Sell individual corporate bonds to pay off mortgage?

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ScroogeMcDuck
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Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Tue Jul 26, 2016 8:17 pm

Hello, this is yet another mortgage payoff thread. We have a $200k mortgage at 4.5% with about 25 years left. Not sure it's relevant, but our home is worth about $600k. We definitely don't want to have the mortgage for 30 years - I would like to pay it off within the next few years. Since rates are lower now but we have enough in bonds to pay off the mortgage, my question is whether we should (a) refinance and then spend a few years paying off the mortgage, or (b) use the $200k we have in individual corporate bonds to pay off the mortgage now.

The individual corporate bonds are a vestige of our pre-Boglehead days when we didn't understand their risk. They mature at various dates from this year through 2023 and the yields range from 3.5% to 5.4%(!). The lowest rated one is Baa3. I'm not sure of the call features. I would like to move away from the risk of holding individual corporate bonds, but my hesitation is that it would move our asset allocation to 88/12 stocks/bonds when our IPS call for no more stocks than 70/30. Our investment portfolio is $1 million, with $700k in stocks and $300k in fixed income ($200k in individual corporate bonds and $100k in bond funds, Treasuries, and cash). We also hold too many individual stocks that I haven't figured out how to get out of without a significant tax hit, but that's probably a separate thread.

We put over $100k a year into investments, so that's why I estimate it would take 2 years to use income to either pay off the mortgage or rebuild our bond holdings. However, I would like to have the flexibility for either of us to take a break from work (voluntary or involuntary). Our income is unreliable in that it mostly comes from me, and I've been saying I'll quit in 3 months for the past 5 years.

Refinancing gives us the most flexibility but I do hate the idea of eating the closing costs when we have the cash to pay it off. What would you do?

qwertyjazz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by qwertyjazz » Tue Jul 26, 2016 8:37 pm

You have intermittent income streams. The ability to pay off your mortgage completely. You have bonds that pay less than the mortgage costs you. I do not know the transaction costs of selling your bonds which might be an issue.
Look at threads on mortgage as negative bond. Realize your AA has never been what you thought it was. Accept that and IMO if transaction costs are not too high then pay off the mortgage.

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Watty
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Re: Sell individual corporate bonds to pay off mortgage?

Post by Watty » Tue Jul 26, 2016 8:45 pm

Be sure to figure out what the capital gains would be if you sold the bonds.

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Tue Jul 26, 2016 8:53 pm

qwertyjazz wrote: Realize your AA has never been what you thought it was.
Thanks, that's a great point.

VaR
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Re: Sell individual corporate bonds to pay off mortgage?

Post by VaR » Wed Jul 27, 2016 12:55 am

1. How does the annual interest received from your corporate bonds compare to the annualized amount of your mortgage payment?
2. What is the closest maturity date of your bonds?
3. How much additional liquid funds do you have? That is, how much of your $1MM is in taxable accounts and thus not encumbered retirement accounts?

I'm guessing that the interest and "principal return on maturity" streams from your corporate bonds will cover your mortgage payment. This would take your intermittent income stream out of the picture. And really, while we are talking about that, if you do run into a cash crunch, you can sell your corporate bonds and use the proceeds to continue to make mortgage payments. In this way your "unemployment cash" is even higher than it would be if you paid off your mortgage.

So the real question comes down to the risk you have with your corporate bonds. They are all investment grade (Moody's Baa3 is the lowest investment grade rating. Note that it is equivalent to S&P/Fitch BBB-). So outright default is very unlikely and the most likely risk you face is downgrade risk and the resulting market value loss as the bond's price would go down on downgrade. How many different company's bonds do you hold?

Where do you hold the bonds? If your dealer has an online trading platform for bonds, you may be able to look at historical trades and get an idea of:
1. What you can sell each of your bond holdings for
2. What the dealer spreads are for your bonds and thus what your transaction costs would be.

If you name a particular bond I'm sure someone could look up the trade data for that bond to give you a better idea of your anticipated transaction costs. If you post all your bond holdings you could also probably get some advice on how diversified your portfolio is.

My bottom line thoughts:
1. Because you want to pay off your mortgage quickly, just sell the bonds and pay off the mortgage. Don't go through the trouble of refinancing.
2. If you do refinance, see if you can find a 5/1 or even a 1/1 adjustable rate mortgage since you will be paying it off quickly. Also see if you can get better quotes with a 5/1 15 year amortization ARM. I suspect you will be able to get a 2%-2.5% rate. Given you're going to be paying it off in 2 years, though, your rate is really more like 3.5% if you include your closing costs.
3. Because you want to sell your individual corporate bonds anyway, do so and pay off your mortgage with the funds. If you have enough liquid assets in your taxable portfolio, you won't have any "liquidity issues" even if your income decreases.

stlutz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by stlutz » Wed Jul 27, 2016 1:12 am

Where are the bonds held? Do you (or does your broker know) the cost basis of each of them? Corporate bonds are much easier to sell than muni bonds, so you shouldn't be scared to do so as long as you are using a broker that is very transparent about the whole process (Fidelity would be one example).
We also hold too many individual stocks that I haven't figured out how to get out of without a significant tax hit, but that's probably a separate thread.
I think that should be a subject for this thread. If you look as the sources of risk resulting from lack of diversification, the equities are likely a much bigger problem than than the bonds. There is a much better chance to a stock losing 75% than an investment-grade bond defaulting. If taxes were not a consideration, I'd look at funding most of the mortgage payoff using proceeds from equity sales as opposed to bond sales.

But, of course, taxes are a consideration. Is there any prospect that you will be in the 15% bracket (meaning 0% LTCG) in the near future? If so, that would be the better time to sell the equities. But even then, you may have enough other income that only some of the stocks can get the 0% rate.

Regardless, if you want to get rid of the individual securities, you're going to have to sell the stocks as some point. With the bonds, you do have the option to do nothing, let them mature, and then use the proceeds to buy bond funds or payoff the mortgage. Stocks don't mature, so you'll have to take some action there.

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Re: Sell individual corporate bonds to pay off mortgage?

Post by magneto » Wed Jul 27, 2016 5:21 am

Not entirely sure of the numbers here.
Please ignore if below getting this hopelessly wrong!

If the Corps are trading well above par as seems likely in today's environment, then yield to maturity will be significantly less than coupon figure quoted?

I.E. Yield spreads (gap) between Mortgage and Corps might be wider than quoted?
And Capital Gain on Corps could be harvested to advantage?
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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whodidntante
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Re: Sell individual corporate bonds to pay off mortgage?

Post by whodidntante » Wed Jul 27, 2016 5:46 am

I would sell all the individual bonds and all the individual stocks if the taxes and transaction costs are acceptable, or at least keep these concentrated investments to a small percentage of your portfolio. Then you can figure out what you want to buy to restore your asset allocation.

The house doesn't need to be an all or nothing thing. Fifty grand in prepayment still saves you significant interest. Just do what you are comfortable with. A big downside is loss of liquidity, but you can consider opening a HELOC to alleviate that to some extent.

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 7:35 am

VaR wrote:1. How does the annual interest received from your corporate bonds compare to the annualized amount of your mortgage payment?

Annually, we pay $14k for the mortgage, $10k of which is interest, and receive $8k in interest from the bonds so the bond interest isn't really covering the mortgage interest.

2. What is the closest maturity date of your bonds?

The closest maturity date is March 2017.

3. How much additional liquid funds do you have? That is, how much of your $1MM is in taxable accounts and thus not encumbered retirement accounts?

Of the $1 million, $750k is in taxable. (We haven't been working very long.) The $250k in retirement accounts is 100% stocks.

I'm guessing that the interest and "principal return on maturity" streams from your corporate bonds will cover your mortgage payment. This would take your intermittent income stream out of the picture. And really, while we are talking about that, if you do run into a cash crunch, you can sell your corporate bonds and use the proceeds to continue to make mortgage payments. In this way your "unemployment cash" is even higher than it would be if you paid off your mortgage.

That's true. To be clear, our income currently isn't intermittent. I just don't like my job.

So the real question comes down to the risk you have with your corporate bonds. They are all investment grade (Moody's Baa3 is the lowest investment grade rating. Note that it is equivalent to S&P/Fitch BBB-). So outright default is very unlikely and the most likely risk you face is downgrade risk and the resulting market value loss as the bond's price would go down on downgrade. How many different company's bonds do you hold?

It's 10 companies.

Where do you hold the bonds? If your dealer has an online trading platform for bonds, you may be able to look at historical trades and get an idea of:
1. What you can sell each of your bond holdings for
2. What the dealer spreads are for your bonds and thus what your transaction costs would be.

The bonds are held in a brokerage account. I'm saying they're worth $200k based on the market value stated on the brokerage account website, but I'll check with my dealer on the actual value and transaction costs.
Thank you for the detailed reply!

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 7:57 am

stlutz wrote:I think that should be a subject for this thread. If you look as the sources of risk resulting from lack of diversification, the equities are likely a much bigger problem than than the bonds. There is a much better chance to a stock losing 75% than an investment-grade bond defaulting. If taxes were not a consideration, I'd look at funding most of the mortgage payoff using proceeds from equity sales as opposed to bond sales.

But, of course, taxes are a consideration. Is there any prospect that you will be in the 15% bracket (meaning 0% LTCG) in the near future? If so, that would be the better time to sell the equities. But even then, you may have enough other income that only some of the stocks can get the 0% rate.

Regardless, if you want to get rid of the individual securities, you're going to have to sell the stocks as some point. With the bonds, you do have the option to do nothing, let them mature, and then use the proceeds to buy bond funds or payoff the mortgage. Stocks don't mature, so you'll have to take some action there.
Of the $700k in stocks, about $250k is in 16 individual stocks. They're all large cap, dividend paying stocks. We have gains on most of them (not the oil stocks...). I would like to take a break from working or change careers within the next few years, so we would be down to one income and in the 0% LTCG bracket during that time. I was planning to sell the stock with gains then.

I've just been holding the stocks with losses. I know the usual Boglehead advice is to sell individual stocks with losses if you no longer want to hold individual stocks, but after selling one I haven't been able to bring myself to sell the rest - locking in the loss does bother me (more so than seeing the decline in value).

On the other hand, selling some of the individual stocks to fund the mortgage payoff would help us maintain our desired asset allocation.

Da5id
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Re: Sell individual corporate bonds to pay off mortgage?

Post by Da5id » Wed Jul 27, 2016 8:02 am

ScroogeMcDuck wrote:
I've just been holding the stocks with losses. I know the usual Boglehead advice is to sell individual stocks with losses if you no longer want to hold individual stocks, but after selling one I haven't been able to bring myself to sell the rest - locking in the loss does bother me (more so than seeing the decline in value).

On the other hand, selling some of the individual stocks to fund the mortgage payoff would help us maintain our desired asset allocation.
If you'd not actually buy the losers now instead of an index fund, surely selling them and getting an index fund is the way to go. Yes you "lock in" the losses, but you get to use the capital loss on your taxes.

And BTW, 16 stocks isn't horribly undiversified either, though I'd rather have an index fund any day myself.

nyblitz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by nyblitz » Wed Jul 27, 2016 9:01 am

Those bonds may well be called (especially the higher interest rate).

All experienced 2ndary market purchases will know this and further discount your bonds.

Are your bonds in round lots?

In your shoes, I'd hold to maturity, hoping for a call - you may not have to do anything to get your money. :-)

qwertyjazz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by qwertyjazz » Wed Jul 27, 2016 9:22 am

nyblitz wrote:Those bonds may well be called (especially the higher interest rate).

All experienced 2ndary market purchases will know this and further discount your bonds.

Are your bonds in round lots?

In your shoes, I'd hold to maturity, hoping for a call - you may not have to do anything to get your money. :-)
Shouldn't the discount for a possible call be less than a definite call?

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 9:43 am

magneto wrote:Not entirely sure of the numbers here.
Please ignore if below getting this hopelessly wrong!

If the Corps are trading well above par as seems likely in today's environment, then yield to maturity will be significantly less than coupon figure quoted?

I.E. Yield spreads (gap) between Mortgage and Corps might be wider than quoted?
And Capital Gain on Corps could be harvested to advantage?
Watty wrote:Be sure to figure out what the capital gains would be if you sold the bonds.
Not sure if this addresses both but capital gains are minimal (about $4k overall).

nyblitz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by nyblitz » Wed Jul 27, 2016 9:49 am

Shouldn't the discount for a possible call be less than a definite call?
The discount will be what the market will pay.

Individual corporates are traditionally relatively illiquid for individual investors.

Just pointing out that the current circumstances may make them more illiquid (if there is a call provision). I could be wrong here though.

But a definite call would be GOOD for the OP (no?), as he's looking to exit these anyway.

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 9:51 am

whodidntante wrote:I would sell all the individual bonds and all the individual stocks if the taxes and transaction costs are acceptable, or at least keep these concentrated investments to a small percentage of your portfolio. Then you can figure out what you want to buy to restore your asset allocation.
Thank you. If, to avoid the tax hit, we only sold stocks with losses in taxable accounts, we'd get $35k. It would help a little bit to reduce our individual stock holdings and maintain our bonds.

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 9:55 am

nyblitz wrote:Are your bonds in round lots?

In your shoes, I'd hold to maturity, hoping for a call - you may not have to do anything to get your money. :-)
Yes, the bonds are in round lots.

So you'd choose to refinance?

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Re: Sell individual corporate bonds to pay off mortgage?

Post by Lafder » Wed Jul 27, 2016 9:59 am

If you sell stocks with losses at the same time as stocks with gains it can cancel out the capital gains tax due.

Perhaps you could post all of your holdings including what is taxable vs retirement, and list the gains and losses, and rephrase your question as "if I want to pull 200k from my taxable investments to pay off my mortgage, where would you pull it from?" and then think about how you feel to imagine doing that.

If you sell 200k in bonds it could really throw off your AA.

In the end it is more of an emotional decision about what feels best for you since which is the best financial decision depends on an unpredictable market.

Your interest rate is high by today's standards! I also would hate to pay refi fees. Especially if you plan to pay off within the next few years anyway.

lafder

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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Wed Jul 27, 2016 10:03 am

Da5id wrote:If you'd not actually buy the losers now instead of an index fund, surely selling them and getting an index fund is the way to go. Yes you "lock in" the losses, but you get to use the capital loss on your taxes.

And BTW, 16 stocks isn't horribly undiversified either, though I'd rather have an index fund any day myself.
I don't mind having some individual stocks, but I would like it to be a smaller percentage of our portfolio (like 15% of our equity holdings).

They generate about $7.5k annually in dividends which might be nice to have if I quit my job. Without the mortgage, our annual expenses would be about $36k.

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Re: Sell individual corporate bonds to pay off mortgage?

Post by qwertyjazz » Wed Jul 27, 2016 10:04 am

nyblitz wrote:
Shouldn't the discount for a possible call be less than a definite call?
The discount will be what the market will pay.

Individual corporates are traditionally relatively illiquid for individual investors.

Just pointing out that the current circumstances may make them more illiquid (if there is a call provision). I could be wrong here though.

But a definite call would be GOOD for the OP (no?), as he's looking to exit these anyway.
Maybe he should ask Launchpad how to make his money bin more liquid
Sorry but seemed to fit :moneybag
G.E. Box "All models are wrong, but some are useful."

MIretired
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Re: Sell individual corporate bonds to pay off mortgage?

Post by MIretired » Wed Jul 27, 2016 10:42 am

ScroogeMcDuck wrote:
nyblitz wrote:Are your bonds in round lots?

In your shoes, I'd hold to maturity, hoping for a call - you may not have to do anything to get your money. :-)
Yes, the bonds are in round lots.

So you'd choose to refinance?
I like this idea. And since nyblitz seems to know indiv. bonds at least more than me.
Because my interp. is that the biggest determinant is the fact you seem to also not want to work- at least where you're at?
If so, maintain liquid assets (except the income they throw off.)
Yea. $200k mort., and $200k bonds which yield higher than mort. (probably?) So, bonds pay mort. payments.
And refi mort.

If you would keep your job, or the possibility of too low of an income in the intermediate term (7-10yrs?) is low, I'd switch extra income towards mort. and pay off in 2 yrs., and not refi.

I'd check all the details as to taxes and fees, etc.
As far as AA of stk/bnd, you could've just sold some stk. (they are kind of high, but see fees/gains taxes.)
Just a quick look. not really a suggestion.

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Re: Sell individual corporate bonds to pay off mortgage?

Post by Flashes1 » Wed Jul 27, 2016 10:53 am

I'd just use excess cash flow to pay off your mortgage and leave the bonds alone. Sounds like you can pay-off your mortgage this way in two years, and you don't have to go thru the hassle of selling the bonds. KISS

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Kenkat
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Re: Sell individual corporate bonds to pay off mortgage?

Post by Kenkat » Wed Jul 27, 2016 12:21 pm

This is a complicated question and the answer in part depends on what is important to you.

How much do you really want to get out of individual bonds?
How quickly do you want your house paid off?

You could get a 10 year or 15 year mortgage for under 3% if you refinanced. If the mortgage interest is fully deductible, you could possibly now be earning more in bond interest than you are paying in mortgage interest. But if the answer to either of the two above questions is a strong positive, you may want to pay off the mortgage anyway.

At a minimum, you should at least refinance (i.e., don't stick with the status quo). Whether you instead go for the payoff will depend on factors such as capital gains taxes and personal feelings about holding a mortgage when you don't really NEED to from a financial perspective.

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Thu Jul 28, 2016 12:06 am

kenschmidt wrote:This is a complicated question and the answer in part depends on what is important to you.

How much do you really want to get out of individual bonds?
How quickly do you want your house paid off?

You could get a 10 year or 15 year mortgage for under 3% if you refinanced. If the mortgage interest is fully deductible, you could possibly now be earning more in bond interest than you are paying in mortgage interest. But if the answer to either of the two above questions is a strong positive, you may want to pay off the mortgage anyway.

At a minimum, you should at least refinance (i.e., don't stick with the status quo). Whether you instead go for the payoff will depend on factors such as capital gains taxes and personal feelings about holding a mortgage when you don't really NEED to from a financial perspective.
Thank you, I gave it more thought and ran through a couple different scenarios and found that if we can refinance at 2.75% for a 15 year mortgage and then pay off the mortgage over two years with cash flow, we end up losing only about $3,000 compared to selling all the bonds to pay it off now. (I assumed we would pay 3% in closing costs, not sure if that's reasonable.) I'm leaning towards doing this - $3,000 seems like a reasonable price to pay to maintain our desired asset allocation and flexibility if we change our minds. We have many decades ahead of us (we're in our early 30s), so having flexibility is a big plus.

My husband thinks no one will understand why we would want to pay off a mortgage so fast - he doesn't know there are so many Bogleheads out there! :D

nyblitz
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Re: Sell individual corporate bonds to pay off mortgage?

Post by nyblitz » Thu Jul 28, 2016 10:42 am

ScroogeMcDuck,

I think your plan here is reasonable.

It's a complex question and you could go in many different directions.

Two other things to consider:

1. With the "unreliable"(yet high) income and thoughts of taking a break in employment, what are the chances you may sell the house to move or travel?

2. If going with your plan, you may want to look at ARMs, which could lower your rate further. Since you plan on paying it off in 2 years anyway, the risk of rising interest rates wouldn't be as severe. Of course, you have to compare the numbers to your specific situation.

Best of luck!

:-)

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Re: Sell individual corporate bonds to pay off mortgage?

Post by joebh » Thu Jul 28, 2016 11:00 am

ScroogeMcDuck wrote:We have a $200k mortgage at 4.5% with about 25 years left. Not sure it's relevant, but our home is worth about $600k. We definitely don't want to have the mortgage for 30 years - I would like to pay it off within the next few years.
Why?
What is your motivation in paying it off within the next few years?
Refinancing gives us the most flexibility but I do hate the idea of eating the closing costs when we have the cash to pay it off. What would you do?
Have you looked into a zero-cost refinancing?

ScroogeMcDuck
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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Thu Jul 28, 2016 8:06 pm

joebh wrote:
ScroogeMcDuck wrote:We have a $200k mortgage at 4.5% with about 25 years left. Not sure it's relevant, but our home is worth about $600k. We definitely don't want to have the mortgage for 30 years - I would like to pay it off within the next few years.
Why?
What is your motivation in paying it off within the next few years?
My husband and I are in our early 30s. I'm the primary earner and plan to leave my profession, probably with a permanent reduction in my income, within the next few years. In preparation for living on just the smaller income, we want to pay off the mortgage and build up our portfolio.
joebh wrote:
Refinancing gives us the most flexibility but I do hate the idea of eating the closing costs when we have the cash to pay it off. What would you do?
Have you looked into a zero-cost refinancing?
I haven't looked into zero-cost refinancing, thank you for the suggestion.!

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Re: Sell individual corporate bonds to pay off mortgage?

Post by ScroogeMcDuck » Thu Jul 28, 2016 8:15 pm

nyblitz wrote:ScroogeMcDuck,

I think your plan here is reasonable.

It's a complex question and you could go in many different directions.

Two other things to consider:

1. With the "unreliable"(yet high) income and thoughts of taking a break in employment, what are the chances you may sell the house to move or travel?

2. If going with your plan, you may want to look at ARMs, which could lower your rate further. Since you plan on paying it off in 2 years anyway, the risk of rising interest rates wouldn't be as severe. Of course, you have to compare the numbers to your specific situation.

Best of luck!

:-)
Thanks nyblitz, I haven't done enough research into ARMs (and zero cost refinancing as joebh mentioned). This mortgage was our first one and I'm ashamed to say we didn't look into any options other than what our broker suggested.

It's unlikely we would move within the next decade - geographically, we're where we want to be, it more than meets our needs size-wise, and prices have gone up so much (our home has increased 30% in value in just a few years) that we're priced out of buying again in our own neighborhood.

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