pay down 1.99% mortgage?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

pay down 1.99% mortgage?

Post by gips »

Hi,

We refinanced our 4.25%, 10 year mortgage with a %1.99 five year fixed penfed hel. our balance is around $175k. we have enough cash to pay off the mortgage and I'm maxing out my pre-tax investments. We have no other debt.

On one hand, it's tough to find a risk-free investment paying 1.99% (after tax I guess) which guides me towards paying off my mortgage. On the other hand, though I can't predict interest rates, given we're at historic lows, it seems a good bet rates will increase over the next 10 years. Finally, an economist would say that today's dollars, due to inflation, are more valuable than dollars 10 years from now...which also argues for slowing down payments.

tia

edited: fixed penfed loan details
Last edited by gips on Mon May 13, 2013 10:27 pm, edited 1 time in total.
Twins Fan
Posts: 2775
Joined: Fri Mar 08, 2013 12:02 pm

Re: pay down 1.99% mortgage?

Post by Twins Fan »

Good job getting it down to a 1.99% heloc!!

And, well, you pretty much nailed it. You will get different schools of thought on this subject.

The "numbers" folks will say you should not pay it down early and invest any extra cash instead. Because of the inflation part, as you mentioned. And, because investing will likely give you better/higher return than 1.99%. Although, that is investing in more risky assets than I believe you're thinking about.

The "peace of mind" folks will say pay it off because it feels great to not have a mortgage.

You say you have enough cash to pay it off now. As in, you have $175K or more right now? Why did you take out the heloc? Seems you're on the fence about being a "numbers" person or a "peace of mind" person? :D
swaption
Posts: 1245
Joined: Tue Jul 29, 2008 11:48 am

Re: pay down 1.99% mortgage?

Post by swaption »

I Bonds much better. Risk free, tax deferred, tax free for education, expected return at your horizon higher, and put option at par if interest rates go up so you can invest in something else.
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

- it's a home equity loan, not a heloc.
- I don't really think of it as numbers vs. peace of mind schools of thought. I think of it as bankers vs. economists. A banker will tell you to pay it off early and not pay interest. An economist will tell you that today's dollars are much more valuable than tomorrow's, so pay it off later (as late as possible).
- I generally subscribe to the banker's view, but today's historically low interest rates have given me pause to reconsider my strategy.

- not sure why I Bonds are better. Current rate is %1.18. Wouldn't the return have to be around 4% given my fed tax rate is around 40%?
User avatar
Watty
Posts: 28859
Joined: Wed Oct 10, 2007 3:55 pm

Re: pay down 1.99% mortgage?

Post by Watty »

If you had a paid of house would you take out a home equity loan just to invest it?
User avatar
G-Money
Posts: 2867
Joined: Sun Dec 09, 2007 6:12 am

Re: pay down 1.99% mortgage?

Post by G-Money »

gips,

Welcome to the forum!

Are you sure you have your numbers right? PenFed had 2 loans with a 1.99% rate. One was a 5 year HEL, the other was a HELOC with an introductory rate of 1.99%. PenFed also had a 10 year HEL at 2.99%. You indicated your rate is 1.99%, but also noted you'll have it paid off in 7 years by paying extra toward principal. Are you sure your loan is fixed at 1.99% for > 5 years?

Assuming it is, then I wouldn't pay it down early. Vanguard's long-term tax exempt fund has a duration of 6+ years and a yield of 2.17% with relatively credit risk. This beats the 1.99% rate. And if you can deduct any portion of the HEL (which you usually can when you refi a purchase money mortgage), your margin would be even bigger.
Don't assume I know what I'm talking about.
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

Watty wrote:If you had a paid of house would you take out a home equity loan just to invest it?
that's precisely what I'm trying to figure out! :sharebeer
Twins Fan
Posts: 2775
Joined: Fri Mar 08, 2013 12:02 pm

Re: pay down 1.99% mortgage?

Post by Twins Fan »

gips wrote:- it's a home equity loan, not a heloc.
- I don't really think of it as numbers vs. peace of mind schools of thought. I think of it as bankers vs. economists. A banker will tell you to pay it off early and not pay interest. An economist will tell you that today's dollars are much more valuable than tomorrow's, so pay it off later (as late as possible).
- I generally subscribe to the banker's view, but today's historically low interest rates have given me pause to reconsider my strategy.

- not sure why I Bonds are better. Current rate is %1.18. Wouldn't the return have to be around 4% given my fed tax rate is around 40%?
Oops, my bad there.

If you have the bankers view, I go back to the question of why did you take out the home equity loan if you had the cash to pay off the mortgage? Or, why were you sitting on a 4.25% mortgage if you don't believe in paying interest?

What options are you thinking of with any cash you don't throw at the mortgage/helo? It doesn't sound like you are wanting to take any risk since you mentioned "risk-free" earlier. If you're not willing to take risk investing the extra cash and only looking at risk-free options, I'd say pay it down or off is the better choice.

Are you able to deduct the interest paid yearly on the mortgage? If so, at a 40% tax rate you have an effective interest rate of about 1.20% on the mortgage... to confound things more. :happy
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

G-Money wrote:gips,

Welcome to the forum!

Are you sure you have your numbers right? PenFed had 2 loans with a 1.99% rate. One was a 5 year HEL, the other was a HELOC with an introductory rate of 1.99%. PenFed also had a 10 year HEL at 2.99%. You indicated your rate is 1.99%, but also noted you'll have it paid off in 7 years by paying extra toward principal. Are you sure your loan is fixed at 1.99% for > 5 years?

Assuming it is, then I wouldn't pay it down early. Vanguard's long-term tax exempt fund has a duration of 6+ years and a yield of 2.17% with relatively credit risk. This beats the 1.99% rate. And if you can deduct any portion of the HEL (which you usually can when you refi a purchase money mortgage), your margin would be even bigger.
ouch, I conflated my last loan and this loan! you're absolutely right, it's a five year HEL, fixed at 1.99% for five years. I'd think a bond fund with an average duration of 6+ years is going to suffer decent principal loss if interest rates rise say 2-3%...which seems entirely possible. no?

twins fan, I accumulated the cash to pay off the loan after I refinanced. Had a very good year last year. so now I'm in a position to pay it off.
Last edited by gips on Mon May 13, 2013 9:39 pm, edited 1 time in total.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: pay down 1.99% mortgage?

Post by grabiner »

gips wrote:ouch, I conflated my last loan and this loan! you're absolutely right, it's a five year HEL, fixed at 1.99% for five years.
Paying it down is an investment with a 5-year duration, as any remaining balance after five years will be refinanced at the current market rate.

Therefore, the fair comparison is a bond fund with a 5-year duration; you could pay down the loan now, or invest in a 5-year bond and then use the bond proceeds to pay down the loan when it resets. (If you hold a 5-year bond to maturity, you don't care what happens to interest rates over those 5 years.)

Admiral shares of Intermediate-Term Tax-Exempt are yielding 1.62%, so if your mortgage is fully deductible in a 25% tax bracket, the bond investment comes out slightly ahead. It isn't risk-free, though, so either paying down the loan or investing is a reasonable decision.
Wiki David Grabiner
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

grabiner wrote:
gips wrote:ouch, I conflated my last loan and this loan! you're absolutely right, it's a five year HEL, fixed at 1.99% for five years.
Paying it down is an investment with a 5-year duration, as any remaining balance after five years will be refinanced at the current market rate.

Therefore, the fair comparison is a bond fund with a 5-year duration.
Is that correct? I'd think a bond fund with a a 5-year duration would maintain a five year duration whereas my timeline would get smaller and smaller. no?
Last edited by gips on Mon May 13, 2013 9:44 pm, edited 1 time in total.
khh
Posts: 343
Joined: Sat Dec 27, 2008 9:31 pm

Re: pay down 1.99% mortgage?

Post by khh »

How about a middle course. Pay $1000 extra per month, for example. Or pay the entire balance in, say, 3 years.
bsteiner
Posts: 9208
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: pay down 1.99% mortgage?

Post by bsteiner »

If the interest is deductible, and if you can use the deduction against ordinary income, there's a tax arbitrage to the extent you can invest for qualified dividends, long-term capital gain and tax-exempt income.

Keeping the loan and the assets protects against the possibility that you'll need to access the assets at a time when you can't otherwise borrow the money.

You may be able to mitigate the investment risk to some degree by investing the money more conservatively than you otherwise would.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: pay down 1.99% mortgage?

Post by grabiner »

gips wrote:
grabiner wrote:
gips wrote:ouch, I conflated my last loan and this loan! you're absolutely right, it's a five year HEL, fixed at 1.99% for five years.
Paying it down is an investment with a 5-year duration, as any remaining balance after five years will be refinanced at the current market rate.

Therefore, the fair comparison is a bond fund with a 5-year duration.
Is that correct? I'd think a bond fund with a a 5-year duration would maintain a five year duration whereas my timeline would get smaller and smaller. no?
Yes. The 5-year duration is the correct comparison now; when you are three years from the reset, you would compare to a bond fund with a 3-year duration in deciding whether to pay down the loan at that time. You don't actually need to hold a bond fund with a 5-year duration, just to recognize that this is the risk-equivalent comparison. If you hold this mortgage and a long-term bond fund, you are taking on some extra risk, which may still be a good idea because you also get a higher return.

It's easier to see the situation if you bought an individual 5-year zero-coupon bond, which has a 5-year duration; the bond could be used to pay down the loan at maturity, and if the bond return is higher than the loan interest, you would come out ahead compared to paying down the loan now.
Wiki David Grabiner
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

grabiner wrote: Yes. The 5-year duration is the correct comparison now; when you are three years from the reset, you would compare to a bond fund with a 3-year duration in deciding whether to pay down the loan at that time. You don't actually need to hold a bond fund with a 5-year duration, just to recognize that this is the risk-equivalent comparison. If you hold this mortgage and a long-term bond fund, you are taking on some extra risk, which may still be a good idea because you also get a higher return.

It's easier to see the situation if you bought an individual 5-year zero-coupon bond, which has a 5-year duration; the bond could be used to pay down the loan at maturity, and if the bond return is higher than the loan interest, you would come out ahead compared to paying down the loan now.
while I agree the 5-year duration is the correct comparison now, I don't think the suggestion of investing in a bond fund with a five year duration is correct since the fund manager is probably trying to maintain the duration. I'd agree, an individual 5-year bond could provide an arbitrage opportunity but finding a risk free (since paying off my loan is risk free) investment which pays more than 1.99% is the problem.
Scooter57
Posts: 2019
Joined: Thu Jan 24, 2013 8:20 am

Re: pay down 1.99% mortgage?

Post by Scooter57 »

G-Money wrote:gips,

Vanguard's long-term tax exempt fund has a duration of 6+ years and a yield of 2.17% with relatively credit risk. This beats the 1.99% rate. And if you can deduct any portion of the HEL (which you usually can when you refi a purchase money mortgage), your margin would be even bigger.
If rates rose only 2% your bond fund would lose 12% of its value and it could take longer than the duration to recover and if they kept rising it would continue to lose principal. This is a situation where you would do much better buying an actual bond with a redemption date rather than a fund. No one really knows how bond funds will behave if rates revert to their norm. My last long bond fund was paying me rates of 6%, 7%, and more not all that long ago.
Twins Fan
Posts: 2775
Joined: Fri Mar 08, 2013 12:02 pm

Re: pay down 1.99% mortgage?

Post by Twins Fan »

gips wrote:ouch, I conflated my last loan and this loan! you're absolutely right, it's a five year HEL, fixed at 1.99% for five years. I'd think a bond fund with an average duration of 6+ years is going to suffer decent principal loss if interest rates rise say 2-3%...which seems entirely possible. no?

twins fan, I accumulated the cash to pay off the loan after I refinanced. Had a very good year last year. so now I'm in a position to pay it off.
Ah, ok gotcha.

And, correct about the bond fund. That could happen, and if you read around on the forum you will see plenty of threads that say it should/would/could happen at any moment. Will that happen, or is it nothing to worry about? None of us in here know.

If we are talking "risk-free" options here, shouldn't we be talking about whether to use this chunk of cash to pay off the mortgage now vs. putting the chunk of cash in a 5 year CD and which will be the better deal 5 years from now? I have seen posts about 5 year CDs out there around 2% now, so that may be available out there. Even if we are talking about an effective interest rate around 1.20% compared to a 2% CD, is that worth it?

Wouldn't be to me. But, I'm not the eek out every penny type and I'm the "banker" or "peace of mind" type also. Unfortunately I nowhere near being in a position to pay off my mortgage. :(

Now, if we're talking about investing this chunk of cash in equities for a long time and expected returns... different story. But, a 5 year timeline and safe to risk-free options... I'd say it's not even worth the effort for a banker type to figure out the difference. Pay off the mortgage. JMHO
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

twins fan, for many years I held a deep belief that investments in broad US equity indices would conservatively yield 6%. 7 to 10 years ago that's where the money would have gone. While I've ridden out every market downturn and resisted market timing, I'm no longer convinced future returns are so rosy. With our conversion to a service economy followed by the rise of outsourcing and the asian economies, it seems to me structural changes are afoot in the US economy.
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: pay down 1.99% mortgage?

Post by Default User BR »

gips wrote: We refinanced our 4.25%, 10 year mortgage with a %1.99 five year fixed penfed hel. our balance is around $175k.
I took out one of those on a paid-off house last year, so what do you think I'll say?


Brian
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: pay down 1.99% mortgage?

Post by Default User BR »

Watty wrote:If you had a paid of house would you take out a home equity loan just to invest it?
I know I would. See above. After tax deductions, I'm paying closer to 1.5%. I could get 2.3% in stable-value if I wanted to be super conservative, but I just threw it into the general investment pool.


Brian
fareastwarriors
Posts: 1405
Joined: Tue Feb 14, 2012 11:31 am

Re: pay down 1.99% mortgage?

Post by fareastwarriors »

Default User BR wrote:
Watty wrote:If you had a paid of house would you take out a home equity loan just to invest it?
I know I would. See above. After tax deductions, I'm paying closer to 1.5%. I could get 2.3% in stable-value if I wanted to be super conservative, but I just threw it into the general investment pool.


Brian
I would too. Never afraid of a bit of debt. I actually took subsidized student loans when I was in college just to fund my Roth IRA. I started that IRA in Dec 2008 so definitely no regrets with the timing of course.

It really depends on what type of person you are. Some prefer to be debt-free if possible and others don't mind some debt and rather of the options of cash on hand.
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: pay down 1.99% mortgage?

Post by Default User BR »

By the way, if anyone is thinking of taking one out, it should be noted that the 1.99% rate is history these days. The best you can do from PenFed is 2.49%.


Brian
User avatar
G-Money
Posts: 2867
Joined: Sun Dec 09, 2007 6:12 am

Re: pay down 1.99% mortgage?

Post by G-Money »

Default User BR wrote:By the way, if anyone is thinking of taking one out, it should be noted that the 1.99% rate is history these days. The best you can do from PenFed is 2.49%.
Looks like the <2% rates on PenFed's used auto loans is gone, too, unless you have a 2012 or 2013 vehicle.
Don't assume I know what I'm talking about.
assumer
Posts: 432
Joined: Fri Dec 21, 2012 10:11 pm

Re: pay down 1.99% mortgage?

Post by assumer »

This page may be of interest to you:

Wiki - Paying down loans versus investing
rkhusky
Posts: 17763
Joined: Thu Aug 18, 2011 8:09 pm

Re: pay down 1.99% mortgage?

Post by rkhusky »

Default User BR wrote:By the way, if anyone is thinking of taking one out, it should be noted that the 1.99% rate is history these days. The best you can do from PenFed is 2.49%.


Brian
Glad I got mine a couple months ago. :happy The difference in interest calculation between the HEL and a mortgage threw me for a few days.
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: pay down 1.99% mortgage?

Post by Default User BR »

G-Money wrote:
Default User BR wrote:By the way, if anyone is thinking of taking one out, it should be noted that the 1.99% rate is history these days. The best you can do from PenFed is 2.49%.
Looks like the <2% rates on PenFed's used auto loans is gone, too, unless you have a 2012 or 2013 vehicle.
So they have. Good to know, as I will not recommend that people refinance auto loans unless they have very new ones.


Brian
inbox788
Posts: 8372
Joined: Thu Mar 15, 2012 5:24 pm

Re: pay down 1.99% mortgage?

Post by inbox788 »

gips wrote:
Watty wrote:If you had a paid of house would you take out a home equity loan just to invest it?
that's precisely what I'm trying to figure out! :sharebeer
I tried to take out a 1.99% Penfed HEL last year, but things dragged out and fell through. I was considering investing in foreclosure property, but glad I didn't get involved. Might have made some money, but there is risk and complications, with problems to solve. Alternatively, I would have paid down my primary mortgage, and knocked down the rate about half a percent, but accelerated minimum payments. I probably could have saved about $1k the first year and $2-3k in 5 years, but cash flow would have been tight, requiring liquidating equities. Since the market has been up, it probably turned out to be a wash.

Those suggesting bond investments (taxable!) returning less than 2% would wind up paying to borrow, so I wouldn't do that. If you're going to invest, have to take more risk to make it worthwhile, like high yield equities? But there's chance it could lose money too. Even bonds can go down if/when rates go up if you're too far out. In any case, I don't see short term rates going up till 2015-6 so by then, the balance on the principal would be half. Similarly, loan funds remaining would likely be about half as well. Was looking at CD rates, and they're not much more than 1%, maybe 1.5% for 5 years, and taxable. So you're paying for the liquidity that you most likely won't use.

So, what's your cash flow? What's your expected average return on equities in the next 5 years? For every 1% greater than about 1.5% (assuming tax deductible interest), you'll make an extra $1k/year (minus tax). Of course you could lose money too, so that's the risk you take. So it's worth it if you can handle the risk and want it. As long as you apply the monthly payment to the investment or invest it all at once, since it's being averaged out over 5 years, the total will be about half, and the overall difference may not be that dramatic, depending on how market performs.
Topic Author
gips
Posts: 1760
Joined: Mon May 13, 2013 5:42 pm

Re: pay down 1.99% mortgage?

Post by gips »

I've decided to continue to pay off the loan over the next five years rather than pay it off now. My reasoning is:

- I'll probably have a small loss over the next year or two but interest rates will probably go up giving me an opportunity for a gain.
- there's an opportunity cost if I pay off the loan now. Perhaps I'll decide to invest the money in real estate or equities
- today's dollars are worth more than tomorrow's

thanks for the analysis.
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: pay down 1.99% mortgage?

Post by Default User BR »

inbox788 wrote:I tried to take out a 1.99% Penfed HEL last year, but things dragged out and fell through.
How did it fall through? Things were slow last year, but most I heard about eventually finished. Mine took about five months, but some of that was my fault.


Brian
inbox788
Posts: 8372
Joined: Thu Mar 15, 2012 5:24 pm

Re: pay down 1.99% mortgage?

Post by inbox788 »

Default User BR wrote:
inbox788 wrote:I tried to take out a 1.99% Penfed HEL last year, but things dragged out and fell through.
How did it fall through? Things were slow last year, but most I heard about eventually finished. Mine took about five months, but some of that was my fault.


Brian
I'm sure I'm partly at fault, but basically, they provided no followup. They never called me. I was always calling them. I had to get on their case at every step. After the online application, I'd be notified that something was missing, but not specific, and I had to talk to agent to figure it out. Sometimes they had it, but in the wrong department. Others were lost and resubmitted. Other times i was never notified, and the only reason i found out something was wrong was checking online and seeing a change in my application status or by calling for an update. It took several rounds before they got what they needed and got to a processor. Then it sat for a month or two, by then it was about 5 months. After a couple of conversations with the processor, and the application was approved, I gave the go ahead, but while I was waiting for the next step, another month or two passes. They say they needed something I never heard about. At this point, some deadline had passed and I had to begin by starting all over with a new application. They said some documentation might be reused, but earning statements and other things would need to be submitted again.

Concurrently, the properties I was looking at were sold and the local foreclosure market shrank and deals were no longer as attractive. I was fed up and gave up at this point.
rkhusky
Posts: 17763
Joined: Thu Aug 18, 2011 8:09 pm

Re: pay down 1.99% mortgage?

Post by rkhusky »

Default User BR wrote:
inbox788 wrote:I tried to take out a 1.99% Penfed HEL last year, but things dragged out and fell through.
How did it fall through? Things were slow last year, but most I heard about eventually finished. Mine took about five months, but some of that was my fault.


Brian
We had a HEL fall through a year or so ago due to the appraisal coming in much lower than we expected, meaning that the amount we could borrow was insufficient to warrant going through with it. We squandered time trying to poke holes in the appraisal, without realizing PenFed was very unlikely to adjust their offer.
Post Reply