CD / Treasury vs Paying off Mortgage - Rates are really close

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chhill121
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CD / Treasury vs Paying off Mortgage - Rates are really close

Post by chhill121 » Sun May 27, 2018 2:17 am

I have a question relating to paying off the mortgage vs investing into the a CD or Treasury Yield

Taxable income - 32% plus california 9.3%

I currently owe 575k on my mortgage with 28 years and 2 months left at a 3.5% interest rate. I have enough funds to pay off my mortgage but it would pretty much leave me with about 100k left in liquid capital. All my retirements account are maxed out and I have about 100k in brokerage taxable account. My question is since the 30 year is about 3.1 right now, would it be smart to purchase a 30 year at 3.1 or even a 10 year at 2.92. Since rates are raising can i essentially offest my mortgage interest after tax deductions with purchasing a 10 year or even an ally CD at 2.25% for 5 year. I am not the smartest in math but I am happy to know there are many you bogleheads with great experience and knowledge. Thanks in advance !

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Artsdoctor
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by Artsdoctor » Sun May 27, 2018 6:12 am

I don't have time to crunch the numbers for you but here are some questions.

What's your age and marital status? Your marital status is important because you'll want to know if you're going to have $12,000 versus $24,000 in a standard deduction for federal taxes. Your mortgage interest may not be as significant as you think.

How important is cash flow to you? The concept of paying off your mortgage is a nice one but your house is a hard asset. You can't easily get money out once you pay it off. Is that OK with you?

Aside from the cash flow question, money is fungible. It shouldn't really matter where the money is, whether it's house, retirement account, taxable account, savings, checking, etc.

Your figures are questionable. Bankrate.com has a 5% CD yielding 2.8%. But why would be looking at CDs if you're marginal tax rate is over 40%, perhaps even susceptible to the NIIT? Shouldn't you be looking at munis?

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Watty
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by Watty » Sun May 27, 2018 9:12 am

One question to ask yourself is, "If I had a paid off house then would I take out a new 3.5% mortgage so that I could invest the money in a bond or CD?" This is really about the same question but a lot fewer people would be that aggressive.

There is a wiki on this choice.

https://www.bogleheads.org/wiki/Paying_ ... _investing

Even if they were at the same interest rates after tax deductions it is still really hard to directly compare the two options since if you keep the mortgage payment you will still have to make something like a $2,000 a month mortgage payment and the interest from the bond or CD will not be enough to pay that. With a paid off house you would have about an additional $2,000 a month.

If you are looking at 10 year investment then your loan balance will only be something like $350K in ten years so you would only need to buy a $350K CD, not a $575K CD.

Even if you do not plan on moving there is non-zero chance that you will move before your expect to which would make things even move complicated since there could be years left on the bond or CD

You also need to consider how much you would pay in capital gains taxes if you have to sell a lot of investments to raise the money to pay off the mortgage.

Another consideration is how long it will be before you retire. For many people having a paid off house by the time they retire works very well since it reduced the cash flow they will need in retirement.

The math is complicated but if your are able to juggle the investments and come out 0.1% ahead after taxes that would be $575 ($575,000 * 0.1%). At best the immediate payoff is pretty negligible especially compared to your income. The chance of a big pay off would be that in ten years the interest rates might be much higher and you would still have a 3.5% mortgage.

One option to consider if you cannot see a clear choice would be to call your lender and ask if they will "recast your mortgage"(Google this) if you pay down 50%(or whatever percent of your loan that makes sense to you). They are not required to do this but they usually will for a processing fee of a few hundred dollars. The way this works is that the interest rate and length of the loan stay the same but the required mortgage payment is reduced by the same percentage. Keeping the length of the loan as long as possible could be important if interest rates get a lot higher.
Last edited by Watty on Sun May 27, 2018 1:42 pm, edited 1 time in total.

delamer
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by delamer » Sun May 27, 2018 10:16 am

How old are you?

What percentage of your net worth would be tied up in the house if you paid off your mortgage?

chevca
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by chevca » Sun May 27, 2018 11:03 am

As of last June, OP was 39...

viewtopic.php?f=1&t=220455&p=3395871#p3395871

So, 40 or almost 40 now.

I don't see $575k cash in that post, but it was about a year ago. My question would be, where would or could the payoff funds come from?

If cash is being piled up because of job instability or whatever, could paying off the house/mortgage and not having that payment offer the same or more feeling of security? Even with job instability, you have two rentals, would have $100k in savings, and investments. Is the job instability that scary without a $575k mortgage? If not, pay it off.

chevca
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by chevca » Sun May 27, 2018 11:12 am

Also, I don't see the 10 year or 30 year options mentioned as smart moves. That's a long time to lock in those rates.

OP, you mention of hint at rising rates. If you feel strongly rates will rise, the technically smarter thing to do would be hold onto your 3.5% mortgage. Shoot, savings accounts used to pay more than that and could again someday.

chhill121
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by chhill121 » Sun May 27, 2018 2:43 pm

hi everyone,

thank you so much for the advice as it has really opened up my mind to multiple thinking scenarios. i am not going to retire soon and moving is def not an option as I have 2 small ones that will need me and the space of our home for at least 18 years.

chevca wrote:
Sun May 27, 2018 11:03 am
As of last June, OP was 39...

viewtopic.php?f=1&t=220455&p=3395871#p3395871

So, 40 or almost 40 now.

I don't see $575k cash in that post, but it was about a year ago. My question would be, where would or could the payoff funds come from?

If cash is being piled up because of job instability or whatever, could paying off the house/mortgage and not having that payment offer the same or more feeling of security? Even with job instability, you have two rentals, would have $100k in savings, and investments. Is the job instability that scary without a $575k mortgage? If not, pay it off.
Yes the cash is currently being piled up in a emergency fund and was added to my last years emergency fund. My income was very volatile last year sometimes going months without income and I see this year to be the same. In turn this made me invest more heavily into emergency fund vs taxable brokerage.
delamer wrote:
Sun May 27, 2018 10:16 am
How old are you?

What percentage of your net worth would be tied up in the house if you paid off your mortgage?
I am close to 40 now and if I pay off my mortgage majority of my net worth will be in real estate. I would say 90% real estate 10% taxable brokerage.
Watty wrote:
Sun May 27, 2018 9:12 am
One question to ask yourself is, "If I had a paid off house then would I take out a new 3.5% mortgage so that I could invest the money in a bond or CD?" This is really about the same question but a lot fewer people would be that aggressive.

There is a wiki on this choice.

https://www.bogleheads.org/wiki/Paying_ ... _investing

Even if they were at the same interest rates after tax deductions it is still really hard to directly compare the two options since if you keep the mortgage payment you will still have to make something like a $2,000 a month mortgage payment and the interest from the bond or CD will not be enough to pay that. With a paid off house you would have about an additional $2,000 a month.

If you are looking at 10 year investment then your loan balance will only be something like $350K in ten years so you would only need to buy a $350K CD, not a $575K CD.

Even if you do not plan on moving there is non-zero chance that you will move before your expect to which would make things even move complicated since there could be years left on the bond or CD

You also need to consider how much you would pay in capital gains taxes if you have to sell a lot of investments to raise the money to pay off the mortgage.

Another consideration is how long it will be before you retire. For many people having a paid off house by the time they retire works very well since it reduced the cash flow they will need in retirement.

The math is complicated but if your are able to juggle the investments and come out 0.1% ahead after taxes that would be $575 ($575,000 * 0.1%). At best the immediate payoff is pretty negligible especially compared to your income. The chance of a big pay off would be that in ten years the interest rates might be much higher and you would still have a 3.5% mortgage.

One option to consider if you cannot see a clear choice would be to call your lender and ask if they will "recast your mortgage"(Google this) if you pay down 50%(or whatever percent of your loan that makes sense to you). They are not required to do this but they usually will for a processing fee of a few hundred dollars. The way this works is that the interest rate and length of the loan stay the same but the required mortgage payment is reduced by the same percentage. Keeping the length of the loan as long as possible could be important if interest rates get a lot higher.
Thank you so much for the suggestion with recasting the mortgage as that idea never crossed my mind. Is there a specific formula / spread sheet where I can crunch the numbers ?
Artsdoctor wrote:
Sun May 27, 2018 6:12 am
I don't have time to crunch the numbers for you but here are some questions.

What's your age and marital status? Your marital status is important because you'll want to know if you're going to have $12,000 versus $24,000 in a standard deduction for federal taxes. Your mortgage interest may not be as significant as you think.

How important is cash flow to you? The concept of paying off your mortgage is a nice one but your house is a hard asset. You can't easily get money out once you pay it off. Is that OK with you?

Aside from the cash flow question, money is fungible. It shouldn't really matter where the money is, whether it's house, retirement account, taxable account, savings, checking, etc.

Your figures are questionable. Bankrate.com has a 5% CD yielding 2.8%. But why would be looking at CDs if you're marginal tax rate is over 40%, perhaps even susceptible to the NIIT? Shouldn't you be looking at munis?
I am married age 40 this year and the standard deduction is 24k but my interest alone on my mortgage last year was 20,274. With added medical expense which i can deduct , being self employed level, sep ira distribution,car reg and other expenses , prop tax I am way over the 24k so I am better off itemizing. I am very new in terms of cd vs munis and even the yielding tax rate. I will def look into that if someone can point me in the right direction for it.

delamer
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by delamer » Sun May 27, 2018 4:22 pm

I would not want 90% of my net worth tied up in real estate at age 40.

mjb
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by mjb » Sun May 27, 2018 9:38 pm

Being in California with higher tax rates, you might want to consider California municipal bond funds. Similar yield, tax free, and liquid.

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grabiner
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by grabiner » Sun May 27, 2018 10:09 pm

chhill121 wrote:
Sun May 27, 2018 2:17 am
I have a question relating to paying off the mortgage vs investing into the a CD or Treasury Yield

Taxable income - 32% plus california 9.3%

I currently owe 575k on my mortgage with 28 years and 2 months left at a 3.5% interest rate.
Most of the interest is deductible, so the after-tax, risk-free return on a mortgage payment is 2.05%, a bit higher if you pay off the whole thing and your other itemized deductions are less than $24K. (You are deducting the maximum $10K in state taxes, but I don't know whether you have other deductions such as charity.
I have enough funds to pay off my mortgage but it would pretty much leave me with about 100k left in liquid capital. All my retirements account are maxed out and I have about 100k in brokerage taxable account. My question is since the 30 year is about 3.1 right now, would it be smart to purchase a 30 year at 3.1 or even a 10 year at 2.92.
See Paying down loans versus investing on the wiki.

If you pay off your mortgage, that would be equivalent to buying a portfolio with a 12-year duration. A portfolio of Treasuries with a 12-year duration would yield about 3%, which would be 2.04% after tax, so that is break-even and keeps liquidity.

However, that particular investment isn't my recommendation, because of your high tax bracket. Admiral shares of Vanguard CA Long-Term Tax-Exempt yield 2.74%, free of federal and state tax; there is some credit risk but less duration risk because this fund has a 7-year-duration. To reduce the risk of having too much in CA, you could split 50/50 between Vanguard's CA and national long-term funds; the national fund yields 2.93%, which is 2.66% after CA tax. (The higher yield is not a free lunch; it implies that investors believe the bonds have somewhat more risk.)
Wiki David Grabiner

bmelikia
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by bmelikia » Sun May 27, 2018 10:21 pm

You probably are not in a position where you will be itemizing your taxes anymore due to the new standard deduction

Your 3.5% mortgage is a NET expense - which might be equal to a 4-4.5% CD on an after tax basis. So if you put your money in a 3-3.5% CD your NET return would be roughly 2.5-2.85% on an after after tax basis.

I would pay down the mortgage then decide if CDs are still right for you after that.

It could be that your need for CDs may be less necessary after having your mortgage paid off
"I would rather die with money, than live without it...." - Bogleheads member Ron | | "The greatest enemy of a good plan, is the dream of a perfect plan." | -Bogle

manedark
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by manedark » Mon May 28, 2018 1:07 am

I have taken that advise from grabiner and invested kn those Munis although a much smaller amount.

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Artsdoctor
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Re: CD / Treasury vs Paying off Mortgage - Rates are really close

Post by Artsdoctor » Tue May 29, 2018 8:12 am

"I am married age 40 this year and the standard deduction is 24k but my interest alone on my mortgage last year was 20,274. With added medical expense which i can deduct , being self employed level, sep ira distribution,car reg and other expenses , prop tax I am way over the 24k so I am better off itemizing. I am very new in terms of cd vs munis and even the yielding tax rate. I will def look into that if someone can point me in the right direction for it."

OK, don't do anything yet! You need to spend some time learning about taxes.

First, you will get $24,000 in a standard deduction if you do nothing. If you itemize and the total is $24,500, you'll be on Schedule A, but your real benefit will only be that added $500 in deductions.

Second, what you deduct is very different than what you're describing. Are you actually deducting medical expenses on Schedule A? I'm skeptical. I think what you're describing is the ability to deduct your medical insurance premiums from your income because you're self-employed. That is not on your Schedule A.

Third, being self-employed and having a SEP-IRA has very little to do with your ability to deduct on Schedule A.

Finally, your property tax (and state income tax) may indeed be high. But these deductions have been significantly curtailed with the new tax law. We may deduct only $10,000 in SALT now.

So from what you're describing, you may be deducting $20,000 in mortgage interest and $10,000 in SALT. Your standard deduction this year will be $24,000 so you're only playing with an added $6,000 in deductions (so let's say an extra $2,400 in your pocket).

If you're truly in the marginal tax brackets you say you are (and I don't think you're taking into consideration the NIIT), I would advise you to think twice about holding CDs in your taxable account.

I also don't think you've described how you're doing with meeting your financial goals--regarding your savings rate. You have a decent income, which may mean that you're going to want to be saving more than the maximum amount in your tax-deferred accounts. While it may seem sufficient to say that you're "maxing out" all of your "retirement accounts," there's a point when even that is not sufficient if you want to meet your needs.

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