Pay off that Mortgage?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
john94549
Posts: 4638
Joined: Tue Jul 26, 2011 8:50 pm

Pay off that Mortgage?

Post by john94549 » Wed Aug 13, 2014 8:16 pm

Assume one has a 3.4%/30 year with 28 years or so to run. Funds are available to either (a) pay off, or (b) invest. One investing option is a 3.3%/10 year CD. Thoughts? Disregard Garn-StGermain, as it's a tad too esoteric.

The mere 10 bp difference over the first ten years makes me reluctant to surrender this mortgage.

Twins Fan
Posts: 2775
Joined: Fri Mar 08, 2013 1:02 pm

Re: Pay off that Mortgage?

Post by Twins Fan » Wed Aug 13, 2014 8:38 pm

Is that the only investment option?

I would look at it the other way. If I were to hold onto a debt having the money to pay it off, but invested the money instead it better give me quite a kicker over the debt interest rate. Nearly identical interest rates for me would be an easy pay off the debt call. Just me though..
Last edited by Twins Fan on Wed Aug 13, 2014 8:42 pm, edited 1 time in total.

bhsince87
Posts: 1415
Joined: Thu Oct 03, 2013 1:08 pm

Re: Pay off that Mortgage?

Post by bhsince87 » Wed Aug 13, 2014 8:42 pm

How old is the mortgage holder? If young (ish), I'd keep the mortgage and invest the funds.
BH87

User avatar
Watty
Posts: 11800
Joined: Wed Oct 10, 2007 3:55 pm

Re: Pay off that Mortgage?

Post by Watty » Wed Aug 13, 2014 8:45 pm

john94549 wrote:Assume one has a 3.4%/30 year with 28 years or so to run. Funds are available to either (a) pay off, or (b) invest. One investing option is a 3.3%/10 year CD. Thoughts? Disregard Garn-StGermain, as it's a tad too esoteric.

The mere 10 bp difference over the first ten years makes me reluctant to surrender this mortgage.


Two problems with that are;

1) What if you decide to move within ten years?

2) The CD will almost cover the interest but each month you will also need come up with extra cash to pay the principle as well.


There is no one right answer so it really depends on the rest of your situation. There is a Wiki on this;

http://www.bogleheads.org/wiki/Paying_d ... _investing

Personally I would ask myself these questions.

1) If you had a paid off house, would you take out a mortgage to invest the money?

2) Would you have to sell stocks or bonds to pay off the mortgage and would that mean you would have to pay capital gains taxes on the sale?

3) Would that put more than a third, or even a quarter of your net worth in the home? If so that might be a diversification issue.

4) A good case can be made that more often than not you will earn more investing the money, but it always adds the risk that things will turn out badly. Do you really have any need to take additional risk?

Quickfoot
Posts: 955
Joined: Fri Jan 11, 2013 1:03 pm

Re: Pay off that Mortgage?

Post by Quickfoot » Wed Aug 13, 2014 9:33 pm

How much of your resources would it take to pay off the mortgage? 100%, 20%, less? If you paid off your mortgage would you control other debt factors (no since paying off the mortgage if you go buy two new luxury cars with loans since you suddenly have much more positive cash flow).

If it was 20% or less of my available money I"d probably pay off the house, more than that I'd probably invest it 40/60 or so. At a 40/60 allocation even with a rather severe market downturn losses would be relatively small but chances are good it would grow at a rate higher than the mortgage interest rate.

Paying off the mortgage may also result in not being able to itemize deductions and could result in higher taxes.

Muni bond funds are yielding 4% right now so you currently could exceed the interest rate even with a bond fund.

User avatar
pjstack
Posts: 1308
Joined: Tue Feb 20, 2007 5:03 am
Location: Harbor City, CA

Re: Pay off that Mortgage?

Post by pjstack » Wed Aug 13, 2014 11:56 pm

Or, you could just pay a little extra each month (on the principal) which will shorten the length of the mortgage.
pjstack

placeholder
Posts: 3954
Joined: Tue Aug 06, 2013 12:43 pm

Re: Pay off that Mortgage?

Post by placeholder » Thu Aug 14, 2014 1:09 am

I would invest but not in a CD.

LongerPrimer
Posts: 903
Joined: Thu Jun 05, 2014 10:01 pm

Re: Pay off that Mortgage?

Post by LongerPrimer » Thu Aug 14, 2014 3:41 am

I always look at this and similar questions concerning assets as a Risk Problem.

If choice A, paid off mortgage: You assume all risks. By owning, this becomes a very Agressive position. This is a limiting position.

If choice B,, maintaining a mortgage and investing the offsetting debt money; You are now laying off some of your risk. Sharing the ownership while retaining the rights, "puts" your ownership. This is actually a Conservative financial decision because you have the options to invest in alternatives or to pay down mortgage.

I am a Conservative person. Are you?

Jack FFR1846
Posts: 5880
Joined: Tue Dec 31, 2013 7:05 am

Re: Pay off that Mortgage?

Post by Jack FFR1846 » Thu Aug 14, 2014 5:48 am

Door #3: Pay off the mortgage, join Digital credit union and refinance your cars at 1.24%.

Personally, I'd pay off the mortgage and be done with it. Then I'd save other money to invest.
Bogle: Smart Beta is stupid

User avatar
Rainier
Posts: 1253
Joined: Thu Jun 14, 2012 5:59 am

Re: Pay off that Mortgage?

Post by Rainier » Thu Aug 14, 2014 5:50 am

I wouldn't pay it off.

I assume you already have enough income to cover the payments. I'd invest the surplus, you could be very conservative and still beat that rate.
- Bill

pacodelostigres
Posts: 117
Joined: Mon Jul 28, 2014 8:14 am

Re: Pay off that Mortgage?

Post by pacodelostigres » Thu Aug 14, 2014 6:58 am

I'd pay if off. You didn't give full details, but I'd guess that most people that are considering paying off a mortgage aren't itemizing to get the tax deduction benefit, or else the benefit is small.

If your marginal tax rate is 30% federal + state, your 3.4% mortgage is 4.86% before taxes. I don't put much value on shared risk with the bank. It's your house, so it's your risk. If you have the cash to pay it off, you're not likely to need to do a short sale or deed in lieu. You probably have adequate insurance. If you're planning to move in a year and are worrying about property values, you probably shouldn't have bought a house 2 years ago.

I'd consider this a legitimate risk free rate of return.

Where else are you going to get almost 5% risk free? Yes, you could invest it in the market and reasonably expect more return. However, is the excess return an adequate risk premium for the difference between a stock (or balanced) portfolio and the risk of home ownership? I would say it is not, because most portfolio theory prices equity at a risk premium to short term risk free rates, which are zero.

We did exactly this a year or so ago. We paid off a 3.125% fixed rate 15 year mortgage aggressively in 2 years. No regrets. I don't care what the market did in the interim, as the stability this gives us in our daily lives and the risk free nature of the excess cash flow (which we're now investing), were the goal. We didn't sacrifice maxing out tax advantaged accounts to get this done, but it was the immediately next priority in line. Had we had the cash on hand to buy the house with cash, we would have done so up front.

chuppi
Posts: 126
Joined: Sat Jun 16, 2012 9:47 am

Re: Pay off that Mortgage?

Post by chuppi » Thu Aug 14, 2014 9:12 am

I think it is best to maximize 401K and Roth. If you have extra money on top of that, you can consider paying of mortgage. Mortgage payoff returns is a sure thing (with interest rates being low now, it is less but still a sure thing). Personally I prefer to be debt free and will sleep better without debt.
On the other hand mortgage payoff is 3.5-4% whereas index fund should return 7-8% over the long run and there you have the 4% difference.

kaudrey
Posts: 834
Joined: Fri Nov 22, 2013 2:40 pm

Re: Pay off that Mortgage?

Post by kaudrey » Thu Aug 14, 2014 9:16 am

Well, I wouldn't invest it in a CD, and I am speaking from my real world situation. I have 2 mortgages on 2 different properties, and I haven't paid them off; I invest instead.

pacodelostigres
Posts: 117
Joined: Mon Jul 28, 2014 8:14 am

Re: Pay off that Mortgage?

Post by pacodelostigres » Thu Aug 14, 2014 10:25 am

chuppi wrote:I think it is best to maximize 401K and Roth. If you have extra money on top of that, you can consider paying of mortgage. Mortgage payoff returns is a sure thing (with interest rates being low now, it is less but still a sure thing). Personally I prefer to be debt free and will sleep better without debt.
On the other hand mortgage payoff is 3.5-4% whereas index fund should return 7-8% over the long run and there you have the 4% difference.



The mortgage payoff is likely an after tax rate, and is risk free. The index fund is risky and subject to taxation. I don't think the 4% premium is adequate compensation, and I personally estimate index funds to return more like 4-5% for the foreseeable future.

User avatar
goodenyou
Posts: 1100
Joined: Sun Jan 31, 2010 11:57 pm
Location: Skating to Where the Puck is Going to Be..or on the golf course

Re: Pay off that Mortgage?

Post by goodenyou » Thu Aug 14, 2014 1:50 pm

The fact that you compared paying off your mortgage to investing in a 3.3% 10-year CD tells me you may be risk adverse. In that case, I would pay off the mortgage. If you wanted to take more risk, and believe that over time you will beat the mortgage rate (it is less than the fixed rate...but you did not include your tax bracket), you could invest in a well-diversified portfolio based on your plan and AA. I think paying off a mortgage depends a lot on your balance sheet, age and total investments. If you had a lot of excess cash and a well-balanced portfolio with stock and bonds and future positive cash flow, I would pay it off. I would not liquidate my entire cash position to do it.
"Ignorance more frequently begets confidence than does knowledge" | "The best years you have left are the ones you have right now"

Twins Fan
Posts: 2775
Joined: Fri Mar 08, 2013 1:02 pm

Re: Pay off that Mortgage?

Post by Twins Fan » Thu Aug 14, 2014 3:07 pm

pacodelostigres wrote:
chuppi wrote:I think it is best to maximize 401K and Roth. If you have extra money on top of that, you can consider paying of mortgage. Mortgage payoff returns is a sure thing (with interest rates being low now, it is less but still a sure thing). Personally I prefer to be debt free and will sleep better without debt.
On the other hand mortgage payoff is 3.5-4% whereas index fund should return 7-8% over the long run and there you have the 4% difference.



The mortgage payoff is likely an after tax rate, and is risk free. The index fund is risky and subject to taxation. I don't think the 4% premium is adequate compensation, and I personally estimate index funds to return more like 4-5% for the foreseeable future.


Funny how very few take the many similar predictions to that into account for these conversations. I agree that returns are likely to be lower than the good old 8% for a while going forward. Especially if a conservative portfolio with plenty of fixed income is being brought up. I don't know the OPs portfolio though, just saying. Betting on getting higher returns investing than paying down a mortgage might not be the safe bet it was, for who knows how long.

Of course it's situational also. But, for low mortgages, low yearly interest, lower tax bracket, and low or no deduction types, I think paying down or off a mortgage is a pretty good guaranteed return to take.

User avatar
dbCooperAir
Posts: 1107
Joined: Tue Jan 07, 2014 10:13 pm

Re: Pay off that Mortgage?

Post by dbCooperAir » Thu Aug 14, 2014 3:30 pm

Not enough information.

If my net worth is $1,000,000 and the mortgage is $90,000 I would pay off the mortgage just because I'm lazy and don't want to keep track of a payment for the next 28 years, I got better things to do.
Neither a wise man nor a brave man lies down on the tracks of history to wait for the train of the future to run over him. | -Dwight D. Eisenhower-

john94549
Posts: 4638
Joined: Tue Jul 26, 2011 8:50 pm

Re: Pay off that Mortgage?

Post by john94549 » Thu Aug 14, 2014 4:44 pm

Thanks to all for the responses thus far. I had always leaned toward just paying off the mortgage, but the emergence of that 3.3% 10-yr CD gave me pause. Since we itemize, and would still be below the limitation on deductions on Sch A (even with the CD interest), tax would probably be a wash for the first couple of years. After two years, the CD actually would generate more interest than we'd be paying on the mortgage balance, so the bigger issue is whether we want to be locked into the payment in retirement*. My wife and I are both 66; I'm retired, she is not (loves her job and they love her).

*My selfish side says "no way." My estate-planning side mutters "forced saving is still savings, even if for heirs". And the eternal optimist in me wonders if, ten years down the road, the interest rate on the renewal CD might be more than enough to cover the payment (i.e., principal plus interest). I suspect, after taxes on the net CD income, it would need to be right around 6% to cover P+I.

User avatar
grabiner
Advisory Board
Posts: 20992
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Pay off that Mortgage?

Post by grabiner » Fri Aug 15, 2014 10:35 am

john94549 wrote:Assume one has a 3.4%/30 year with 28 years or so to run. Funds are available to either (a) pay off, or (b) invest. One investing option is a 3.3%/10 year CD. Thoughts? Disregard Garn-StGermain, as it's a tad too esoteric.

The mere 10 bp difference over the first ten years makes me reluctant to surrender this mortgage.


The CD is actually better than the mortgage, because it has less interest-rate risk. If interest rates rise over the next ten years, you can reinvest the CD money at a new, higher rate, while keeping the mortgage at a low rate. If interest rates fall, you haven't lost much (assuming that your mortgage interest is deductible), and you can pay off the mortgage then.

What is your tax bracket? A better option might be a municipal-bond investment, such as Admiral shares of Vanguard Long-Term Tax-Exempt at a 2.6% yield exempt from federal tax, or a fund for your state if appropriate. If you are in a 25% tax bracket, the after-tax rate on the mortgage is 2.55%. Long-Term Tax-Exempt has a bit of credit risk, but a lower duration than the CD.

I have the same logic in not paying off my mortgage. My rate is 2.625% for 14 years (I paid a lot of points to get that rate, and I assume you did as well), and I can do better than this with municipal bonds. I don't actually hold municipal bonds because my bonds are all in my retirement account.
David Grabiner

Post Reply