Mortgage lump sum question - What would you do?

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AverageGolfer
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Mortgage lump sum question - What would you do?

Post by AverageGolfer » Sat Oct 06, 2018 10:04 am

Long time lurker here. This board has provided me great insights over the past 10 year or so, putting my family on the right financial path. Thank you all!

I've presented this scenario privately to a few people and was hoping for additional thoughts, recommendations...

Tax rate: 45M, MFJ, at the very top of the 15% bracket in 2017
2018 I will probably take the new standard deduction.

taxable account: $350k, but 170k in LTCG (all stock index funds)
** I can get about $135k of this out for limited capital gains cost, about $2.8k in taxes
EFund: 3-6 months expenses (about 20k)
Non Taxable: 670k across IRA's, 401K, etc. (I max out my 401K and 2 IRA's every year, the rest to taxable or 529)
Kids 12&9: about $60k saved up in 529's, saving about $350 per month total. I'm not sure if one is college material, but trying to prepare.

Overall asset allocation across portfolio: 70% stocks, 30% bonds (Total bond and TIPS all in tax deferred)

Mortgage: 15 year loan, 13 years remaining at 2.75% ($195k left on the loan, $350K value)

What would be your advice in this situation in regards to a mortgage pay down of $135k? Good idea? Bad idea?

The idea is to have mortgage done before Kid 1 gets to college age.

Many thanks,
AverageGolfer

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cheese_breath
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Re: Mortgage lump sum question - What would you do?

Post by cheese_breath » Sat Oct 06, 2018 10:23 am

Come back and ask me in 13 years, but my thoughts are I could probably average better than 2.75% growth with a good investment portfolio over that time period. I'd keep my $135K invested and continue making monthly payments on the mortgage.
The surest way to know the future is when it becomes the past.

mortfree
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Re: Mortgage lump sum question - What would you do?

Post by mortfree » Sat Oct 06, 2018 10:33 am

So you payoff your mortgage and then you have to take out student loans (at a higher rate)?

That 2.75% rate just may be priceless now.

Do you really want to plow 200k more of untouchable money (relatively) into your home??

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FiveK
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Re: Mortgage lump sum question - What would you do?

Post by FiveK » Sat Oct 06, 2018 4:47 pm

Assuming your gross income is ~$104K (close enough?), you might want to put only ~$2600 into traditional, and the rest into Roth. In other words, contribute enough to traditional to stay out of the 22% bracket, and pay the 12% for the privilege of using Roth.

And I'd hold on to a 2.75% mortgage as long as possible.

JoeRetire
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Re: Mortgage lump sum question - What would you do?

Post by JoeRetire » Sat Oct 06, 2018 6:56 pm

AverageGolfer wrote:
Sat Oct 06, 2018 10:04 am
What would be your advice in this situation in regards to a mortgage pay down of $135k? Good idea? Bad idea?
Bad idea to pay off such a cheap mortgage.
The idea is to have mortgage done before Kid 1 gets to college age.
Why? Are you losing a lot of sleep thinking about your mortgage payment these days?

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Taylor Larimore
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Re: Mortgage lump sum question - What would you do?

Post by Taylor Larimore » Sat Oct 06, 2018 7:21 pm

Mortgage: 15 year loan, 13 years remaining at 2.75% ($195k left on the loan, $350K value)

What would be your advice in this situation in regards to a mortgage pay down of $135k? Good idea? Bad idea?
Average Golfer:

Your 2.75% mortgage loan is valuable. It would be impossible to obtain this mortgage today. I'm not sure about the tax considerations, but your mortgage loan may be deductible which makes it even better.

I once had a GI low-interest mortgage on an apartment building. The 90% mortgage was assumable. When the buyer learned about the mortgage I was able to obtain a significantly higher price.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

Lafder
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Re: Mortgage lump sum question - What would you do?

Post by Lafder » Sat Oct 06, 2018 7:25 pm

You will feel brilliant and satisfied if you pull out the money to pay off the mortgage, and then the market crashes bad in the next year so that money does not drop in value, and you are able to trickle in the mortgage payments into the market :)

Assume the financial difference of paying off vs not is small. Then what would you feel more secure with ?

We ran some scenarios a decade ago, with varying rates of return on the money left invested, and the fixed cost of the mortgage. Versus paying off the mortgage and putting the payment equivalents into the market, losing the growth in the market,not having to pay the mortgage interest, and the added money from the equivalents of the mortgage payments put into the market. In our case, the numbers were close even as we played with adjusting the assumed market returns. But before we made a decision, the market crashed and we no longer had enough to consider paying off the mortgage.

So I am not biased to go ahead and pay off if you can :)

But, with minimal capital gains taxes.

lafder

OregonDucksFan
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Re: Mortgage lump sum question - What would you do?

Post by OregonDucksFan » Sat Oct 06, 2018 8:01 pm

If you've room at 0% capital gains and you don't expect to stay in 0% capital gains bracket, you could sell some to pay extra principal, but not so much to move you into 15% LTCG.

If you have to pay any LTCG to pay off the loan, I wouldn't pay off 2.75% mortgage.

delamer
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Re: Mortgage lump sum question - What would you do?

Post by delamer » Sat Oct 06, 2018 10:00 pm

I wouldn’t pay off the mortgage because the rate is so low. And you could just continue to pay it down normally for 6 years and reevaluate at that time.

However, given that you have significant other liquid assets, I don’t think it would be a huge mistake to pay it off now.

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car733
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Re: Mortgage lump sum question - What would you do?

Post by car733 » Sun Oct 07, 2018 12:29 am

wow! 2.75%... That's a keeper :wink:

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Watty
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Re: Mortgage lump sum question - What would you do?

Post by Watty » Sun Oct 07, 2018 12:57 am

AverageGolfer wrote:
Sat Oct 06, 2018 10:04 am
Overall asset allocation across portfolio: 70% stocks, 30% bonds
It is not exact but one issue with keeping the mortgage is that in many ways it is like having a negative bond and when you look at it that way it skews your asset allocation.

You have roughly a million in investments now so that you would have about $700K in stocks and $300K in bonds, but if you net out your mortgage from the bonds that is only about $100K in bonds. That is not exact but using the mortgage for leverage does make your portfolio more aggressive.

With keeping the mortgage you also have more sequence of returns risk. Here is a simplified example of this that I have posted before.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
All that said the 2.75% rate is really good so even though I am usually in the "pay it off" chorus I would have a time justifying paying that off.
AverageGolfer wrote:
Sat Oct 06, 2018 10:04 am
I can get about $135k of this out for limited capital gains cost, about $2.8k in taxes
One way to hedge your bets would to take that $135K out of the stock market and buy a 5 year CD with it that pays more than the mortgage interest rate. Preferably one that has only a small penalty to cash out early. That would take away some sequence of returns risk and also get your asset allocation closer to where you want it to be. In five years when the CD matures you can decide if paying the mortage down makes sense then.

CurlyDave
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Re: Mortgage lump sum question - What would you do?

Post by CurlyDave » Sun Oct 07, 2018 1:06 am

If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.

JoeRetire
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Re: Mortgage lump sum question - What would you do?

Post by JoeRetire » Sun Oct 07, 2018 7:35 am

CurlyDave wrote:
Sun Oct 07, 2018 1:06 am
If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.
Why would the bank give you a discount?

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grabiner
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Re: Mortgage lump sum question - What would you do?

Post by grabiner » Sun Oct 07, 2018 9:31 am

AverageGolfer wrote:
Sat Oct 06, 2018 10:04 am
** I can get about $135k of this out for limited capital gains cost, about $2.8k in taxes

Mortgage: 15 year loan, 13 years remaining at 2.75% ($195k left on the loan, $350K value)

What would be your advice in this situation in regards to a mortgage pay down of $135k? Good idea? Bad idea?
Wiki article link: Paying down loans versus investing

Since paying down the loan gives you a guaranteed return at a future date, it is analogous to buying a bond portfolio. (You can do the paydown without changing your risk, by moving an equal dollar amount in your 401(k) from bonds to stock.) Paying down your loan from 13 years to 3 would be equivalent to buying 120 bonds maturing in 3-13 years, with an overall duration slightly less than eight years. If you are in the 22% tax bracket, you can earn 3.09% on bonds with a seven-year duration (Vanguard Long-Term Tax-Exempt); if you are in the 12% bracket, you can earn 3.06% with a six-year duration and less risk (Intermediate-Term Bond Index, which is more than half Treasuries).

Therefore, you will lose a bit at the same risk level for paying down the mortgage, even though it is not deductible.
Wiki David Grabiner

Mike Scott
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Re: Mortgage lump sum question - What would you do?

Post by Mike Scott » Sun Oct 07, 2018 9:43 am

I don't think I would be looking at a partial paydown. I would go for all or none and probably lean toward the none given your loan terms. If the loan/debt bothers you, what about moving enough money for a full payoff into a CD or something similar that has a higher rate than the loan? You keep the liquidity and could use that money to payoff the loan anytime you wanted/needed.

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Re: Mortgage lump sum question - What would you do?

Post by The Wizard » Sun Oct 07, 2018 10:57 am

JoeRetire wrote:
Sun Oct 07, 2018 7:35 am
CurlyDave wrote:
Sun Oct 07, 2018 1:06 am
If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.
Why would the bank give you a discount?
Because you have an existing mortgage at 3.0% APR while they are writing new mortgages at 7.0% APR.
Well, that doesn't apply in 2018 but it did at one time...
Attempted new signature...

JoeRetire
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Re: Mortgage lump sum question - What would you do?

Post by JoeRetire » Sun Oct 07, 2018 1:50 pm

The Wizard wrote:
Sun Oct 07, 2018 10:57 am
JoeRetire wrote:
Sun Oct 07, 2018 7:35 am
CurlyDave wrote:
Sun Oct 07, 2018 1:06 am
If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.
Why would the bank give you a discount?
Because you have an existing mortgage at 3.0% APR while they are writing new mortgages at 7.0% APR.
Well, that doesn't apply in 2018 but it did at one time...
The question wasn't directed at you, and wasn't for some imaginary point in time. Sorry if that wasn't clear.

And even if we imagine a 3.0% versus 7.0% case, I've not heard of a bank actually doing this.
Have others seen this happen? Do you have a link to a source?

CurlyDave
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Re: Mortgage lump sum question - What would you do?

Post by CurlyDave » Tue Oct 09, 2018 1:26 am

JoeRetire wrote:
Sun Oct 07, 2018 7:35 am
CurlyDave wrote:
Sun Oct 07, 2018 1:06 am
If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.
Why would the bank give you a discount?
Because current mortgages are at much higher rates. $100k loaned @ 6% brings the same income as $150k loaned @ 4%.

In the late 80s people with low fixed rate mortgages were getting unsolicited offers from the mortgage holders of 80% payoffs. I know, I got them.

gotester2000
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Re: Mortgage lump sum question - What would you do?

Post by gotester2000 » Tue Oct 09, 2018 2:29 am

2.75% rate, primary mortgage interest deduction from income and age only 45- why would you prepay so cheap money?

rakish_weasel
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Re: Mortgage lump sum question - What would you do?

Post by rakish_weasel » Tue Oct 09, 2018 3:16 am

Average Golfer:

I am pretty much the same age as you, similar income, similar assets, and faced similar question just a couple months ago. Would recommend you read the thread on that, here: viewtopic.php?f=1&t=258536&p=4110539#p4110539

Key differences: I am single with no kids, and my mortgage rate was 3.75%, a full percentage point more than yours. Still relatively cheap rate, however, historically.

Another key difference: the payoff money I intended to use to pay off the mortgage was sitting in a rather large EF ($100K) -- because of this, the money was not invested in ETFs/mutualfunds, and there were no capital gains taxes to consider. So that, coupled with the higher interest rate, made my situation a bit more of a no-brainer than perhaps yours is -- but still fairly similar situations overall.

That said, a month ago did pull the trigger and paid off the remaining $87K of the mortgage with EF money --- it did lower my EF significantly, but with the mortgage eliminated my monthly expenses are pretty much halved, which means that smaller EF goes a much longer ways. I went from ~2 yrs EF, down to about 18 mos -- still healthy, but I'm slowly working it back up to 2 years' worth.

A month after the fact, I can tell you this much: I do not regret the move at all. Quite the opposite -- it is an incredible feeling. People will tell you that the low mortgage rate is valuable and that you can earn more in the markets -- and there's some real truths to that. Nobody knows where the markets will go in the next 5-10 year, and it's a fool's errand to attempt to guess. All I'll say is that we ARE in Year 10 of a bull market, and so it's probably safe to say we are not in the *beginning* of a bull, and that it's much more likely that we're in the mature/waning years of one. Nobody knows for sure, but... I think there is value in diversifying assets. I was pretty heavily tilted towards equities (hardly any bonds in my portfolio), and so I liked the idea of diversifying assets by paying off mortgage whilst continuing to max out 401K and Roth IRA contributions.

The peace of mind and the certain 'lightness' and feeling of freedom that comes from paying off your mortgage -- this is not a measurable thing, but is not to be underestimated. I could very well have squeezed out a bit more from the markets than my 3.75% rate... but that was never guaranteed, as the markets could easily downturn tomorrow. The 3.75%? That's a rock-solid 100% guaranteed return. That, coupled with the peace of mind that goes with not owing a dime to anybody... well, each person has to decide for him/her self what that's worth... but to me it was unequivocally worth it. No regrets, and very much enjoying the new mortgage-free life. I do encourage you to read the thread I linked above, and consider it from all angles, and make the choice that is best for *you* and your family -- there really is no right/wrong in this particular instance.

Let us know what you wind up doing, and regards,
-RW

AverageGolfer
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Re: Mortgage lump sum question - What would you do?

Post by AverageGolfer » Tue Oct 09, 2018 8:03 am

rakish_weasel wrote:
Tue Oct 09, 2018 3:16 am
Average Golfer:

I am pretty much the same age as you, similar income, similar assets, and faced similar question just a couple months ago. Would recommend you read the thread on that, here: viewtopic.php?f=1&t=258536&p=4110539#p4110539

Key differences: I am single with no kids, and my mortgage rate was 3.75%, a full percentage point more than yours. Still relatively cheap rate, however, historically.

Another key difference: the payoff money I intended to use to pay off the mortgage was sitting in a rather large EF ($100K) -- because of this, the money was not invested in ETFs/mutualfunds, and there were no capital gains taxes to consider. So that, coupled with the higher interest rate, made my situation a bit more of a no-brainer than perhaps yours is -- but still fairly similar situations overall.

That said, a month ago did pull the trigger and paid off the remaining $87K of the mortgage with EF money --- it did lower my EF significantly, but with the mortgage eliminated my monthly expenses are pretty much halved, which means that smaller EF goes a much longer ways. I went from ~2 yrs EF, down to about 18 mos -- still healthy, but I'm slowly working it back up to 2 years' worth.

A month after the fact, I can tell you this much: I do not regret the move at all. Quite the opposite -- it is an incredible feeling. People will tell you that the low mortgage rate is valuable and that you can earn more in the markets -- and there's some real truths to that. Nobody knows where the markets will go in the next 5-10 year, and it's a fool's errand to attempt to guess. All I'll say is that we ARE in Year 10 of a bull market, and so it's probably safe to say we are not in the *beginning* of a bull, and that it's much more likely that we're in the mature/waning years of one. Nobody knows for sure, but... I think there is value in diversifying assets. I was pretty heavily tilted towards equities (hardly any bonds in my portfolio), and so I liked the idea of diversifying assets by paying off mortgage whilst continuing to max out 401K and Roth IRA contributions.

The peace of mind and the certain 'lightness' and feeling of freedom that comes from paying off your mortgage -- this is not a measurable thing, but is not to be underestimated. I could very well have squeezed out a bit more from the markets than my 3.75% rate... but that was never guaranteed, as the markets could easily downturn tomorrow. The 3.75%? That's a rock-solid 100% guaranteed return. That, coupled with the peace of mind that goes with not owing a dime to anybody... well, each person has to decide for him/her self what that's worth... but to me it was unequivocally worth it. No regrets, and very much enjoying the new mortgage-free life. I do encourage you to read the thread I linked above, and consider it from all angles, and make the choice that is best for *you* and your family -- there really is no right/wrong in this particular instance.

Let us know what you wind up doing, and regards,
-RW
Thanks Rakish (and others for replying as well),

I checked out your thread and many others on this topic. There is no shortage of these payoff threads and they are all very helpful, thank you! I think what's driving my interest in payoff is the bull run we've been on. My gains alone in the taxable account are almost enough to knock out the mortgage completely, but with sizable capital gains. It would not be surprising to me to see that balance drop considerably in the next year or two. I can payoff about 3/4 of it with minimal tax hit. I realize it probably makes little sense financially on the surface, but shouldn't the length of this bull run factor into the equation? Is 28% of my net worth in the house too much?

JoeRetire
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Re: Mortgage lump sum question - What would you do?

Post by JoeRetire » Tue Oct 09, 2018 10:11 am

CurlyDave wrote:
Tue Oct 09, 2018 1:26 am
JoeRetire wrote:
Sun Oct 07, 2018 7:35 am
CurlyDave wrote:
Sun Oct 07, 2018 1:06 am
If you really, seriously want to pay off the mortgage (I think it is a bad idea) you could contact the bank and ask what kind of discount they would give you for an immediate payment in full.

I suspect you could pay off the mortgage at 90 cents on the dollar, maybe less.
Why would the bank give you a discount?
Because current mortgages are at much higher rates. $100k loaned @ 6% brings the same income as $150k loaned @ 4%.

In the late 80s people with low fixed rate mortgages were getting unsolicited offers from the mortgage holders of 80% payoffs. I know, I got them.
What was the spread between the mortgage rate you held and the going rates in the late 80s?
What do you think the spread is today?

rakish_weasel
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Re: Mortgage lump sum question - What would you do?

Post by rakish_weasel » Wed Oct 10, 2018 4:09 pm

AverageGolfer -- I don't think 28% is all that unusual or ill-advised, as a percent of NW. Above 50%, it gets more suspect. But it really boils down to what your desired AA is. Some folks here will treat bonds and home equity as two totally different things, which they are.... but I tend to take a more distilled view along the lines of "Equities vs. Bonds/House". To that extent, if your desired AA is 70/30, then 28% of NW in your house means you could shift more of your investable assets into equities. To be clear -- plenty on BH will disagree with this, and I'd suggest you listen to them as well. I look at it more from a "risky vs. less-risky" standpoint, and home equity falls into the latter. Since my own house equity is around 26% of my NW, my actual investable assets' AA tilts heavier towards equities as a result. Without the house, I'd have more in bonds.

Biggest thing is to decide on an AA, decide on how/if you want to include your home equity in that equation, and then stick to your AA, rebalancing periodically as needed.

As for your "shouldn't the length of this bull run factor into the equation?" question... many people on here will say 'no'. The logic here is that one shouldn't time the market -- and that should hold true whether just embarking on a bull, deep into a mature bull (as we are now), or starting or deep into a recession. In other words -- it doesn't matter, the theory goes, just stick to your AA and ignore the market fluctuations.

Personally, I find it impossible to ignore that we're in Year 10 of a bull market. I don't take that to mean that we're thusly about to hit a recession, but... I do think it means we are *unlikely* to see another 10 years of bull run tacked onto this past 10. That's why I felt comfortable shifting $87K or so of cash assets into home equity to lock in a 3.75% gain -- it was a diversification of assets, so that not all of my income/assets went to riskier bets like equities.

As to whether you should cash in investments to do this... I have less strong a feeling about that. I don't tend to touch my taxable account as a general rule, regardless of what the markets are doing -- but that's not to say you shouldn't do it. I would simply examine how your *overall* AA shifts, if you were do what you're suggesting. Would you end up on or near your desired overall AA if you sold $135k of taxable funds and plowed them into the mortgage? If so, I don't think you'd be doing much harm. But at 2.75%, it's a smaller gain, to be sure.

Lastly, I might try to get a bit more accuracy on your EF size. You state your $20K is good for about "3-6 months." That's a pretty sizeable range there. I'd want a clearer picture of my monthly expenses, to determine if that $20k is really only good for 3 months, or if it is actually more like 6. Only you can decide what a proper EF for you is... but I'd suggest that with a wife and two kids who are a number of years away from flying the nest, that an EF of at least 6 months is advisable, with 12 mos not being a bad idea at all. 3 mos is pushing it, unless you feel exceedingly confident you can hop right to another job in case your current one is suddenly taken from the picture.

-RW

AverageGolfer
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Re: Mortgage lump sum question - What would you do?

Post by AverageGolfer » Wed Oct 10, 2018 6:03 pm

Many thanks for the well thought out response, RW. My "emergency fund" in PMM and Ally also doubles as a collection point for annual Roth contributions, so it is probably closer to 3 months of expenses. I always considered the large taxable account as the 2nd tier for any real issues like job loss (as well as my wife's smaller income).

Thanks again. I'll probably end up waiting it out for a few years, build up more cash and see where I stand.

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