Pay down home or increase Retirement Contributions

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Pay down home or increase Retirement Contributions

Post by Drock3307 » Sat Aug 12, 2017 11:19 am

Hello, our mortgage rate is only 2.62% on a 30-year loan thanks to employee discount of 2% my wife gets at her credit union job. We still have 26 years to go! Currently, we are putting in 15% in retirement. We are 35 and we started kind of late so feel we should be putting more than 15% but also want to payoff mortgage in the next 10 years so we can only afford 15% to retirement now. Some people have suggested to put more in retirement since our mortgage rate is low. I hate debt and want this risk paid off asap. If we pay it off in 10-12 years, we can save roughly $80K in interest. Once paid off, we can max out retirement. During this 10 year period, we may sell and upgrade to a bigger house (necessity not want) when prices get a bit better. What would you do in my situation? Thanks!

Kennyt7
Posts: 32
Joined: Mon Jan 19, 2015 7:28 pm

Re: Pay down home or increase Retirement Contributions

Post by Kennyt7 » Sat Aug 12, 2017 11:28 am

MAX OUT RET PLAN contributions The mortgage will be paid off

Kennyt7
Posts: 32
Joined: Mon Jan 19, 2015 7:28 pm

Re: Pay down home or increase Retirement Contributions

Post by Kennyt7 » Sat Aug 12, 2017 11:29 am

Any excess $$$ could be additional principal payments towards mortgage if desired

KlangFool
Posts: 6960
Joined: Sat Oct 11, 2008 12:35 pm

Re: Pay down home or increase Retirement Contributions

Post by KlangFool » Sat Aug 12, 2017 11:57 am

OP,

Why would you choose to pay 25% tax in order to save 2.62% interest? How does this make any sense? This is assuming that you do not pay any state income tax. Or else, the number is even higher.

KlangFool

WL2034
Posts: 398
Joined: Tue May 21, 2013 10:36 pm

Re: Pay down home or increase Retirement Contributions

Post by WL2034 » Sat Aug 12, 2017 12:05 pm

With the limited information given, I will join the others saying maximizing retirement seems prudent. 2.62% is so low, and that's before any tax deduction. Inflation was 2.1% for 2016, 1.7% for the past 12 months ending July 2017.

Finance-MD
Posts: 314
Joined: Sun Mar 26, 2017 9:27 am

Re: Pay down home or increase Retirement Contributions

Post by Finance-MD » Sat Aug 12, 2017 12:24 pm

If you hate debt, why not rent a home?
That's the easiest way to get out of mortgage debt (sell home and rent)
you have a goal of upgrading your home to a new one but also paying off your current home. Are you trying to pay it off, then sell it, then get another mortgage?
The benefit of paying off the home mathematically is the increased cash flow.
But if you turn around and buy another one with a mortgage, you didn't pay off anything.
Then you will want to pay off that house as soon as possible. Will this whole process take you 15+ years? What if you want to upgrade again.

The psychological benefit of paying your house down faster is that you may be motivated to allocate a higher portion of your cash flow toward net worth gain (debt payoff /investing). If that's the case for you, and you wouldn't be motivated to aggressively allocate to retirement because it's not as gratifying... then by all means, pay your debt down - just acknowledge that the money could better be allocated to your 401k and likely IRA and taxable accounts.

cherijoh
Posts: 4049
Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: Pay down home or increase Retirement Contributions

Post by cherijoh » Sat Aug 12, 2017 12:29 pm

Kennyt7 wrote:
Sat Aug 12, 2017 11:28 am
MAX OUT RET PLAN contributions The mortgage will be paid off
+1

OP - IMO you are being very short-sighted to focus on eliminating below-market-rate debt over maxing out your retirement plans:
  • Any excess tax-advantaged space that you leave on the table is lost forever. If you pay off your mortgage early you will have more money to invest later but some of it will then be in taxable. This can really come back and bite you when you decide to de-risk your asset allocation and don't have enough space in tax-advantaged plans for tax-inefficient bonds and have to put bonds in taxable.
  • Even conservative investors should expect their portfolio to beat the interest rate you are paying over a time period equal to the length of your remaining mortgage.
  • By maxing out my tax-advantaged plans, my take home pay is only reduced by 68 cents for every dollar I invest - I'm in 25% marginal bracket Federal and ~7% state. I expect to be able to use lower tax brackets for Roth conversions after I retire and prior to RMDs. YMMV
  • A fixed rate mortgage is the best inflation hedge that an individual investor can find - and the lower the rate the better the hedge. If interest rates continue to ratchet up slowly, you'll soon be able to find FDIC insured CDs that pay more than your subsidized mortgage. PenFed may even be offering some now.

OhBoyUhoh
Posts: 17
Joined: Wed Feb 10, 2016 2:16 pm
Location: SW Ohio

Re: Pay down home or increase Retirement Contributions

Post by OhBoyUhoh » Sat Aug 12, 2017 12:36 pm

Hello, Klangfool wrote"

"Why would you choose to pay 25% tax in order to save 2.62% interest?"

I am unclear what the 25% tax comes from, can you explain briefly?

Thank you.

cherijoh
Posts: 4049
Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: Pay down home or increase Retirement Contributions

Post by cherijoh » Sat Aug 12, 2017 12:43 pm

OhBoyUhoh wrote:
Sat Aug 12, 2017 12:36 pm
Hello, Klangfool wrote"

"Why would you choose to pay 25% tax in order to save 2.62% interest?"

I am unclear what the 25% tax comes from, can you explain briefly?

Thank you.
I think Klangfool was talking about the pay taxes now vs. later argument and assumed OP is in the 25% marginal tax bracket. Basically the same thing as my third bullet in my earlier post.

retiredjg
Posts: 30592
Joined: Thu Jan 10, 2008 12:56 pm

Re: Pay down home or increase Retirement Contributions

Post by retiredjg » Sat Aug 12, 2017 12:44 pm

I have mixed feelings about this. Financially, it is better to keep the mortgage. If you are in the 25% bracket and deduct your mortgage interest, the interest rate is only 1.965%. Almost any investment will make more than that so it makes sense to invest your money rather than use it to pay off the mortgage early.

On the other hand, there is an emotional side to investing and paying bills. Emotionally, it is not wrong to pay the mortgage early. There's a balance there and you'll have to find yours.

I would tend to keep the mortgage, maybe paying 1 or 2 extra payments a year to satisfy that emotional side. This puts more away for retirement. If you should have an unexpected reduction in salary (disability, illness, babies) but can still pay the ordinary mortgage note you will be in better shape for retirement on the new lower salary.

Keeping the mortgage gives you more flexibility.

KlangFool
Posts: 6960
Joined: Sat Oct 11, 2008 12:35 pm

Re: Pay down home or increase Retirement Contributions

Post by KlangFool » Sat Aug 12, 2017 12:50 pm

OhBoyUhoh wrote:
Sat Aug 12, 2017 12:36 pm
Hello, Klangfool wrote"

"Why would you choose to pay 25% tax in order to save 2.62% interest?"

I am unclear what the 25% tax comes from, can you explain briefly?

Thank you.
OhBoyUhoh,

OP's marginal income tax rate is 25% as indicated by his other thread. If he pays additional $1,000 to his mortgage instead of contributing that $1,000 to the Trad. 401K. He will be paying 25% tax on that $1,000.

KlangFool

Dottie57
Posts: 2252
Joined: Thu May 19, 2016 5:43 pm

Re: Pay down home or increase Retirement Contributions

Post by Dottie57 » Sat Aug 12, 2017 1:01 pm

Pay a certain amoun extra to mortgage (applied to principal). Put the rest of money to retirement. It doen't have to be all one and nothing for the other.

I paid my mortgage off early but did not neglect retirement.

CppCoder
Posts: 542
Joined: Sat Jan 23, 2016 9:16 pm

Re: Pay down home or increase Retirement Contributions

Post by CppCoder » Sat Aug 12, 2017 1:19 pm

Given your wife's occupation, what would be the rate and fees to refinance to a 15 year mortgage (or 10 if that's really your goal)? You could do the refinance, be forced to pay the larger payments, and call that good enough. You'll still pay off the house on an accelerated schedule (relative to your 30 year mortgage), and hopefully, you'll still have extra to be able to build up to greater than 15% retirement contributions. Sure, the 30 year gives you flexibility to not have to pay the higher rate monthly, but it takes a long time to build equity in your home. If you end up moving every 5-8 years and getting new 30 year mortgages, you'll just be perpetually paying interest and never building equity.

OhBoyUhoh
Posts: 17
Joined: Wed Feb 10, 2016 2:16 pm
Location: SW Ohio

Re: Pay down home or increase Retirement Contributions

Post by OhBoyUhoh » Sat Aug 12, 2017 1:30 pm

Thank you, KlangFool and Cherijoh for your explanations. I can see it's all math and even on other posts jimb_atlanta gives good examples why not paying off early can be advantageous. I was not thinking about the taxes at all. Thanks again!
~Will

Ron
Posts: 6112
Joined: Fri Feb 23, 2007 7:46 pm

Re: Pay down home or increase Retirement Contributions

Post by Ron » Sat Aug 12, 2017 1:39 pm

Don't forget, that $80k interest requires you to earn an amount much more than $80k to net out your prepayments.

Although our situation was much different (with a mortgage/note rate of 6.875%) back in the early 90's when we had our current/retirement home built, it's something to think about.

In our case, we put 50% down (had bought/upgraded over the early years of our marriage) and took out a 30-year loan. We could have applied for a 15 year loan at a lower interest rate, but we wanted the flexibility to prepay if we had the extra money along the way.

During the period of '94 - '99, we made extra principal payments which resulted in paying off the loan in October of 1999 - after 5.5 years. Our interest "saved" (that is, not having to pay in the future) was around $120k, but to get that $120k in net pay, with our tax rate (FIT, state, local) we would have had to "earn" just under $150k. Since we were paying down quickly, we accrued little interest that could be deducted from our Federal tax.

The kicker is that as soon as we paid off the note, we took our monthly payment amount, along with the extra we were paying and increased our respective 401(k) contributions (we always maxed out our IRA's over the years). As you know, with the market dropping 2000-02 we were able to buy "on the cheap". The result is that our retirement was moved up to start earlier than originally planned; age 59 for me - not necessarily early, but much earlier than I could ever imagine.

Paying down the mortgage/note worked out well, in our case, being our savings in interest paid along with being able to invest at a good time came together. In your case, I can't offer a suggestion.

Just to tell a story of one who has gone through what you are doing, but at a much different time.

FWIW,

- Ron

indexonlyplease
Posts: 794
Joined: Thu Apr 30, 2015 12:30 pm
Location: Pembroke Pines, FL

Re: Pay down home or increase Retirement Contributions

Post by indexonlyplease » Sat Aug 12, 2017 2:02 pm

I am a fan of paying off the mortgage. Why, you never know what lies in the future. Like loss of job and delay of getting another job. Easy to pay bills when no mortgage.

Why not pay the mortgage like a 15 yr loan. You will save lots of interest. Also, with raises and cutting expenses you can save more for retirement. In 15 years you will only be 50 with a paid off mortage and good investments. Then for the next 15 years you can go crazy maxing out the investments.

Also, none of this matters if you decide if you decide to go into debt again with a bigger house.

User avatar
whodidntante
Posts: 2198
Joined: Thu Jan 21, 2016 11:11 pm

Re: Pay down home or increase Retirement Contributions

Post by whodidntante » Sat Aug 12, 2017 2:22 pm

indexonlyplease wrote:
Sat Aug 12, 2017 2:02 pm
I am a fan of paying off the mortgage. Why, you never know what lies in the future. Like loss of job and delay of getting another job. Easy to pay bills when no mortgage.
To me, potential job loss is an argument against prepaying a mortgage. You need liquidity to deal with a long period of unemployment, not a paid off house.

ryman554
Posts: 785
Joined: Sun Jan 12, 2014 9:44 pm

Re: Pay down home or increase Retirement Contributions

Post by ryman554 » Sat Aug 12, 2017 3:50 pm

whodidntante wrote:
Sat Aug 12, 2017 2:22 pm
indexonlyplease wrote:
Sat Aug 12, 2017 2:02 pm
I am a fan of paying off the mortgage. Why, you never know what lies in the future. Like loss of job and delay of getting another job. Easy to pay bills when no mortgage.
To me, potential job loss is an argument against prepaying a mortgage. You need liquidity to deal with a long period of unemployment, not a paid off house.
You need liquidity for cash-flow reasons. A mortgage is usually the largest single contributor to cash-outflow.

I do agree that prepaying a mortgage is a bad idea since it locks up funds without reducing required monthly payments (modulo mortgage recasting), however, paying off a mortgage removes a lot of shackles. if you are the type that can save up and payoff a mortgage early, and don't drain the emergency fund to do so, paying off that house just extended your emergency fund a very long time. Plus it will have demonstrated habits that indicate, unless the timing was incredibly unlucky, the savings will recover quickly.

Once you have the funds to payoff a mortgage, you are in the realm of the question of "should I borrow money on a house to invest?"

indexonlyplease
Posts: 794
Joined: Thu Apr 30, 2015 12:30 pm
Location: Pembroke Pines, FL

Re: Pay down home or increase Retirement Contributions

Post by indexonlyplease » Sat Aug 12, 2017 3:56 pm

whodidntante wrote:
Sat Aug 12, 2017 2:22 pm
indexonlyplease wrote:
Sat Aug 12, 2017 2:02 pm
I am a fan of paying off the mortgage. Why, you never know what lies in the future. Like loss of job and delay of getting another job. Easy to pay bills when no mortgage.
To me, potential job loss is an argument against prepaying a mortgage. You need liquidity to deal with a long period of unemployment, not a paid off house.
That can only be stated by someone that does not own a home with no mortgage. You don't need liquidity because your house is paid off. And your emergency fund will take care of the other bills for 6-12 months. Even a part time job will pay to put food on table and pay electric bill. Not having to worry about a $2000k month morgage is big stress off the family.

Also, I never heard someone complain about not having a mortgage but I have heard many complain about not investing wisely when they are in retirement.

No one in retirement will complain about no mortgage and small investments and SS. They will live well in retirement.

This is why so many retires still struggle in retirement. They still have a mortgage.

User avatar
whodidntante
Posts: 2198
Joined: Thu Jan 21, 2016 11:11 pm

Re: Pay down home or increase Retirement Contributions

Post by whodidntante » Sat Aug 12, 2017 4:19 pm

indexonlyplease wrote:
Sat Aug 12, 2017 3:56 pm
whodidntante wrote:
Sat Aug 12, 2017 2:22 pm
indexonlyplease wrote:
Sat Aug 12, 2017 2:02 pm
I am a fan of paying off the mortgage. Why, you never know what lies in the future. Like loss of job and delay of getting another job. Easy to pay bills when no mortgage.
To me, potential job loss is an argument against prepaying a mortgage. You need liquidity to deal with a long period of unemployment, not a paid off house.
That can only be stated by someone that does not own a home with no mortgage. You don't need liquidity because your house is paid off. And your emergency fund will take care of the other bills for 6-12 months. Even a part time job will pay to put food on table and pay electric bill. Not having to worry about a $2000k month morgage is big stress off the family.

Also, I never heard someone complain about not having a mortgage but I have heard many complain about not investing wisely when they are in retirement.

No one in retirement will complain about no mortgage and small investments and SS. They will live well in retirement.

This is why so many retires still struggle in retirement. They still have a mortgage.
Despite starting off with an appeal to authority, you supported my point. It comes down to preference and what makes someone feel good. What makes me feel good is having lots of money available. In long-term unemployment I will have more flexibility and resources at my disposal because my house remains leveraged at a low fixed rate. Others are extremely debt-averse and will eliminate that mortgage as a matter of preference.

Ron Ronnerson
Posts: 744
Joined: Sat Oct 26, 2013 6:53 pm
Location: Bay Area

Re: Pay down home or increase Retirement Contributions

Post by Ron Ronnerson » Sat Aug 12, 2017 5:01 pm

I suggest you calculate your effective rate to make an informed decision. Subtract any mortgage interest deduction benefit that you're getting that exceeds the standard deduction and also subtract your local/regional rate of inflation. Your actual rate seems to be great and you may even possibly be making money on this loan. However, I'd run the numbers and see if you still find it worthwhile to pay off early. Everyone places a different value on the feeling of not having debt. Maybe it will still be worth it to you but perhaps not.

Drock3307
Posts: 13
Joined: Sat Aug 12, 2017 11:04 am

Re: Pay down home or increase Retirement Contributions

Post by Drock3307 » Sat Aug 12, 2017 7:35 pm

Thank you everyone! After reading through, we'll do a combo to satisfy both sides. However, I will put more in retirement and less to extra principal payments than I had planned but still save about $50k in interest. Mathwise, I agree it make sense to contribute more to retirement than pay off mortgage early. When we upgrade, it will be a one time event. Our plan is to sell our current home then use all proceeds toward new home so our new mortgage will be the least amount possible. We bought low so we have a good amount of equity. If my wife change jobs, we lose the rate discount and our rate goes up to 4.62%. She doesn't plan to but you'll never know. We are only 4 years into our mortgage so inclined to make some extra principal payments.

The main goal is to retire early (after mortgage payoff) so it make sense to put more in retirement.

Post Reply