Paydown mortage to deduction limit

[daum]

I'm selling my old house and will have ~800k after the sale. Only current debit is the new house mortgage which ~1.05MM @ 4.75%. I already max out tax advantaged accounts and live in MA. From my understanding, it'd be best to pay down the new mortgage to $750k so the interest is deductible. Just wanted to confirm that makes the most sense going forward.

Thanks!

[exodusNH]

I'm selling my old house and will have ~800k after the sale. Only current debit is the new house mortgage which ~1.05MM @ 4.75%. I already max out tax advantaged accounts and live in MA. From my understanding, it'd be best to pay down the new mortgage to $750k so the interest is deductible. Just wanted to confirm that makes the most sense going forward.

Thanks!

It makes sense, because that is a 4.75% after tax return, which, depending on your tax rate, could be anywhere between a 5-10% return, which is on par with equity returns.

[lakpr]

It MAY make sense.

With a $750k mortgage, the first year you will pay a mortgage interest of $750,000 * 4.75% = $35,625.
Assuming max SALT deduction = $10,000
Total Itemizable deductions = $35,625 + $10,000 = $45,625
Standard Deduction = $27,500 (assuming Married Filing Jointly; correct me if that's not the case)
Tax benefit = 24% Federal Tax rate + 5% Massachussets tax rate assumed = 29% on the difference of ($45,625 - $27,500 = $18,125) = $5,256.
So you are paying $35,625 - $5,256 = $30,369 (there are some cents involved, but I rounded to the nearest dollar).
So effective after-tax interest you pay = $30,369 / $750,000 = 4.05%

Now, to earn an after-tax interest of 4.05% at 29% combined tax rate + 3.8% NIIT, you should be investing your money in either Treasuries that are yielding 4.05% / (1 - 24% - 3.8% NIIT) = 5.60%, or CDs that should be yielding at least 4.05% / (1 - 29% - 3.8% NIIT) = 6.02%

I don't see any treasuries yielding 5.6% or CDs yielding 6% anywhere, at any maturity. So that leaves only investing 100% of the money you are not paying down the mortgage, into stocks.

With stocks, you are subject to at least a 15% long term capital gains rate + 3.8% NIIT + 5% MA state tax = 23.8%, and you must hold the investment at least one year to realize this LTCG. Assuming that's a given (that you WILL hold the investment at least a full year), it's the same as expecting at least a 4.05% / (1 - 23.8%) = 5.3% return.

That's the bottom line. How confident are you, that you WILL invest the entire money that's NOT paying down the mortgage into 100% stocks, and how confident are you that it WILL earn at least 5.3% on a long-term basis in a taxable account?

Personally, I would pay down the mortgage to the maximum extent possible. [ I am assuming you aren't otherwise hurting for liquidity, emergency fund is fully funded, and you job is at least somewhat stable ].

Edited to add: You can also adopt the view point that you are paying a liquidity premium, if you choose the keep the maximum mortgage. 10-year treasuries are yielding 3.4% as I write this post, or at 24% + 3.8% NIIT that is 2.455% after-tax. So you are paying a difference of 4.05% - 2.455% = 1.6% on the liquidity premium. On a principal amount of $800k you realized from past home sale - $250.5k that you need to paydown the current mortgage to get down to $750k = $550k approximately, that amounts to $8773 per year.

So, are you willing to pay $730 per month in insurance premiums -- the benefit is that $550k is available to you at any time during the mortgage period?

[KlangFool]

OP,

Unless your portfolio is at 3M, why does it makes any sense to put that much eggs into your house basket?

KlangFool

[cchrissyy]

well, the interest coming from 750k is deductible no matter what yuo do. i bet you know that but the written phrasing was unclear.

anyway, sure, pay down to that level, unless that puts too much of your assets and liquidity into the house as compared to your other assets. since you didn't write about your brokerage or retirement accounts, i can't tell if the proposed payment leaves you underweight in those areas.

[toddthebod]

I'm selling my old house and will have ~800k after the sale. Only current debit is the new house mortgage which ~1.05MM @ 4.75%. I already max out tax advantaged accounts and live in MA. From my understanding, it'd be best to pay down the new mortgage to $750k so the interest is deductible. Just wanted to confirm that makes the most sense going forward.

Thanks!

Here's how I would think about it: is it worth paying off a $355,000 at 4.75% loan? The interest on the remaining $750,000 is deductible whether or not you pay off the first $355,000.

[daum]

It MAY make sense.

With a $750k mortgage, the first year you will pay a mortgage interest of $750,000 * 4.75% = $35,625.
Assuming max SALT deduction = $10,000
Total Itemizable deductions = $35,625 + $10,000 = $45,625
Standard Deduction = $27,500 (assuming Married Filing Jointly; correct me if that's not the case)
Tax benefit = 24% Federal Tax rate + 5% Massachussets tax rate assumed = 29% on the difference of ($45,625 - $27,500 = $18,125) = $5,256.
So you are paying $35,625 - $5,256 = $30,369 (there are some cents involved, but I rounded to the nearest dollar).
So effective after-tax interest you pay = $30,369 / $750,000 = 4.05%

Now, to earn an after-tax interest of 4.05% at 29% combined tax rate + 3.8% NIIT, you should be investing your money in either Treasuries that are yielding 4.05% / (1 - 24% - 3.8% NIIT) = 5.60%, or CDs that should be yielding at least 4.05% / (1 - 29% - 3.8% NIIT) = 6.02%

I don't see any treasuries yielding 5.6% or CDs yielding 6% anywhere, at any maturity. So that leaves only investing 100% of the money you are not paying down the mortgage, into stocks.

With stocks, you are subject to at least a 15% long term capital gains rate + 3.8% NIIT + 5% MA state tax = 23.8%, and you must hold the investment at least one year to realize this LTCG. Assuming that's a given (that you WILL hold the investment at least a full year), it's the same as expecting at least a 4.05% / (1 - 23.8%) = 5.3% return.

That's the bottom line. How confident are you, that you WILL invest the entire money that's NOT paying down the mortgage into 100% stocks, and how confident are you that it WILL earn at least 5.3% on a long-term basis in a taxable account?

Personally, I would pay down the mortgage to the maximum extent possible. [ I am assuming you aren't otherwise hurting for liquidity, emergency fund is fully funded, and you job is at least somewhat stable ].

Edited to add: You can also adopt the view point that you are paying a liquidity premium, if you choose the keep the maximum mortgage. 10-year treasuries are yielding 3.4% as I write this post, or at 24% + 3.8% NIIT that is 2.455% after-tax. So you are paying a difference of 4.05% - 2.455% = 1.6% on the liquidity premium. On a principal amount of $800k you realized from past home sale - $250.5k that you need to paydown the current mortgage to get down to $750k = $550k approximately, that amounts to $8773 per year.

So, are you willing to pay $730 per month in insurance premiums -- the benefit is that $550k is available to you at any time during the mortgage period?

Thank you so much for the in-depth analysis, so many different ways to look at this, and this really helps!

OP,

Unless your portfolio is at 3M, why does it makes any sense to put that much eggs into your house basket?

KlangFool

Curious with why 3M is the breakpoint for this?



Thanks everyone for all the feedback/view points so far, very very valuable.

Daum

[KlangFool]

Curious with why 3M is the breakpoint for this?



Thanks everyone for all the feedback/view points so far, very very valuable.

Daum

daum,

Because even if you pay off the house, your still have a 2m portfolio. Your house is probably around 1.2m to 1.5m. Your house will not be bigger than your portfolio of 2m.

KlangFool

[daum]

daum,

Because even if you pay off the house, your still have a 2m portfolio. Your house is probably around 1.2m to 1.5m. Your house will not be bigger than your portfolio of 2m.

KlangFool

Thanks for the explanation.