Should I sell Taxable TSM to pay off 15 year Mortgage?

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Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Wed May 22, 2013 10:36 am

reposting because somehow my post was lost or deleted. Sorry to anyone who had already responded. I did read 2 of the replys.

I was out to dinner the other night with friends who told me their house is paid for. That got me thinking… is the time right for me to pay off my mortgage? I expect to be in my house for another 7-10 years at least. So, of course, I consulted the wikis and forums in Bogleheads and found quite a few posts on the same topic with mixed advice. So, I am hoping to get some advice specific to my circumstances.

For background, last summer I improved my Investment Plan and implemented my new asset allocation with help and advice from Bogleheads, notably Retiredjg and Livesoft. If you want specifics you can look at my post from August 14, 2012 titled “Please review my new improved investment plan.” To briefly summarize, I am 49, I have adequate emergency funds, fully funding 401(k), my asset allocation is 70/30 with most bonds in tax-deferred accounts and broad based index funds in taxable. My mortgage is a 15 year mortgage (13 years remaining), principle is $183,000 at 4.25% interest (3.06% effective rate given my 28% tax bracket. The available funds to potentially pay off the mortgage are currently in a taxable account in Vanguard Total Stock Market Index Fund. The balance is currently $242,000. This account has increased in value a total of $42,000 since I invested the money last March-August 2012. The account is in my partner’s name, the LT capital gains would be 0% and the ST Capital gains tax would be 15%.

In other recent posts, notably "Pay down 2.75% 15 Year Mortgage vs Invest in Taxable Account" I see that livesoft recommended that OP keep his mortgage, invest the money until he made gains in the market to pay off the mortgage at some later date. Retiredjg recommended keeping the mortgage and redirecting the $350 per month for a new car fund or to build wealth. In my situation, which of the following options do you think is the best:

1. Keep existing mortgage & keep existing investment.
2. Sell $180,000 of the taxable fund and pay off the mortgage. Redirect the $1500 monthly payment back into Vanguard Total Stock Market Index Fund each month. Advantage: saves the interest, takes advantage of the $42,000 gain, dollar cost averaging for the monthly payment, eliminate the mortgage hassle & the escrow required for my current mortgage. Disadvantage: the investment might end up earning more if I keep it in TSM and the mortgage interest is my only significant income tax deduction.
3. Refinance existing mortgage. After a brief Internet investigation I could potentially get 2.625% 10 year fixed rate mortgage with no points or closing costs from Amerisave. I could certainly do more shopping around.

As always, I really appreciate the advice.
Thank you,
TaraBara
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby steve r » Wed May 22, 2013 11:08 am

Given your high six figure investments are aggressive (age - 20 in bonds) ... paying down you home makes (conservative) some sense.

That said, all at once moves are dicey. Perhaps a 7 arm (fixed for 7 years) and pay it off in 7 years (or 5 year ARM). Sort of a middle ground between paying now or 15 years. Such a product would allow you to play games with your cash reserve ... it could be smaller because under an emergency you could significantly reduce your loan payments. A 5 year arm would give you even better rates.

If you do pay off the house now, in my view you could raise your equity percentages a couple percentage points (not more than 5 percent - given you are reducing taxable investments by 3 or 4 times this amouont).
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby am » Wed May 22, 2013 12:22 pm

I payed my house off with taxable total market and international at about Dow 14000 and had about 40k of taxable long term gains. That being said, I am still very happy with the decision. Had the market tanked and lost the opportunity to pay off my house (mortgage was about 350k) I would have felt much worse.

My opinion is that you should pay off your house. While no one knows where the market is headed, I think it is frothy right now and artificially stimulated by fed policies. How would you feel if you lost the opportunity and the market tanked 40-50% and stayed there for years? The piece of mind of having no debt is priceless.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby inbox788 » Wed May 22, 2013 12:26 pm

Tarabara wrote: My mortgage is a 15 year mortgage (13 years remaining), principle is $183,000 at 4.25% interest (3.06% effective rate given my 28% tax bracket.
The account is in my partner’s name, the LT capital gains would be 0% and the ST Capital gains tax would be 15%.

Yes, refinance! Why haven't you lowered your interest rate to a 15 year 3%? Also, look into penfed 5/5 with 2.5% rate for 5 years and 30 year amortization. It effectively lowers your rate to under 2% saving you almost $2,000 a year for the next 5 years.

Separate matter but if you have 0% capital gains opportunity, seems like it would make sense to sell and rebuy back to raise your cost basis for free.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Investing is boring » Wed May 22, 2013 12:40 pm

1: What are the gains on each of your tax lots? If for example, you have 20% gains on $100k and 100% gains on the remainder, then it may make sense to apply the $100k against the mortgage as a one time payment.

2: Another way to think about this is to target paying the home off in 3 - 5 years. Do the calculation, and withdraw as necessary to supplement your income in accomplishing that goal.

3: Last, you could do what I would do. Pay off the house, and move the AA to a slightly more aggressive position to make it an Equities-neutral transaction (i.e. draw all money from bonds). Then spend the next few years building your bond allocation back up.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Bacchus01 » Wed May 22, 2013 1:30 pm

I would refinance. In a modest, conservative investment allocation you should be able to beat 2.625% CAGR over the next 10 years.

I might suggest you even take a bit more risk by taking out a 5/1 or 7/1 ARM. Invest the additional savings. If, after 5 years, the rate resets and you don't like the new rate, then simply pay it off.

I'm a big fan of having some liquidity and believe you'll return more than the 2% or so you can get on an ARM over that timeframe.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby C8H18Engineer » Wed May 22, 2013 1:43 pm

Another viewpoint is that the mortgage is giving you some cash-flow flexibility. If you were (heaven forbid) found between jobs in the next few years, I think you would rather be in a position of having liquid assets to pay the mortgage rather than a smaller portfolio from which to draw living expenses if the duration of the unemployment exhausted the emergency reserve.

I also agree with other posters - you should look at refinancing. I just locked in a 15 year at 2.75%. (oops typo... 2.75%)
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby bungalow10 » Wed May 22, 2013 1:52 pm

I'd pay half off, and the other half I'd refi to a Penfed 5-year HEL at 2.49%.

If you decide not to pay off the mortgage, at least refinance it. Rates are much lower now.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Wed May 22, 2013 1:52 pm

May I ask what lender you used for the 15 year 1.75%? That is a good deal!!
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Wed May 22, 2013 1:54 pm

Ahhh 2.75%, that is easier to achieve. If I do not pay it off, I will definately refinance. so, I have already narrowed my options from 3 to 2. thanks for the feebback so far!!
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Investing is boring » Wed May 22, 2013 1:56 pm

If you use Bond's to pay off the mortgage, you are trading a ~1.7% PRE TAX return on TBM for a ~2.75% PRE TAX return on a refinance.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Default User BR » Wed May 22, 2013 5:38 pm

I was at about your point last year, although lower home value and therefore remaining balance. Mine was difficult to do a standard refinance on, so I went with the Penfed home-equity loan (5-year at 1.99%). That rate isn't available anymore though.


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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Artsdoctor » Wed May 22, 2013 5:42 pm

Tara,

You can definitely do better on the mortgage. Compare current 5/1, 7/1, and 15 year loans. Then you can run the numbers. You can definitely scotch the idea of keeping the current mortgage.

For me, I appreciate flexibility. If you find that the 7/1 rate is competitive, you could figure out how much your monthly payment would be in order to pay off the the loan in 7 years (you would have your required monthly payment plus an added principle amount) but in the case of a temporary emergency, you can fall back on the required montly payment only. All the while, your equity fund will continue to hopefully appreciate (one would like to think that equities would perform better than a mortgage rate over 7 years but you can't be sure).

Others will like the emotional freedom of being debt-free.

I'm not sure there's a perfect answer here because it's your personal sense of priorities.

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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby sometimesinvestor » Wed May 22, 2013 8:13 pm

Surprised that no one else asked but if and only if your property taxes are not high and you don't have a high state tax and are not all that generous with regard to charity deductions then the major deductable advantage of the mortgage can be compared to the amount of the standard deduction and so paying off the mortgage could pay off.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Thu May 23, 2013 6:15 am

To answer questions above: My real estate taxes are not low, about 8,500. Charitable gifts at least 2-3 thousand. The mortgage interest is my major deduction.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Investing is boring » Thu May 23, 2013 8:12 am

Tarabara wrote:To answer questions above: My real estate taxes are not low, about 8,500. Charitable gifts at least 2-3 thousand. The mortgage interest is my major deduction.


$8,500 is VERY low for some parts of the country, like NJ. :)

Will say it one more time. If you have enough in bonds to close out the mortgage, then you are trading a ~1.7% pre-tax return for a pre-tax return of your mortgage rate. Even if you assume your tax bill will be 10% lower in retirement when you take the earnings on your bonds, paying off the mortgage is simply better.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Bacchus01 » Thu May 23, 2013 8:20 am

Investing is boring wrote:If you use Bond's to pay off the mortgage, you are trading a ~1.7% PRE TAX return on TBM for a ~2.75% PRE TAX return on a refinance.


He's not. OP clearly stated he was using TSM.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Investing is boring » Thu May 23, 2013 8:23 am

Bacchus01 wrote:
Investing is boring wrote:If you use Bond's to pay off the mortgage, you are trading a ~1.7% PRE TAX return on TBM for a ~2.75% PRE TAX return on a refinance.


He's not. OP clearly stated he was using TSM.



OP also clearly stated that they have a 70/30 portfolio. But that TSM is the taxable holding. You convert the bonds in tax-deferred to TSM, then sell the TSM in taxable to produce the cash. Net effect: you are paying the mortgage with bonds.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby bigred77 » Thu May 23, 2013 9:23 am

+1 for refinancing to penfeds 5/5 ARM at 2.5%, no points and no closing costs.

You can self amortize over the 5 years and if you don't like the reset rate you can simply pay it off then.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Thu May 23, 2013 11:54 am

Thanks for all the advice. Your responses prompted me to check into a few more details:

    I pay 3.07% State Income Tax and 1.35% Local tax
    Real estate tax was $7511 in 2012
    My mortgage interest deduction in 2012 was $8148 so if I pay off the mortgage, I will owe another $2281 in taxes.

I also checked the lots in my TSM and sadly more of it is Short Term than I thought. We would have to pay 15% income tax on $35,000 of it ($5250).

At a minimum, I will definitely refinance so option 1 is out. It appears that the other two options (pay off/refinance) are pretty good so it might come down to me just choosing. Today I am leaning towards refinancing and looking to pay it off later when the investment quailifies as long term. But I might still change my mind!!

Many of you recommend PenFed and quote very low rates. On their website I see:
HEL 60 months 2.49%, 61-120 month 3.99%
5/5 HELC 3.75%
5/5 ARM 2.75% APR

I do not see anything lower than that. As the previous poster said, the 5/5 ARM looks like best deal. Any others i should investigate?

Thanks,
TaraBara
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Grt2bOutdoors » Thu May 23, 2013 11:57 am

I don't like ARM's in a rising rate enviornment. If you do use a 5/5 option, make sure you have the funds to pay off in 5 years, otherwise you'll be rueing the day you refied from your current low rate.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby retiredjg » Fri May 24, 2013 12:02 pm

Tarabara wrote:The account is in my partner’s name, the LT capital gains would be 0% and the ST Capital gains tax would be 15%.

Maybe. Maybe not.

Your partner is in the 15% bracket now, but what bracket would these gains push him/her into? If the gains push your partner into the 25% bracket, all the gains above the line would be taxed at either 15% (long term) or 25% (short term).


What to do with the mortgage is one of those questions that generate A LOT of differing opinions. There is no consensus on what is "best". This likely means that it all comes out in the wash (long term difference won't be that much) and that your personal feeling about mortgage debt vs no debt should play a significant role in your decision.

Since you and your partner are not married under your state's laws, the protections for a surviving partner should also be considered. I actually doubt this is much of a factor if the house is jointly owned, but you should be sure.

The decision to pay off the mortgage is also one that doesn't have to be all or nothing. Refinancing has already been discussed (sort of a middle ground) and that's a good idea if you don't extend the years back to the point that you end up paying more in the long run. Another middle ground is to accelerate your payments by paying extra on the principal each month. Or refinance and pay some extra each month.

I think any decision or combination of decisions you make here is likely to be fine. It seems like there are no bad choices. Do what makes you and your partner feel good.

I would be cautious of ARM's in what could be a rising rate environment. On the other hand, you do have the funds to just pay it off in 5 years if the rates go up enough to be undesirable. In the meantime, you might be able to pay an extra low rate for that 5 years and save a little more.
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Re: Should I sell Taxable TSM to pay off 15 year Mortgage?

Postby Tarabara » Fri May 24, 2013 2:20 pm

Thank you so much retiredjg. Thanks for pointing out that the gains would likely push partner into another tax bracket, I didn't even think of that. I think in our case the refinancing is looking like very good option, and we can always decide to pay it off sooner by making additional payments or paying off completely as some later date.
Thanks all!!
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