Investing Inheritance

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maverick1099
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Investing Inheritance

Post by maverick1099 » Tue Jul 12, 2011 9:17 pm

Quick History:

Married, both 30
Only debt is mortgage ~490k@5%
Marginal tax rate 25%/9.55% (CA)
Effective tax rate: 18.6%/6.2%
AA - 70/30
401k contributions his-max, hers-~14k (working to max this out)
Emergency fund - 6-9 months and growing


We are working to lower our AGI even more to get below the Roth contribution limit.

Currently I do not have any taxable investments.

Unfortunately my grandfather passed away in the spring and has left my family with some inheritance. I am not sure exactly how much money there will be in the end (in the process of selling his paid off house). I am estimating ~150k at this point and I am at a loss for the proper way to invest this. Assuming it is invested in a taxable account I know I will want a tax efficient set of investments and generally to stay away from bonds for this type of account.

I could really use some guidance on this one...

Thanks
Mike

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jainn
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Re: Investing Inheritance

Post by jainn » Tue Jul 12, 2011 10:03 pm

maverick1099 wrote:Quick History:

Married, both 30
Only debt is mortgage ~490k@5%
Marginal tax rate 25%/9.55% (CA)
Effective tax rate: 18.6%/6.2%
AA - 70/30
401k contributions his-max, hers-~14k (working to max this out)
Emergency fund - 6-9 months and growing


We are working to lower our AGI even more to get below the Roth contribution limit.

Currently I do not have any taxable investments.

Unfortunately my grandfather passed away in the spring and has left my family with some inheritance. I am not sure exactly how much money there will be in the end (in the process of selling his paid off house). I am estimating ~150k at this point and I am at a loss for the proper way to invest this. Assuming it is invested in a taxable account I know I will want a tax efficient set of investments and generally to stay away from bonds for this type of account.

I could really use some guidance on this one...

Thanks

Mike
If you deposit the 150k and write a check to your mortgage company you will reduce your mortgage payoff date from 2040 to 2026, assuming you have a 30 year mortgage created 1 year ago (2010). How does that sound?

If that doesn't sound good to you, you may be more risk taking. If so, then I would suggest putting 10% in a 1 year CD and the remaining in Vanguard Total World Stock Index ETF, NYSE ticker: VT, with no intention to sell for 30 years or retirement, whichever comes first.

You can also contribute a total of 10k between your Roth IRA and your wifes Roth IRA for 2011.

Regards

maverick1099
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Joined: Thu Dec 09, 2010 1:10 am

Post by maverick1099 » Tue Jul 12, 2011 10:51 pm

If you deposit the 150k and write a check to your mortgage company you will reduce your mortgage payoff date from 2040 to 2026, assuming you have a 30 year mortgage created 1 year ago (2010). How does that sound?
I thought about this and I am a little weary of it for the simple reason that I know this will not be our "final" home. I would venture to guess we will be moving in ~5yr time period. Given the state of things and the short horizon I am not sure investing in equity is the right move. I am certainly open to the possibility that I am entirely wrong though.
If that doesn't sound good to you, you may be more risk taking. If so, then I would suggest putting 10% in a 1 year CD and the remaining in Vanguard Total World Stock Index ETF, NYSE ticker: VT, with no intention to sell for 30 years or retirement, whichever comes first.
For my own edification, is there a reason you chose the %'s and fund/CD?
I am assuming the fund is tax efficient, but I would get taxed on the CD gains? I like the idea of having some of it in a more secure investment like the CD but the interest rates are pretty weak right now, no?
You can also contribute a total of 10k between your Roth IRA and your wifes Roth IRA for 2011.
Agreed. Assuming we can get ourselves back to an eligible status I would like to max out the Roth's regardless of the inheritance.

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jainn
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Post by jainn » Tue Jul 12, 2011 11:41 pm

maverick1099 wrote:
If you deposit the 150k and write a check to your mortgage company you will reduce your mortgage payoff date from 2040 to 2026, assuming you have a 30 year mortgage created 1 year ago (2010). How does that sound?
I thought about this and I am a little weary of it for the simple reason that I know this will not be our "final" home. I would venture to guess we will be moving in ~5yr time period. Given the state of things and the short horizon I am not sure investing in equity is the right move. I am certainly open to the possibility that I am entirely wrong though.
If that doesn't sound good to you, you may be more risk taking. If so, then I would suggest putting 10% in a 1 year CD and the remaining in Vanguard Total World Stock Index ETF, NYSE ticker: VT, with no intention to sell for 30 years or retirement, whichever comes first.
For my own edification, is there a reason you chose the %'s and fund/CD?
I am assuming the fund is tax efficient, but I would get taxed on the CD gains? I like the idea of having some of it in a more secure investment like the CD but the interest rates are pretty weak right now, no?
You can also contribute a total of 10k between your Roth IRA and your wifes Roth IRA for 2011.
Agreed. Assuming we can get ourselves back to an eligible status I would like to max out the Roth's regardless of the inheritance.

If you guess you will be moving in 5 years you can still add equity to your home and ultimately be mortgage free in 15 years in the off chance you do not move. If you do move - the equity will result in cash when you sell.

The reasoning behind 90% invested in fund and 10% in CD was that I understand it is nearly impossible to inherit a particular sum of money and not use at least 1% of it for fun. Putting 10% of the inheritence in a illiquid CD gives you time to think and ultimately when it expires you can decide what you want to do with the $15k. The 90% into ETF ticker VT is tax effecient and encapsulates the entire world with ~2900 stocks.

You can read up on Vanguard VT etf via google - can google "Vanguard VT" without the quotes.

Regards

FireProof
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Post by FireProof » Wed Jul 13, 2011 12:15 am

VT is pointless. VTI + VXUS is both cheaper and better diversified.

maverick1099
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Post by maverick1099 » Wed Jul 13, 2011 12:20 am

If you guess you will be moving in 5 years you can still add equity to your home and ultimately be mortgage free in 15 years in the off chance you do not move. If you do move - the equity will result in cash when you sell.
Good point. I guess my concern is putting money into equity and having continued decline of the housing market to the point I begin to loose the equity I put in...
The reasoning behind 90% invested in fund and 10% in CD was that I understand it is nearly impossible to inherit a particular sum of money and not use at least 1% of it for fun. Putting 10% of the inheritence in a illiquid CD gives you time to think and ultimately when it expires you can decide what you want to do with the $15k. The 90% into ETF ticker VT is tax effecient and encapsulates the entire world with ~2900 stocks.
Makes sense. I figured I would use around 10k but this seems like a good approach as well.
You can read up on Vanguard VT etf via google - can google "Vanguard VT" without the quotes.
I will check this one out.
Thanks for the recommendation

Bob's not my name
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Post by Bob's not my name » Wed Jul 13, 2011 4:13 am

You can do back door Roths even if you're over the phaseout for direct contributions. You can read about back door Roths on the wiki. I forget if they spell back door as one word or two.

trasmuss
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Post by trasmuss » Wed Jul 13, 2011 6:13 am

You may wish to consider the admiral version of Vanguard's Total Stock Market fund. It is tax efficient and has a very low expense. You can use your 401k for bonds.

If you wish you can reinvest dividends until you retire, take dividends at retirement, and leave it to heirs (tax free stepped up basis). They can then repeat the process and in effect create a legacy fund that can last forever.

John Bailout
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Post by John Bailout » Wed Jul 13, 2011 11:14 am

maverick1099 wrote:
If you guess you will be moving in 5 years you can still add equity to your home and ultimately be mortgage free in 15 years in the off chance you do not move. If you do move - the equity will result in cash when you sell.
Good point. I guess my concern is putting money into equity and having continued decline of the housing market to the point I begin to loose the equity I put in...
So you are implying you are getting ready to walk away from your mortgage?

Unless you are able to shirk the responsibility of paying back what you owe, paying off your mortgage early vs. stashing the money outside of the mortgage at a similar interest rate comes to the same outcome (time value of money ignored) if you sell the house at a lower price than what you paid for. Or am I missing something?

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Watty
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Post by Watty » Wed Jul 13, 2011 11:33 am

If you deposit the 150k and write a check to your mortgage company you will reduce your mortgage payoff date from 2040 to 2026, assuming you have a 30 year mortgage created 1 year ago (2010). How does that sound?

It would sound better if you did this to either;

1) Call your lender first and ask if they will "recast your mortage" (google this) and reduce your monthely mortage payment by more than a quarter. You can still pay more if you want.

2) Run the numbers to see if refinancing to a 15 year mortage to get a lower interest rate after you paid down the mortage would make sense.
Last edited by Watty on Wed Jul 13, 2011 11:41 am, edited 1 time in total.

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amdmaxx
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Post by amdmaxx » Wed Jul 13, 2011 11:40 am

Another vote for using $150k towards your mortgage principal.

spencer99
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Re: Investing Inheritance

Post by spencer99 » Wed Jul 13, 2011 1:25 pm

maverick1099 wrote:
I could really use some guidance on this one...

First of all, sorry for your loss Mike.

I'd advise you to avoid the pressure to do something now. You've got plenty of time to do this right. I'd recommend you place the money somewhere safe/secure ... maybe a CD. Then work through this in your own good time, do lots of reading (list on this forum's wiki), monitor this forum, and ultimately develop a comprehensive investment policy statment that brings together the inherited money with your current investments in a fully realized investment plan that achieves your long-term objectives.

Good luck,

S

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hand
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Post by hand » Wed Jul 13, 2011 2:03 pm

I'd suggest putting at least $73k towards your mortgage to get you under the $417k conforming mortgage threshold. Assuming good credit and house worth > $520k (80% LTV) , you should then be able to do a no-cost refi to drop your 30 year rate below 4.5%.

This would improve your finances in a number of ways:
a) 5% return on the 70k you invest until such time as you sell the house
b) 0.5% reduction in interest payments on the remaining mortgage ($2k savings first year)
c) Monthly cashflow required to service mortgage reduced

There are numerous options for the remaining funds, but this type of guaranteed return is the holy grail of investing!!

YDNAL
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Re: Investing Inheritance

Post by YDNAL » Wed Jul 13, 2011 2:25 pm

maverick1099 wrote:Only debt is mortgage ~490k@5%
Marginal tax rate 25%/9.55% (CA)

Unfortunately my grandfather passed away in the spring and has left my family with some inheritance. I am not sure exactly how much money there will be in the end (in the process of selling his paid off house). I am estimating ~150k at this point and I am at a loss for the proper way to invest this. Assuming it is invested in a taxable account I know I will want a tax efficient set of investments and generally to stay away from bonds for this type of account.
Mike,

Consider grandpa's gift to reduce 5% mortgage debt.

Even after tax deduction, you are guaranteed a good risk-free return. Bottom line, he would have helped you get rid of debt much faster and with much less cost (interest).
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Aptenodytes
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Post by Aptenodytes » Wed Jul 13, 2011 2:40 pm

In addition to the good ideas already put forth, you could consider:

+ Use the inheritance to make sure you max out every conceivable payment toward tax-sheltered accounts for the next several years. You have one 401K that is not currently maxed; that implies you don't have income to support maxing it. Draw from the inheritance to max this one out. Do you have any self-employment income? Create a SEP IRA and max that out too. Sounds like you can do a back-door Roth, so use this money to max out those too. In other words, keep some of the inheritance in cash to support your behavior of maxing out every conceivable tax-sheltered account.

+ Nobody has raised college tuition yet, and there are different approaches. If you might be planning to have children soon and would like to pay for as much of their college as possible, consider parking the inheritance in cash and then pile it into 529s or similar vehicles when the first child is born. You can front load a 529 with 5-years' worth of contributions (I think that'd be about $60K).

If those ideas don't carry you too far, then I would be inclined to leave your mortgage as is (your rate is reasonably low already) and put the whole thing in a small number of index funds and consider it part of of your retirement portfolio.

maverick1099
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Post by maverick1099 » Wed Jul 13, 2011 6:41 pm

You can do back door Roths even if you're over the phaseout for direct contributions. You can read about back door Roths on the wiki. I forget if they spell back door as one word or two.
I will have to take a closer look at this. I am assuming this is done via a traditional IRA that is then converted. Is there a tax liability to this?
You may wish to consider the admiral version of Vanguard's Total Stock Market fund. It is tax efficient and has a very low expense. You can use your 401k for bonds.

If you wish you can reinvest dividends until you retire, take dividends at retirement, and leave it to heirs (tax free stepped up basis). They can then repeat the process and in effect create a legacy fund that can last forever.
This is an interesting idea as well because I have been wondering how I would maintain my AA @ 70/30 given the tax inefficiency of bond funds. I would still be heavily weighted towards stock funds.
So you are implying you are getting ready to walk away from your mortgage?

Unless you are able to shirk the responsibility of paying back what you owe, paying off your mortgage early vs. stashing the money outside of the mortgage at a similar interest rate comes to the same outcome (time value of money ignored) if you sell the house at a lower price than what you paid for. Or am I missing something?
No not at all. Sorry if I gave that impression. I was simply concerned about the possibility of the housing market continuing to decline (thus eating up my additional equity bit by bit) and, perhaps, not recovering in the short time horizon of 5 yrs. Does that make sense or am I missing something?
It would sound better if you did this to either;

1) Call your lender first and ask if they will "recast your mortage" (google this) and reduce your monthely mortage payment by more than a quarter. You can still pay more if you want.

2) Run the numbers to see if refinancing to a 15 year mortage to get a lower interest rate after you paid down the mortage would make sense.
I have not heard of recasting... I will have to take a look. I had not thought about the 15 year option either. Thanks for bring these up!
Another vote for using $150k towards your mortgage principal.
Seems we are drawing closer to a consensus... :wink:
First of all, sorry for your loss Mike.

I'd advise you to avoid the pressure to do something now. You've got plenty of time to do this right. I'd recommend you place the money somewhere safe/secure ... maybe a CD. Then work through this in your own good time, do lots of reading (list on this forum's wiki), monitor this forum, and ultimately develop a comprehensive investment policy statment that brings together the inherited money with your current investments in a fully realized investment plan that achieves your long-term objectives.

Good luck,

S
Thank you for the condolences. This seems like sage advice. I am in no rush at the moment since there have been no distributions from the trust at this time. Having never been through this before I am guessing when I say I think this is at least 3-6 months out so I am trying to take the time in the interim to formulate a well thought out plan so I am prepared when the time comes.
I'd suggest putting at least $73k towards your mortgage to get you under the $417k conforming mortgage threshold. Assuming good credit and house worth > $520k (80% LTV) , you should then be able to do a no-cost refi to drop your 30 year rate below 4.5%.

This would improve your finances in a number of ways:
a) 5% return on the 70k you invest until such time as you sell the house
b) 0.5% reduction in interest payments on the remaining mortgage ($2k savings first year)
c) Monthly cashflow required to service mortgage reduced

There are numerous options for the remaining funds, but this type of guaranteed return is the holy grail of investing!!
Good point about getting out of jumbo to lower the rates. Definitely worth looking at. Do you think 5% appreciation is a reasonable assumption right now? My gut, uneducated, reaction to this is it seems optimistic? Points b) and c) are indeed appealing!
Mike,

Consider grandpa's gift to reduce 5% mortgage debt.

Even after tax deduction, you are guaranteed a good risk-free return. Bottom line, he would have helped you get rid of debt much faster and with much less cost (interest).
What would you do with the remaining funds? 5% ~25000$ unless I am misunderstanding your point entirely?

In addition to the good ideas already put forth, you could consider:

+ Use the inheritance to make sure you max out every conceivable payment toward tax-sheltered accounts for the next several years. You have one 401K that is not currently maxed; that implies you don't have income to support maxing it. Draw from the inheritance to max this one out. Do you have any self-employment income? Create a SEP IRA and max that out too. Sounds like you can do a back-door Roth, so use this money to max out those too. In other words, keep some of the inheritance in cash to support your behavior of maxing out every conceivable tax-sheltered account.

+ Nobody has raised college tuition yet, and there are different approaches. If you might be planning to have children soon and would like to pay for as much of their college as possible, consider parking the inheritance in cash and then pile it into 529s or similar vehicles when the first child is born. You can front load a 529 with 5-years' worth of contributions (I think that'd be about $60K).

If those ideas don't carry you too far, then I would be inclined to leave your mortgage as is (your rate is reasonably low already) and put the whole thing in a small number of index funds and consider it part of of your retirement portfolio.
I think a hybrid approach is making more sense to me. We do not have children at the moment and are undecided going forward. From my understanding ensuring retirement and/or reducing my mortgage liability will free up more cash that can then be allocated to college funds should the need arise. Am I way off base?

Thanks for all the great feed back so far!
Mike

YDNAL
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Re: Investing Inheritance

Post by YDNAL » Wed Jul 13, 2011 6:50 pm

maverick1099 wrote:
YDNAL wrote:Mike,

Consider grandpa's gift to reduce 5% mortgage debt.

Even after tax deduction, you are guaranteed a good risk-free return. Bottom line, he would have helped you get rid of debt much faster and with much less cost (interest).
What would you do with the remaining funds? 5% ~25000$ unless I am misunderstanding your point entirely?
Mike, yes, you sure misunderstood my post.

Your "5% mortgage debt" is ~$490K. Reduce it by $150K from grandpa.
maverick1099 wrote:Only debt is mortgage ~490k@5%
Marginal tax rate 25%/9.55% (CA)
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Post by maverick1099 » Wed Jul 13, 2011 6:53 pm

Got it...
Thanks for clarifying.

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Post by Ping Pong » Wed Jul 13, 2011 7:04 pm

maverick1099 wrote: No not at all. Sorry if I gave that impression. I was simply concerned about the possibility of the housing market continuing to decline (thus eating up my additional equity bit by bit) and, perhaps, not recovering in the short time horizon of 5 yrs. Does that make sense or am I missing something?
If your house declines by $50,000, it won't matter if you've paid down your mortgage or not. You'll still be out $50,000 when you sell.

The only exception is if you're underwater and willing to walk away and the bank can't come after you.

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Re: Investing Inheritance

Post by YDNAL » Wed Jul 13, 2011 7:12 pm

Ping Pong wrote:
maverick1099 wrote: No not at all. Sorry if I gave that impression. I was simply concerned about the possibility of the housing market continuing to decline (thus eating up my additional equity bit by bit) and, perhaps, not recovering in the short time horizon of 5 yrs. Does that make sense or am I missing something?
If your house declines by $50,000, it won't matter if you've paid down your mortgage or not. You'll still be out $50,000 when you sell.
If the market value decreases, you obviously don't get that (the market value) back. A mortgage reduction is always there to get back.

House $200K
Loan $100K
Equity $100K

New Price $150K
Loan $100K*
Equity $50K

* If you reduced the loan $50K (say), you get that back on a sale.

New Price $150K
New Loan $50K
Equity $100K
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

maverick1099
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Post by maverick1099 » Wed Jul 13, 2011 11:28 pm

If the market value decreases, you obviously don't get that (the market value) back. A mortgage reduction is always there to get back.

House $200K
Loan $100K
Equity $100K

New Price $150K
Loan $100K*
Equity $50K

* If you reduced the loan $50K (say), you get that back on a sale.

New Price $150K
New Loan $50K
Equity $100K
Makes sense... unless your house value depreciates after the mortgage reduction.

New Price $150K
New Loan $50K
Equity $100K

Market drops 20%
New New Price $120K
New Loan $50K
Equity $70K

Which is actually a 60% loss on the money put in to lower the mortgage. This is my concern about putting it all into the mortgage given the volatility of the housing market. I have read predictions of 20% loss over the next 2yrs due to the over abundance of inventory further depressing house prices. Of course, this may or may not happen and nobody knows for sure. If we assume a continued declined for the next 2 years and I am looking at a 5 year time horizon that only leaves 3 years or so to recover and maybe gain equity if I am lucky. Hence my initial hesitance... Now if I was in a house that I planned to stay in for the next 30+ years, I would not hesitate to use the inheritance to reduce the mortgage.
Am I being overly pessimistic?

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hand
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Post by hand » Thu Jul 14, 2011 4:27 am

I'd suggest putting at least $73k towards your mortgage to get you under the $417k conforming mortgage threshold. Assuming good credit and house worth > $520k (80% LTV) , you should then be able to do a no-cost refi to drop your 30 year rate below 4.5%.

This would improve your finances in a number of ways:
a) 5% return on the 70k you invest until such time as you sell the house
b) 0.5% reduction in interest payments on the remaining mortgage ($2k savings first year)
c) Monthly cashflow required to service mortgage reduced

There are numerous options for the remaining funds, but this type of guaranteed return is the holy grail of investing!!
Good point about getting out of jumbo to lower the rates. Definitely worth looking at. Do you think 5% appreciation is a reasonable assumption right now? My gut, uneducated, reaction to this is it seems optimistic? Points b) and c) are indeed appealing!

Apologies for being unclear. The 5% is not an assumption of appreciation, but rather a guaranteed "return" (or interest savings) on each dollar prepaid. (If you borrowed $100 at 5% for a year, you would owe $105 at the end of the year; if you repay the $100 immediately, you only owe the $100 and at the end of the year, you have $5 in your pocket that you wouldn't otherwise have.) This is why so many posters recommend to prepay your mortgage - your guaranteed "return" (or interest savings) on a $150k prepayment is roughly $7,500 a year(!).

Note mortgage interest is sometimes deductible, so actual "return" may be a bit less than 5% depending on your tax situation, but still a pretty sweet deal as zero risk.

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Re: Investing Inheritance

Post by YDNAL » Thu Jul 14, 2011 6:04 am

maverick1099 wrote:
If the market value decreases, you obviously don't get that (the market value) back. A mortgage reduction is always there to get back.

House $200K
Loan $100K
Equity $100K

New Price $150K
Loan $100K*
Equity $50K

* If you reduced the loan $50K (say), you get that back on a sale.

New Price $150K
New Loan $50K
Equity $100K
Makes sense... unless your house value depreciates after the mortgage reduction.

New Price $150K
New Loan $50K
Equity $100K

Market drops 20%
New New Price $120K
New Loan $50K
Equity $70K

Which is actually a 60% loss on the money put in to lower the mortgage. This is my concern about putting it all into the mortgage given the volatility of the housing market. I have read predictions of 20% loss over the next 2yrs due to the over abundance of inventory further depressing house prices. Of course, this may or may not happen and nobody knows for sure. If we assume a continued declined for the next 2 years and I am looking at a 5 year time horizon that only leaves 3 years or so to recover and maybe gain equity if I am lucky. Hence my initial hesitance... Now if I was in a house that I planned to stay in for the next 30+ years, I would not hesitate to use the inheritance to reduce the mortgage.
You shouldn't mix apples and oranges.
1. You don't control the market (apples).
2. You DO control the debt (oranges).
3. Whether/not Market Value drops 20%, you owe ~$460K.
4. Whether/not Market Value drops 20%, if you reduced the debt by $150K, you owe $310K.
Am I being overly pessimistic?
I don't know.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Post by maverick1099 » Thu Jul 14, 2011 10:24 am

Apologies for being unclear. The 5% is not an assumption of appreciation, but rather a guaranteed "return" (or interest savings) on each dollar prepaid. (If you borrowed $100 at 5% for a year, you would owe $105 at the end of the year; if you repay the $100 immediately, you only owe the $100 and at the end of the year, you have $5 in your pocket that you wouldn't otherwise have.) This is why so many posters recommend to prepay your mortgage - your guaranteed "return" (or interest savings) on a $150k prepayment is roughly $7,500 a year(!).

Note mortgage interest is sometimes deductible, so actual "return" may be a bit less than 5% depending on your tax situation, but still a pretty sweet deal as zero risk.
I see what you are saying. Good point, thanks for clarifying.
You shouldn't mix apples and oranges.
1. You don't control the market (apples).
2. You DO control the debt (oranges).
3. Whether/not Market Value drops 20%, you owe ~$460K.
4. Whether/not Market Value drops 20%, if you reduced the debt by $150K, you owe $310K.
This is a good alternative way to look at it. Good counter point so to speak and exactly the input I was looking for.

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Re: Investing Inheritance

Post by maverick1099 » Thu Feb 23, 2012 2:55 pm

Update -

Married, both 30
Only debt is mortgage:
391k@3.125% on a 7/1 over a 30yr term
87k@6.5% over a 15yr term (about 3 years into it)
Marginal tax rate 25%/9.55% (CA)
Effective tax rate: 18.6%/6.2%
AA - 70/30
401k contributions his-max, hers-~14k (working to max this out)
Emergency fund - 6-9 months and growing

What has changed:
We restructured our first mortgage to lower the rate to the 3.125% we have now. This has lowered our monthly payments a good chunk ~$600. We are currently still paying the original monthly payment, which is to say we are prepaying on the principle by ~$600/mo.
We had the 2nd mortgage before but I had not broken it out.
We have a number of potential tax deductions coming to us in the form of a K-1 from the trust.
My wife has switched to my health ins, which means I have another ~$325 pre tax deduction to my check (should help AGI).
We are hopeful with the new deductions and the higher ROTH phase out income range will allow us to contribute to ROTHs.

I took the advice to sit tight on the cash and let some time pass before doing anything. I am glad I did so as we have a much lower rate on our mortgage now which is pushing me towards taxable investing. Our mortgage interest is deductible so I am pretty sure the effective rate on the 1st mortgage is well below 3% which is the traditional inflation rate (side note: how do I calculate the effective rate?).

On the other hand, paying off the 2nd reduces the monthly payment by an additional $875 which could, in turn, but put towards a taxable investing account...

I am still on the fence whether or not to invest in a taxable account (after all pre tax accounts are maxed, of course), pay off the 2nd mortgage or some combination of the two.

With the new information/developments, what would you suggest?

Thanks
Mike

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damjam
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Re: Investing Inheritance

Post by damjam » Thu Feb 23, 2012 5:16 pm

maverick1099 wrote: how do I calculate the effective rate?
If you are not subject to AMT, the effective rate of your first mortgage is:
3.125(1-(.25+.0955))=2.045

The effective rate of your second mortgage is:
6.5(1-(.25+.0955))=4.25

If you are subject of AMT your effective rates will be higher.

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Re: Investing Inheritance

Post by interplanetjanet » Thu Feb 23, 2012 5:42 pm

damjam wrote:If you are not subject to AMT, the effective rate of your first mortgage is:
3.125(1-(.25+.0955))=2.045

The effective rate of your second mortgage is:
6.5(1-(.25+.0955))=4.25

If you are subject of AMT your effective rates will be higher.
Why? The lowest AMT bracket is 26%, so the first mortgage will enjoy a lower effective rate. The second mortgage will be partially or fully nondeductible (depending on how far it "sticks you into" AMT land) so it will have a higher one.

-janet

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Re: Investing Inheritance

Post by maverick1099 » Thu Feb 23, 2012 6:40 pm

Thanks for formula. I do not believe we will be subject to AMT...

Given the effective rates, does it make sense to pay off the 2nd completely (or some portion of it) and use the extra monthly income as contributions to a taxable account or does it make more sense to leave the mortgages alone and invest in a taxable account directly?

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Re: Investing Inheritance

Post by damjam » Thu Feb 23, 2012 8:03 pm

Without knowing your full situation, I will say this: If you can find a risk-free investment that will return better than 4.25% guaranteed then invest in it. Otherwise pay off the second mortgage.
But I don't know your full situation, for instance is your 6 to 9 month emergency fund sufficient? Do you need liquidity for some other reason, like purchasing a car or new home? Only you know the answers to those questions.

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damjam
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Re: Investing Inheritance

Post by damjam » Thu Feb 23, 2012 8:07 pm

interplanetjanet wrote:
damjam wrote:If you are not subject to AMT, the effective rate of your first mortgage is:
3.125(1-(.25+.0955))=2.045

The effective rate of your second mortgage is:
6.5(1-(.25+.0955))=4.25

If you are subject of AMT your effective rates will be higher.
Why? The lowest AMT bracket is 26%, so the first mortgage will enjoy a lower effective rate. The second mortgage will be partially or fully nondeductible (depending on how far it "sticks you into" AMT land) so it will have a higher one.

-janet
Chalk that up to my tenuous grasp of the AMT. I thought all deductions were reduced under AMT, but what you are saying suggests first mortgages are fully deductible under AMT. MY bad. Thanks for the correction.

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Re:

Post by grabiner » Thu Feb 23, 2012 8:08 pm

maverick1099 wrote:
If you deposit the 150k and write a check to your mortgage company you will reduce your mortgage payoff date from 2040 to 2026, assuming you have a 30 year mortgage created 1 year ago (2010). How does that sound?
I thought about this and I am a little weary of it for the simple reason that I know this will not be our "final" home. I would venture to guess we will be moving in ~5yr time period.
That actually makes paying down the mortgage a much better deal. Paying down the mortgage is an investment with a guaranteed return of 3.4% in your tax bracket; however, you don't realize the benefit until the mortgage is gone. This can happen when the mortgage is paid off, but you can also get the benefit when you sell the house because you get your net equity from the sale. Thus, if you pay down the mortgage and stay in the house, you have made an investment with a 3.4% return and a 14-year duration, equivalent to buying a risk-free but long-term bond. If you pay down the mortgage and sell the house in 2017, you have made an investment with a 3.4% return and a 5-year duration, equivalent to buying a risk-free intermediate-term bond.
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Re: Investing Inheritance

Post by maverick1099 » Thu Feb 23, 2012 8:28 pm

Without knowing your full situation, I will say this: If you can find a risk-free investment that will return better than 4.25% guaranteed then invest in it. Otherwise pay off the second mortgage.
But I don't know your full situation, for instance is your 6 to 9 month emergency fund sufficient? Do you need liquidity for some other reason, like purchasing a car or new home? Only you know the answers to those questions.
Our jobs are pretty secure so I am happy with the 6-9 month emergency fund. We have newer cars (2010) that we paid for in full so no loan and no need for a car anytime soon. A new home will likely be in the cards but likely we are looking at 5 years.
That actually makes paying down the mortgage a much better deal. Paying down the mortgage is an investment with a guaranteed return of 3.4% in your tax bracket; however, you don't realize the benefit until the mortgage is gone. This can happen when the mortgage is paid off, but you can also get the benefit when you sell the house because you get your net equity from the sale. Thus, if you pay down the mortgage and stay in the house, you have made an investment with a 3.4% return and a 14-year duration, equivalent to buying a risk-free but long-term bond. If you pay down the mortgage and sell the house in 2017, you have made an investment with a 3.4% return and a 5-year duration, equivalent to buying a risk-free intermediate-term bond.
Good point. Currently returning about 9-13.5% on my investments but as we all know past performance does not guarantee future performance. Even after paying off the 2nd I would have some remainder that I could invest...

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Re: Investing Inheritance

Post by grabiner » Thu Feb 23, 2012 9:33 pm

maverick1099 wrote:
grabiner wrote:That actually makes paying down the mortgage a much better deal. Paying down the mortgage is an investment with a guaranteed return of 3.4% in your tax bracket; however, you don't realize the benefit until the mortgage is gone. This can happen when the mortgage is paid off, but you can also get the benefit when you sell the house because you get your net equity from the sale. Thus, if you pay down the mortgage and stay in the house, you have made an investment with a 3.4% return and a 14-year duration, equivalent to buying a risk-free but long-term bond. If you pay down the mortgage and sell the house in 2017, you have made an investment with a 3.4% return and a 5-year duration, equivalent to buying a risk-free intermediate-term bond.
Good point. Currently returning about 9-13.5% on my investments but as we all know past performance does not guarantee future performance. Even after paying off the 2nd I would have some remainder that I could invest...
The fair comparison is to a low-risk investment. If you want to buy more stock, you can use the inheritance to buy stock, or you can use the inheritance to pay down your mortgage and move bonds to stock in your 401(k). Thus the decision of how much stock risk to take can be independent of the decision whether to pay down the mortgage (unless you want to hold more stock than your total investment amount after the mortgage paydown). Once you know how much stock risk you want to take, you can decide whether paying down the mortgage or buying more bonds (buy a stock index fund in taxable and move stock to bonds in the 401(k)) is a better deal.
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Re: Investing Inheritance

Post by maverick1099 » Fri Feb 24, 2012 1:14 am

I hadn't looked at it that way.
How would you classify the mortgage pay down? It's not quite cash and it's not really real estate... maybe more like a high yield bond?

I like this approach, it makes sense to me and ties in with the rest of our investments through our AA.

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Re: Investing Inheritance

Post by grabiner » Fri Feb 24, 2012 8:00 pm

maverick1099 wrote:I hadn't looked at it that way.
How would you classify the mortgage pay down? It's not quite cash and it's not really real estate... maybe more like a high yield bond?
For most investors, it's a risk-free bond. If you pay down your mortgage today, then you are guaranteed to avoid future mortgage payments on some definite date (unless you default on the mortgage and the bank can't cover the mortgage balance). That is the same benefit you would get from a Treasury bond; if you buy a Treasury bond, you will get back a certain number of dollars on a certain date.

And the fact that it is risk-free is what makes paying down a loan an attractive investment for many investors. If you buy corporate or municipal bonds instead, you expect to get payments on some future date, but there is some risk that the corporation or municipality will default. (It's not a very large risk for high-grade bonds.)
Wiki David Grabiner

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