Pay down mortgage now, or wait?

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Morik
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Pay down mortgage now, or wait?

Post by Morik » Wed Jul 27, 2016 11:57 am

We plan to buy a new house in ~10 years.

We have ~$180k saved right now towards the down payment. (In a 50/50 stock/muni bond split right now, planning to glide that down so that we have no stock by 5 years).
(We also plan to sell our current home and apply that money towards the new house, but want a separate down payment fund so we can be flexible on when to sell, etc.)

I also plan to fund this down payment amount some more over time, once we have a better idea of how much we want to spend on the new house.

Our current home is on a 15 year mortgage at 2.75%. I usually end up paying AMT--IIRC mortgage interest deductions don't get counted for AMT, so I think my actual cost here is 2.75%. (Can anyone confirm that AMT gets rid of the mortgage interest deduction?)

There is $300k or so left on the mortgage (monthly payments are ~$3k), and ~12 years left on the mortgage.

So it seems we have 2 options:
1) Put the $180k towards the current mortgage. This will pay off our current loan faster, and then rebuild our down payment fund with what used to be our mortgage payments, once the house is paid off.
This nets an immediate 2.75% on the $180k.
Our mortgage would then be paid off in ~4 years instead of ~12.

2) Keep the $180k + any additional we save towards this invested, and just pay off the mortgage over the remaining 12 years.
(Well, for the next 10 or so, then sell the house and pay off remaining mortgage from that, and apply the rest of the proceeds towards the new house's mortgage.)

My inclination is to go with #2.
But I hesitate because:
- Keeping the cash available increases our financial flexibility. Though we do have a (probably overly funded) emergency fund: ~13 months expenses: 8 in checking/savings accounts, and 5 in intermediate muni bonds. Though thats at our current spending level. Cutting back in an emergency could net us ~21 months expenses, maybe a bit more.
- 2.75% is a pretty good rate to have debt at. Though with current bond yields and such, beating that with investing over a 10 year time frame is a pretty iffy proposition.

One other thing is that we plan to do some fixing/improving of our porch (replacing rotting wooden porch with larger screened in area), which we think will run $15k-$25k (haven't gotten estimates yet, just wildly guessing).
That will likely come out of our over-funded emergency funds.
I think there is room to do that and still drop the $180k into the mortgage and maintain plenty of financial flexibility.

Thoughts?

EDIT: Just did some digging, and apparently my mortgage interest IS deductible for AMT, since it was used to buy my primary residence.
In that case our actual rate will be 2.75 * (1 - 0.33) = 1.84%. (33% federal tax bracket. State doesn't allow a mortgage interest deduction.)

This makes it a harder decision IMO--beating 1.84% over the next 10 years, even investing conservatively, seems a lot easier than beating 2.75%.

EDIT 2: One additional question: If I pay down the mortgage now and finish paying it off in 4 years, will that negatively impact my credit score in 10 years since I won't have an additional 6 years of on-time mortgage payments, plus the open mortgage account, on the credit score?
Last edited by Morik on Wed Jul 27, 2016 12:37 pm, edited 2 times in total.

tampaite
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Re: Pay down mortgage now, or wait?

Post by tampaite » Wed Jul 27, 2016 12:27 pm

Morik wrote:We plan to buy a new house in ~10 years.

Thoughts?
My thoughts are since you are planning to buy a house in the next 10 years - better to pay off your existing mortgage.

10 years is too far long in the timeline to determine what the housing prices, stock market or interest rates would be - Go with what's known today!

investor1
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Re: Pay down mortgage now, or wait?

Post by investor1 » Wed Jul 27, 2016 1:25 pm

I'd leave the money invested in something else. 1.84% shouldn't be that hard to beat after taxes. You can always pay it off later if you wish.

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grabiner
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Re: Pay down mortgage now, or wait?

Post by grabiner » Wed Jul 27, 2016 5:36 pm

Morik wrote:EDIT: Just did some digging, and apparently my mortgage interest IS deductible for AMT, since it was used to buy my primary residence.
In that case our actual rate will be 2.75 * (1 - 0.33) = 1.84%. (33% federal tax bracket. State doesn't allow a mortgage interest deduction.)
The deduction is at your marginal AMT rate, which is 35% if you are in the AMT phase-out of personal exemptions, otherwise 28%.
EDIT 2: One additional question: If I pay down the mortgage now and finish paying it off in 4 years, will that negatively impact my credit score in 10 years since I won't have an additional 6 years of on-time mortgage payments, plus the open mortgage account, on the credit score?
Yes, it will decrease your score, but it may not matter. If you have several credit cards which you pay on time and your balance is much less than the limit, your score can be good enough to get the lowest mortgage rate whether you have morgage or auto loans or not.
Wiki David Grabiner

Morik
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Re: Pay down mortgage now, or wait?

Post by Morik » Wed Jul 27, 2016 5:56 pm

grabiner wrote:
Morik wrote:EDIT: Just did some digging, and apparently my mortgage interest IS deductible for AMT, since it was used to buy my primary residence.
In that case our actual rate will be 2.75 * (1 - 0.33) = 1.84%. (33% federal tax bracket. State doesn't allow a mortgage interest deduction.)
The deduction is at your marginal AMT rate, which is 35% if you are in the AMT phase-out of personal exemptions, otherwise 28%.
Is there an easy way to check which applies to me? (I file with TaxActOnline.)
grabiner wrote:
EDIT 2: One additional question: If I pay down the mortgage now and finish paying it off in 4 years, will that negatively impact my credit score in 10 years since I won't have an additional 6 years of on-time mortgage payments, plus the open mortgage account, on the credit score?
Yes, it will decrease your score, but it may not matter. If you have several credit cards which you pay on time and your balance is much less than the limit, your score can be good enough to get the lowest mortgage rate whether you have morgage or auto loans or not.
I don't have an auto loan, but I do have several credit cards (3? 4? I only use 1 regularly, and 1 other one when traveling as it doesn't have a foreign transaction fee.)

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grabiner
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Re: Pay down mortgage now, or wait?

Post by grabiner » Thu Jul 28, 2016 8:51 am

Morik wrote:
grabiner wrote:
Morik wrote:EDIT: Just did some digging, and apparently my mortgage interest IS deductible for AMT, since it was used to buy my primary residence.
In that case our actual rate will be 2.75 * (1 - 0.33) = 1.84%. (33% federal tax bracket. State doesn't allow a mortgage interest deduction.)
The deduction is at your marginal AMT rate, which is 35% if you are in the AMT phase-out of personal exemptions, otherwise 28%.
Is there an easy way to check which applies to me? (I file with TaxActOnline.)
If you can change your numbers online, add $1000 to your income and see what happens to your tax; does it go up by $280 or $350?

If not, look at Form 6251. Line 29 shows your exemption amount. If the amount is zero, your entire exemption was phased out and your marginal tax rate is 28%. If the amount is positive but less than the normal exemption (shown on the form), you are in the phase-out range and your marginal tax rate is 35%. If you have the full exemption, you have not reached the phase-out range and your marginal tax rate is 28%.
Wiki David Grabiner

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coachz
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Re: Pay down mortgage now, or wait?

Post by coachz » Thu Jul 28, 2016 9:03 am

I don't do any debt so my answer is always "pay it off". Last house was paid for, tornado blew it away. Insurance paid. Wrote checks for $320k and built another house paid for. Bought a new car 2 weeks ago for wife's retirement gift (i so sweet). Wrote check for $23k. I just can't do debt anymore. I'm just weird that way. :beer

Morik
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Re: Pay down mortgage now, or wait?

Post by Morik » Thu Jul 28, 2016 10:04 am

grabiner wrote:
Morik wrote:
grabiner wrote:
Morik wrote:EDIT: Just did some digging, and apparently my mortgage interest IS deductible for AMT, since it was used to buy my primary residence.
In that case our actual rate will be 2.75 * (1 - 0.33) = 1.84%. (33% federal tax bracket. State doesn't allow a mortgage interest deduction.)
The deduction is at your marginal AMT rate, which is 35% if you are in the AMT phase-out of personal exemptions, otherwise 28%.
Is there an easy way to check which applies to me? (I file with TaxActOnline.)
If you can change your numbers online, add $1000 to your income and see what happens to your tax; does it go up by $280 or $350?

If not, look at Form 6251. Line 29 shows your exemption amount. If the amount is zero, your entire exemption was phased out and your marginal tax rate is 28%. If the amount is positive but less than the normal exemption (shown on the form), you are in the phase-out range and your marginal tax rate is 35%. If you have the full exemption, you have not reached the phase-out range and your marginal tax rate is 28%.
Thanks Grabiner--form 6251 line 29 shows an amount less than the full exemption, so it seems that my marginal tax rate is 35%.

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Watty
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Re: Pay down mortgage now, or wait?

Post by Watty » Thu Jul 28, 2016 12:13 pm

If you do decide to pay it down then you can call your lender first and see if they will "recast your mortgage" (google this). They are not required to do this but they often will for a processing fee of a couple of hundred dollars. This means that if you pay down your mortgage by 33%(or whatever) then your mortgage payment could also be decreased by the same percentage, but the length of your loan and the interest rate would stay the same. This can be important if interest rates go up or something happens and you need better cash flow.
grabiner wrote:
EDIT 2: One additional question: If I pay down the mortgage now and finish paying it off in 4 years, will that negatively impact my credit score in 10 years since I won't have an additional 6 years of on-time mortgage payments, plus the open mortgage account, on the credit score?
Yes, it will decrease your score, but it may not matter. If you have several credit cards which you pay on time and your balance is much less than the limit, your score can be good enough to get the lowest mortgage rate whether you have morgage or auto loans or not.


It may be more complex. I don't follow my credit score very closely but one of my credit unions has a free link to check your credit score so I check that occasionally. After I paid it off it went up noticeably, I would suspect because my total monthly payments went down to basically zero. As the other post mentioned this likely doesn't matter much one way or the other if you already have a high credit score.

Morik
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Re: Pay down mortgage now, or wait?

Post by Morik » Thu Jul 28, 2016 6:10 pm

Right now Equifax has me at 820 and Transunion at 817, though a few months ago when I checked it was around 760. Not sure what happened to spike it. So could probably take a hit and still qualify for best rates?

(I'm leaning towards keeping it with the 1.84% effective rate. Actually 2.75*(1-.35) = 1.78%.

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