When to choose investing over loan repayment?

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When would you choose to invest over loan repayment?

When the loan interest is below 15%
1
1%
When the loan interest is below 10%
3
2%
When the loan interest is below 10%
3
2%
When the loan interest is below 8%
4
3%
When the loan interest is below 7%
14
10%
When the loan interest is below 6%
20
14%
When the loan interest is below 5%
35
24%
When the loan interest is below 4%
25
17%
When the loan interest is below 3%
13
9%
When the loan interest is below 2%
11
8%
Never
14
10%
 
Total votes: 143

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When to choose investing over loan repayment?

Postby mptfan » Wed Jul 18, 2007 1:05 pm

What is the cutoff interest rate at which you would invest as opposed to repay debt? For example, I think everyone would agree that if you had a loan (such as credit card debt) at 25% interest, you should pay it off before investing. However, I also think everyone would agree that if you had a zero interest loan, you should invest before paying it off. My question is, what is your cutoff point? At what interest rate would you say it becomes advisable to invest as opposed to repay the loan?

Let's keep this simple please and not make this a debate about taxes, or about what you think the future tax structure will be. Do not consider taxes. Do not consider the mortgage interest deduction, only look at the after tax rates. Do not consider the tax benefits of pretax retirement plans.

EDIT: Come on guys, I am not asking about some hypothetical point in the future with unknown and unknowable rates. I am asking about right now, under existing rates and existing market conditions. Geez. :roll:
Last edited by mptfan on Wed Jul 18, 2007 3:14 pm, edited 3 times in total.

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Postby Alex Frakt » Wed Jul 18, 2007 1:12 pm

There is no fixed number. I'd invest when the after-tax yield on intermediate term bonds is greater than the after-tax cost of the loan.

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Postby mptfan » Wed Jul 18, 2007 1:14 pm

lowwall, what is the current after tax yield on intermediate bonds? That is your number.

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Postby livesoft » Wed Jul 18, 2007 1:18 pm

It can't be simple because it will depend on the prevailing interest rates at the time and your anticipation of future rates.

I would not consider paying off a long-term loan until it was more than 1.5% above prevailing interest rates, because prevailing interest rates could go to up 2% in a couple of years.

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Postby Nitsuj » Wed Jul 18, 2007 1:35 pm

I have to say that it's a function of current interest rates and not a specific number. If I can earn 5% in a savings account and I have a 3% loan, or if I can earn 8% in a savings account with a 6% loan. For example.

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Postby mptfan » Wed Jul 18, 2007 1:35 pm

livesoft wrote:It can't be simple because it will depend on the prevailing interest rates at the time and your anticipation of future rates.


It is that simple, I am asking about current rates.

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Postby mptfan » Wed Jul 18, 2007 2:08 pm

Nitsuj wrote:I have to say that it's a function of current interest rates and not a specific number. If I can earn 5% in a savings account and I have a 3% loan, or if I can earn 8% in a savings account with a 6% loan. For example.


Nitsuj, you are in luck, because I am asking about current interest rates. :wink:

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Postby United » Wed Jul 18, 2007 2:23 pm

"Investing" is too broad of a term for me to answer this poll. It can really depend on whether an individual is investing in an IRA or what their tax rate is.


That being said, I don't want to be a party pooper. My gut votes 7%. I'm confident I would turn down a 5% CD and accept a 10% CD. Although debt is a little different, I would still place the number somewhere between 5% and 10%.

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Postby mptfan » Wed Jul 18, 2007 2:30 pm

United wrote:"Investing" is too broad of a term for me to answer this poll. It can really depend on whether an individual is investing in an IRA or what their tax rate is.


United, surely there is a number at which you would pay down the debt regardless of what you invest in? For example, is there any investment that you can think of where you would invest in it before paying down a 25% credit card debt? I doubt it. So surely there is a number above which you would not consider investing, no matter the investment, and below which you would consider investing. Tell me that number. :roll:

You guys are really over-thinking this.
Last edited by mptfan on Wed Jul 18, 2007 2:33 pm, edited 1 time in total.

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Re: When to choose investing over loan repayment?

Postby sgeeeee » Wed Jul 18, 2007 2:31 pm

mptfan wrote:What is the cutoff interest rate at which you would invest as opposed to repay debt? For example, I think everyone would agree that if you had a loan (such as credit card debt) at 25% interest, you should pay it off before investing. However, I also think everyone would agree that if you had a zero interest loan, you should invest before paying it off. My question is, what is your cutoff point? At what interest rate would you say it becomes advisable to invest as opposed to repay the loan?

Let's keep this simple please and not make this a debate about taxes, or about what you think the future tax structure will be. Do not consider taxes. Do not consider the mortgage interest deduction, only look at the after tax rates. Do not consider the tax benefits of pretax retirement plans.
EDIT: Come on guys, I am not asking about some hypothetical point in the future with unkown and unknowable rates. I am asking about right now, under existing rates and existing market conditions. Geez. :roll:
That makes no sense to me. You seem to be saying, "Neglecting reality, what is the cutoff interest rate at which you would invest rather than pay off the loan?"

Reality requires that you consider the term of the loan (and therefore the length of your investment), the tax implications of the loan, the risk implications of owning vs. holding the loan, etc. For a 30 year home loan with reasonable tax assumptions, your odds are historically pretty good of having your investment beat the payoff decision at anything below about 6% to 6.5% -- if you invest in a 50/50 stock/bond allocation. :D

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Postby mptfan » Wed Jul 18, 2007 2:32 pm

United wrote: That being said, I don't want to be a party pooper. My gut votes 7%. I'm confident I would turn down a 5% CD and accept a 10% CD. Although debt is a little different, I would still place the number somewhere between 5% and 10%.


United, there are no 10% CDs on the current market. I am asking about current rates that exist today, currently. :roll:

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Postby Nitsuj » Wed Jul 18, 2007 2:37 pm

Well, I would not pay down my mortgage much faster than the scheduled rate, and it's at 5.25%.

We have the cash to pay it all off if we so chose, but are using current income to pay it.

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Postby mptfan » Wed Jul 18, 2007 2:39 pm

sgeee, can you envision any circumstance, under current market conditions and current tax rates, that you would invest before paying off a 25% interest rate credit card? I suspect the answer is no. :roll: If the answer is no, then surely there is a number, below 25%, where the answer might turn into a yes? :wink: Tell me that number.

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Postby rnitz » Wed Jul 18, 2007 3:24 pm

I think Nitsuj is on to something. I'm guessing a fair number of us have mortgages - if you're putting new money into stocks or bonds and not paying down your mortgage then your cutoff number is at least your mortgage rate.

I put down 7%. My mortgage is 4.75% and I'm not paying it down (faster than the scheduled rate). New money goes into my AA mix of equities and bonds.

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Postby Cosmo » Wed Jul 18, 2007 3:29 pm

Surprised by the number of people who picked below 4%. Vanguard Prime earns over 5% presently. Sounds silly to me IMO.

Sounds equally silly that someone would ALWAYS invest the money even if they had 18% credit card debt.

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Postby White Coat Investor » Wed Jul 18, 2007 3:36 pm

Cosmo wrote:Surprised by the number of people who picked below 4%. Vanguard Prime earns over 5% presently. Sounds silly to me IMO.

Sounds equally silly that someone would ALWAYS invest the money even if they had 18% credit card debt.


Don't forget taxes. Vanguard Prime pays 5.1% but I only make 3.9% off of it.
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Postby sgeeeee » Wed Jul 18, 2007 3:38 pm

mptfan wrote:sgeee, can you envision any circumstance, under current market conditions and current tax rates, that you would invest before paying off a 25% interest rate credit card? I suspect the answer is no. :roll: If the answer is no, then surely there is a number, below 25%, where the answer might turn into a yes? :wink: Tell me that number.

I would never make that decision based on such a simple minded approach.

A loan has a duration. That's important. If it is very short, then the only investments I would consider making rather than pay off the loan is a fixed interest investment. Stock investments could decline radically in value for a short period. The comparison has to be to bonds with similar duration. If the loan duration is 30 years, I would consider a balanced portfolio investment since the historical record indicates stock/bond investments tend to be secure over those time periods.

A loan has risk associated with it as do underlying investments. If the loan is large, the risk may impact my decision significantly. Similarly, if a loan payoff is for a home in a deteriorating neighborhood that I don't plan to keep for very long, I have to consider that risk. So there is a risk allocation issue as well as a financial issue.

A loan has tax implications. If I am retired, the loan is large, does not offer significant tax advantages, and I have significant tax burden associated with my annual withdrawal rate, the loan costs me even more than the payments. If I am gaining tax advantages from the loan, it costs me less than the monthly payments.

It sounds like what you really want to know is the existing bond rates. Even these will vary depending on duration and risk. What do you want to compare to? A two year corporate bond? A 5 year treasury? etc.? :D

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Postby White Coat Investor » Wed Jul 18, 2007 4:15 pm

rnitz wrote:I think Nitsuj is on to something. I'm guessing a fair number of us have mortgages - if you're putting new money into stocks or bonds and not paying down your mortgage then your cutoff number is at least your mortgage rate.


What if you're doing both?

Here is my current (considering current interest rates) take on it:

I am NOT paying down my 0% credit card (until I pay it off in full next year)
I am NOT paying down my 0% student loan (until 2010 when it goes to 8%)
I am NOT paying down a 1.9% credit card loan.
I am making extra payments on my 6.125% mortgage, but I am not directing a lot of my money toward it (basically converted it from a 30 year loan to a 15 year loan)
I would invest in a tax-protected account rather than pay down any loan less than 7-8%, especially if there were tax benefits to the loan (mortgage, student loan etc)
I would not invest in a taxable account unless the loan were less than 5% (thus my answer.) I use 5% because I believe my portfolio will have an after-expense, after-tax long-term return of at least 8%, so 5% gives me a comfortable "margin of safety" for investing. Even if I only get a long-term return of 6%, it was still a good idea.
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Postby mptfan » Wed Jul 18, 2007 4:17 pm

sgeee, I'm surprised that you would consider investing in lieu of paying down a credit card which is charging you 25% interest. Very surprised. I would not even give it a second thought.

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Postby sgeeeee » Wed Jul 18, 2007 5:56 pm

mptfan wrote:sgeee, I'm surprised that you would consider investing in lieu of paying down a credit card which is charging you 25% interest. Very surprised. I would not even give it a second thought.

I think you misunderstood my post. Good luck. :D

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Postby chipmunk » Wed Jul 18, 2007 6:15 pm

I am one of the two weirdos who voted 'never.' My goal is to become totally debt-free, including the mortgage, irregardless of the interest rate.

Yes, I drank the Dave Ramsey Kool-Aid, and am a member of the cult. What convinced me to think this way was when I went to a Dave Ramsey live event. He said to become totally debt-free except the mortgage (along with a fully-funded emergency fund) before investing. He showed the audience a credit card, and had chains on, indicating how debt makes you a slave. This visual aid made an impression in my mind that I will never forget. I also recall calling American Express and closing my last and final credit card account shortly after attending this event. I had been holding out because I got this credit card after graduating from college, as I thought it was somewhat of a status symbol, along with some financial 'security.' The lady on the other end thought I was a weirdo, and asked me how I would pay for things like airline tickets and car rentals. I told her I would just have to figure out a way. I wasn't even sure myself how I would do this (I travel frequently), so it took a bit of faith on my end. It turned out that I was able to use a debit card 99%+ of the time. The one time I had a problem was with one of the rental car agencies that required a deposit when using a debit card. So, I switched rental car agencies, and haven't had another problem since then.

Edited to add: Let me add that part of the Dave Ramsey plan is a compromise between paying off the mortgage and investing. When you are debt-free except the mortgage, under his plan, you limit investing to 15% of your household income. Then, once the mortgage is gone, you increase that 15%. So, when there is a mortgage, you don't throw everything at the mortgage before investing.

Dan
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Postby whitemiata » Wed Jul 18, 2007 6:18 pm

It's difficult to answer your question, if for no other reason that you're asking to ignore aspects that I think are key to the decision.

But I'll play.

If the loan is a credit-card type loan, where consumption has already taken place and I am essentially repaying *convenience* interest, then I would definitelly pay this off asap if the interest is anything over about 5% (we're not taking into consideration taxes and I'm assuming it's a shortish term loan).

In the case of a mortgage, on the other hand... my payments are both paying off the interest AND also buying equity. In that case I would only speed up paying to the point where I am maximizing my debt reduction while at the same time minimizing my equity acquisition.

Let me explain this.

Say that I'm buying a home and the interest is 7% on the 15 year mortgage, and I expect to be in the home 25 years. If I were to hypothetically prepay the whole mortgage on day one I would get the equivalent of a 7% return (again, not considering taxes etc) but ONLY for 15 years. The remaining 5 years I'd get no interest benefit and my money would be tied up in the property with no hope to reinvest it (without incurring higher interest and refi charges).

On the other hand if I had a 15 year loan and expected to be in the home only 5 years, I'd gladly throw everything I got at the house as I would truly get 7% yearly for the whole time i have the home.

Don't know if this makes sense... maybe I'm totally off here

Alessandro

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Postby mptfan » Wed Jul 18, 2007 8:17 pm

Alessandro, I think you are really off base. Your house doesn't know and doesn't care if you have a mortgage. The value of your house will be the same regardless. So the amount of mortgage interest that you pay is completely independent of whether you live in your house 1 year or 100 years.

People have been brainwashed to think that mortgage debt is somewhow ok if you will only live in the house for X years. But have you ever heard anyone say that it's ok to buy something with a credit card and pay 18% interest (say a gold watch), so long as you only plan on keeping for two years, and you plan on re-selling it for at least as much as you paid for it? Of course not, because it's nonsense. Even if you resell the watch in two years and get back your purchase price, you have paid an exhorbitant amount of interest for those two years to the credit card company. It doesn't matter what you bought, or how long you will keep it, it matters how much the interest charges are.

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Postby whitemiata » Wed Jul 18, 2007 9:14 pm

mptfan wrote:Alessandro, I think you are really off base. Your house doesn't know and doesn't care if you have a mortgage. The value of your house will be the same regardless. So the amount of mortgage interest that you pay is completely independent of whether you live in your house 1 year or 100 years.


Ok, but the problem is not the mortgage interest. I'm all for paying the mortgage interest, and paying it off as fast as possible. It's the principal I don't want to pay off any sooner than I have to as that amounts to tieing up my cash into something that while valuable (a roof over the head) is a relatively poor investment compared to market alternatives (don't include the value of not paying rent because the comparison here is between paying off the mortgage faster or taking one's time... therefore the rent avoidance is there etiher way)

Hypothetically speaking, If there was an option where one could pay the interest without paying the principal (but it have the same effect as if you'd paid principal) and then dalay paying principal at the regular mortgage schedule I would definitelly do that.

Of course I realize that this hypothetical is an impossibility as no lender in their right mind would ever go for such an arrangement.

Alessandro

P.S. Another point - the mortgage is a fairly strong inflation hedge.

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Postby mptfan » Wed Jul 18, 2007 9:23 pm

whitemiata wrote:Hypothetically speaking, If there was an option where one could pay the interest without paying the principal (but it have the same effect as if you'd paid principal) and then dalay paying principal at the regular mortgage schedule I would definitelly do that.

Of course I realize that this hypothetical is an impossibility as no lender in their right mind would ever go for such an arrangement.

Alessandro


LOL. So you are basing your argument on something that you admit is impossible?? Hmmm. :roll:

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Postby mptfan » Wed Jul 18, 2007 9:26 pm

whitemiata wrote:P.S. Another point - the mortgage is a fairly strong inflation hedge.


This is another myth perpetuated by the mortgage industry which is nonsense. Which is a better inflation hedge...a relatively low mortgage payment (compared to renting), or, no mortgage payment?? Hmm.... I pick the second one. Remember, the choice is not between paying your mortgage payment and renting... the choice is between paying your mortgage payment and not paying your mortgage payment (i.e., paying your mortgage off early and having no more payments). Think about that for a second, and then tell me which one gives you a better inflation hedge. :wink:

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Postby White Coat Investor » Wed Jul 18, 2007 9:31 pm

mptfan wrote:
whitemiata wrote:P.S. Another point - the mortgage is a fairly strong inflation hedge.


This is another myth perpetuated by the mortgage industry which is nonsense. Which is a better inflation hedge...a relatively low mortgage payment (compared to renting), or, no mortgage payment?? Hmm.... I pick the second one. Remember, the choice is not between paying your mortgage payment and renting... the choice is between paying your mortgage payment and not paying your mortgage payment (i.e., paying your mortgage off early).


I agree with WhiteMiata. If inflation goes crazy, your FIXED mortgage stays at the same rate. If you were paying 6% on your mortgage, and inflation goes to 8%, I would take as long as possible to pay that mortgage back because I am paying it with cheaper and cheaper money all the time. I have a similar situation with a credit card loan given to me...1.9% fixed for life. Inflation is at 3% (even higher YTD), I pay 1.9%. The way I figure it they loaned me a certain amount of money and I'm paying them back even less than they loaned me. I view a fixed mortgage in a high inflation environment in a similar way, even if the inflation rate doesn't exceed the mortgage rate, it still functions as an inflation hedge.
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Postby mptfan » Wed Jul 18, 2007 9:38 pm

Emergdoc, I must strongly disagree. (I think for the first time, since I think I have agreed with everything you have posted thus far)

I will say that your point is well taken IF someone continues to live above their means and will have a continuing need to borrow money in an inflationary environment. In that situation, yes, it's better to hold on to a 6% mortgage if interest rates rise to 8%, because by avoiding paying off the 6% loan early, you have avoided taking on new debt at higher rates.

However, and here is where I disagree, and where I agree with Dave Ramsey... if you stop living above your means, and if you stop borrowing money and taking on new debt to finance a life that you can't afford, then, in that situation, a mortgage offers no hedge against inflation, because you have no more need of debt, and won't be borrowing anymore money at the inflated rates.

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Postby whitemiata » Wed Jul 18, 2007 9:54 pm

mptfan,

Question for you.

It's the day before inflation started exploding in the 70s.

You just bought a home and have a mortgage with a 7% interest rate

Somehow you are privy to the fact that inflation will be going double-digit.

Your income is such that you have the money to signficantly lob off principals off your mortgage every other week.

You have two choices:

1. Pay the regular mortgage amount (maybe an extra payment per year just for kicks and grins) and invest the rest in a total market index fund

or

2. Throw most of your cash at paying off the mortgage.

What do you do?

Alessandro

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Postby mptfan » Wed Jul 18, 2007 9:58 pm

I pay off the mortgage.

By the way, I don't accept your statement that somehow I would be privy to the fact that inflation would be going double digits. It is impossible to know the future, and I don't accept an impossible hypothetical. (Although it appears you enjoy presenting them :wink: )

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Postby Nitsuj » Wed Jul 18, 2007 10:01 pm

mptfan wrote:I pay off the mortgage.

By the way, I don't accept your statement that somehow I would be privy to the fact that inflation would be going double digits. It is impossible to know the future, and I don't accept an impossible hypothetical. (Although it appears you enjoy presenting them :wink: )

Surprise! A new airport has been built, you are directly under the flightpath. That paid for home loses all sorts of value overnight.

Ooops.

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Postby whitemiata » Wed Jul 18, 2007 10:04 pm

mptfan wrote:I pay off the mortgage.

By the way, I don't accept your statement that somehow I would be privy to the fact that inflation would be going double digits. It is impossible to know the future, and I don't accept an impossible hypothetical. (Although it appears you enjoy presenting them :wink: )


LOL

Hey... I'm not the one who started out with the "disregard taxes, disregard deductability...." you set this in fantasyland... I'm just building Epcot center, man :lol:

P.S. you really pay off the mortgage? I must be really missing something here

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Postby White Coat Investor » Wed Jul 18, 2007 10:07 pm

mptfan wrote:Emergdoc, I must strongly disagree. .


Let's try this one...how about my student loan. In 1993 I took out a $5000 loan. The terms of the loan are extremely favorable to me as I have been able to defer the accrual of interest AND payments on the loan all the way through college, medical school, residency, and military service. In fact, I will pay this loan back as a lump sum in 2010, just before I start accruing interest on it. Essentially, this is a 0% loan to me for 17 years. In August 1993 when I took out the loan CPI was at 144.8. It is currently at 208.352. I calculate that $5000 in 1993 is the equivalent of $3474.89. Thanks to inflation I am not only making $1500 tax-free, but I also have had free use of $5000 for 14 years. Even Dave Ramsey wouldn't pay this loan back early. IMHO, this is what happens when you have a low fixed rate mortgage and inflation skyrockets.

When interest payments are less than the inflation rate you are MAKING MONEY by not paying the loan back.

Now it is a little bit trickier when the inflation rate doesn't exceed the loan rate, but a similar situation applies. Let's say I have a 6% loan and inflation increases from 3% to 5%. Although I am still a Dave Ramsey Debt Slave (because I am paying more than whatever I would have paid had I paid cash), the terms have become much more favorable to me as a debtor. This now functions as an inflation hedge because more of my disposable income is now available to me. An example may clarify this:

30 year 100K Loan fixed at 6% ($7264/year)
Inflation increases from 3% to 5%.
Income increases from $100K to $105K (keeping pace with inflation)
% of income required to service debt decreases from 7.3% to 6.9%

If you run this out for 10 years of 5% inflation, your % of income required to service the debt falls to 4.5%. Thus, a fixed loan serves as an inflation hedge. I'm not saying it is better to have debt than to have none, only that a fixed-rate, long-term loan serves as an inflation hedge. In the case of unexpected inflation, that loan becomes more valuable to you as an investor/consumer.

It is noteworthy at this point to mention that in a deflationary environment fixed rate debtors get really hosed as their real payments get bigger and bigger and bigger.
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Postby White Coat Investor » Wed Jul 18, 2007 10:13 pm

Nitsuj wrote:[
Surprise! A new airport has been built, you are directly under the flightpath. That paid for home loses all sorts of value overnight.

Ooops.


Ummm....this has nothing to do with the discussion. The value of the home has nothing to do with whether or not the mortgage serves as an inflationary hedge. If the airport gets built he's screwed whether he paid the mortgage off or not.
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Re: Weirdo here

Postby White Coat Investor » Wed Jul 18, 2007 10:14 pm

chipmunk wrote:I am one of the two weirdos who voted 'never.' My goal is to become totally debt-free, including the mortgage, irregardless of the interest rate.

Yes, I drank the Dave Ramsey Kool-Aid, and am a member of the cult.
Dan


I think we've discovered who the other "weirdo" is. :) Just kidding mpt.
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Postby mptfan » Wed Jul 18, 2007 10:19 pm

Emergdoc, regarding your zero interest student loans, you are correct, but since you are not paying any interest at all, you gain nothing from paying them back early, so my argument does not apply to debt with a zero interest rate.

Regarding your hypothetical of the inflation rate exceeding the loan interest rate, I hadn't considered that. It's possible, though unlikely, and I will have to give that more thought.

Regarding your more realistic example of the 6% mortgage, I have to disagree. Again, if you assume that you have sufficient income to support your lifestyle while living below your means and saving money, and with a funded emergency fund and adequate insurance, then you have no more need of debt. In that situation, it doesn't matter how high inflation gets (assuming it is not higher than the loan rate because, as noted above, I haven't fully considered that scenario) you are still paying back the same interest rate, and you will still benefit from paying less interest or no interest once it is paid off. And since you won't need anymore debt, it will no longer matter whether inflation is 3% or 5% or 10% because you won't be borrowing any more money, and you have no more need of a hedge against inflation.

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Postby mptfan » Wed Jul 18, 2007 10:24 pm

whitemiata wrote:P.S. you really pay off the mortgage? I must be really missing something here


Yes, I really would, all else being equal. However, I would not forego investing in retirement accounts, because you can't go back in time and use up your IRA eligibility for prior years. But once my retirement accounts are filled up, I would pay off the mortgage.

The thing that you are missing seems so obvious to me...by paying off the mortgage, I avoid paying the mortgage interest for years and years, and that's a guaranteed return, and the mortgage has no more claim on my future income.

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Postby Nitsuj » Wed Jul 18, 2007 10:28 pm

EmergDoc wrote:
Nitsuj wrote:[
Surprise! A new airport has been built, you are directly under the flightpath. That paid for home loses all sorts of value overnight.

Ooops.


Ummm....this has nothing to do with the discussion. The value of the home has nothing to do with whether or not the mortgage serves as an inflationary hedge. If the airport gets built he's screwed whether he paid the mortgage off or not.

Sure it does. Had he been only paying the regular payment and investing the rest he'd have gains on that "rest" as a diversifier, and could walk away from the house if necessary and not lose the entire price of the house.

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Postby Nitsuj » Wed Jul 18, 2007 10:30 pm

mptfan wrote:The thing that you are missing seems so obvious to me...by paying off the mortgage, I avoid paying the mortgage interest for years and years, and that's a guaranteed return, and the mortgage has no more claim on my future income.

Even when you can earn more in a savings account than you are paying on your mortgage? Which ignoring taxes, my wife and I are doing right now.

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Postby White Coat Investor » Wed Jul 18, 2007 10:32 pm

mptfan wrote:Regarding your more realistic example of the 6% mortgage, I have to disagree. .


It isn't that the inflation rate needs to exceed the loan rate for it to be a profitable strategy. In inflation + a very low risk investment return > loan rate then the loan should not be paid back (excepting behavioral finance issues.) Example, inflation rises from 3% to 6%, 10 year CDs go from 5% to 8%. Now it is silly to pay back a 7% mortgage (tax effects neglected in this example.) This is what the OP was getting at with his poll.
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Postby mptfan » Wed Jul 18, 2007 10:33 pm

Nitsuj wrote:Sure it does. Had he been only paying the regular payment and investing the rest he'd have gains on that "rest" as a diversifier, and could walk away from the house if necessary and not lose the entire price of the house.


You really believe that? :roll: You think the lender will just walk away?

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Postby mptfan » Wed Jul 18, 2007 10:35 pm

EmergDoc wrote: This is what the OP was getting at with his poll.


Emergdoc, I am the OP. :wink:

I will give your point some more thought, I am tired right now and must sleep.

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Postby Nitsuj » Wed Jul 18, 2007 10:35 pm

mptfan wrote:You really believe that? :roll: You think the lender will just walk away?

It will be a hit to your credit, for sure, but you seem to be presenting a need for no more credit again. The lender only has a claim on the house, so let them have it, if the worst happens. Negotiate the best terms you can beforehand, of course.
Last edited by Nitsuj on Wed Jul 18, 2007 10:36 pm, edited 1 time in total.

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Postby White Coat Investor » Wed Jul 18, 2007 10:36 pm

Nitsuj wrote:
Sure it does. Had he been only paying the regular payment and investing the rest he'd have gains on that "rest" as a diversifier, and could walk away from the house if necessary and not lose the entire price of the house.


Or he might have losses. Either way the value of the home has nothing to do with how the mortgage acts in an inflationary or deflationary environment.

In an deflationary environment, the loan holder is hosed. The house value goes down, the mortgage becomes more expensive, his salary goes down, and his stock portfolio tanks.

In an inflationary environment, the loan holder is rewarded. The house value goes up, the mortgage gets cheaper, his salary goes up, and his stock portfolio (theoretically) keeps up with inflation.
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Postby White Coat Investor » Wed Jul 18, 2007 10:37 pm

mptfan wrote:Emergdoc, I am the OP. :wink:


You got me. Must be time for me to go to bed too. :)
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Postby mptfan » Wed Jul 18, 2007 10:40 pm

Nitsuj wrote:The lender only has a claim on the house.....


This is a false statement. When you get a mortgage, you enter into a contract with the lender which requires you to repay the loan with interest, according to the terms of the contract. If you default, the lender can (and usually will) sue you and force you to pay, regardless of what happens to the house. You will then be responsible to pay the legal costs and attorney's fees as well, in addition to the principal and interest.

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Postby whitemiata » Wed Jul 18, 2007 10:46 pm

mptfan wrote:
whitemiata wrote:P.S. you really pay off the mortgage? I must be really missing something here


Yes, I really would, all else being equal. However, I would not forego investing in retirement accounts, because you can't go back in time and use up your IRA eligibility for prior years. But once my retirement accounts are filled up, I would pay off the mortgage.

The thing that you are missing seems so obvious to me...by paying off the mortgage, I avoid paying the mortgage interest for years and years, and that's a guaranteed return, and the mortgage has no more claim on my future income.


I am not really missing your point.

I did indeed pay off my mortgage. It was a 5.95% loan for the record, initiated in 1998.

I've simply been second-guessing the decision I made back then ever since and am now somewhat annoyed by the fact that the money that is locked up in equity in the home is not appreciating at the same rate that the rest of my investments are.

:-)

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Postby mptfan » Wed Jul 18, 2007 10:51 pm

There is no "money" in your house. It's a house, not a bank. :)

It's easy to second guess after the fact, after you have the benefit of witnessing the future. What if you had taken "money" out of the house (as you say) in 1999 or 2000 and invested in the high flying market at the time.... only to watch your "money in the house" drop in value by 40%?? Would that have been the right thing to do?

P.S. This "money locked up in my house" thing is another myth perpetuated by the mortgage industry. I wish someone would show me where all the money is that is supposed to be locked up in my house! I can't seem to find it! All I can see are walls and windows and a roof... no money.

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Postby Nitsuj » Wed Jul 18, 2007 11:00 pm

mptfan wrote:
Nitsuj wrote:The lender only has a claim on the house.....


This is a false statement. When you get a mortgage, you enter into a contract with the lender which requires you to repay the loan with interest, according to the terms of the contract. If you default, the lender can (and usually will) sue you and force you to pay, regardless of what happens to the house. You will then be responsible to pay the legal costs and attorney's fees as well, in addition to the principal and interest.

Ah, so it is.

I guess the best bet is to pay off the mortgage with credit cards and default on those then ;)

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Postby mptfan » Wed Jul 18, 2007 11:08 pm

Nitsuj wrote:I guess the best bet is to pay off the mortgage with credit cards and default on those then ;)


That won't change the result because you have a contractual obligation to pay credit card debts too, and you will be sued upon default.


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