continue paying $1,500 a month mortgage for the first 10 years of their retirement. The house would be paid off when they turn 75.
My husband likes #1. But I think there are tax benefits to #2, particularly if the excess cash we would have spent paying down the mortgage went into a Roth IRA.
Thoughts?
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Hi Lori,
Financial analyst here, and I explicitly don't give financial advice on boards like this.
I will tell you some broad truths about a hypothetical person in that scenario.
Option 1 is a great option. If the person is using standardized deductions, option 1 is probably the best goal.
Option 2 is survivable, but I would suggest extreme caution in believing that in 10 years interest rates will be anywhere near their current historic lows. History suggests that in 10 years that couple will see significantly higher interest rates and might not save near as much as they had planned.
Option 3 is much safer than option 2. If someone was going to pick anything other than option 1 they should pick option 3 with their eyes wide open and keep option 2 in their back pocket so they could reassess their plans in 5 years and again in 10 years to determine which was better at that top. Since rates might go up, option 3 must be the default over option 2.
The reason option1 is superior if the person is using standardized deductions is that 3.75% is substantially higher than the risk free rate. If the person uses standardized deductions, there is no benefit to the mortgage interest. Your scenario suggests a roth IRA, so I assume the hypothetical person would be taxed on earned income but not taxed on interest income since it would be a tax advantaged account. By investing the money in anything except for government bonds (U.S. government, don't get cute with emerging market sovereign debt), the excess return is simply payment for the risk borne. Since the other investors may be comparing interest on those securities to the risk free rate, rather than to your mortgage rate, they have more to gain by taking the risk than your hypothetical couple. Therefore, the couple is getting less return for their risk. 10 years is not a long enough period to assume the geometric mean of markets averaging over 8% per year. There would be potential for significant loss.
The hypothetical couple may want to speak to a CFP. Note: This would be a fee only financial planner, not one that is paid commission to convince them to purchase certain products through the financial planner.