In the world of personal finance, you can always generate a good debate if you talk about paying off your mortgage early. The argument usually boils down to something like this:
If your interest rate is 4%, then paying extra towards that mortgage will earn you 4%. If you think you can earn more than 4% elsewhere, then don’t pay off your mortgage.
However, when it comes down to if YOU should pay extra towards YOUR mortgage, the above statement is an oversimplication. As Einstein is credited with saying, “Make everything as simple as possible, but not simpler.”
Since I am faced with this decision myself, let’s address the implied assumptions in the sentence above and all the other little details that go into the decision.
Warning: This is a braindump post and thus rather long and detailed…
Assumption #1: Your mortgage interest is 100% tax-deductible.
- In order for paying off your mortgage at 4% to get you the same net return as an investment earning 4%, the assumption is that your mortgage interest is 100% tax-deductible while your potential investment is to be taxed at your ordinary income tax rate. That way, the taxes cancel out.
- Mortgage interest is only tax-deductible if you itemize. However, the standard deduction in 2013 is $12,200 for married filing joints and $6,100 for single filers. This is the amount that anyone can deduct. Let’s say your mortgage is for $250,000 and the interest rate is 4%. That’s $10,000 in interest annually. So far, the married folks have no tax benefit at all! You would need a lot of other deductions like state income tax, property tax, and charitable contributions to push you over the hump. For example if you have $7,200 in other deductions, then only $5,000 of your $10,000 in mortgage interest is actually saving you anything extra in taxes. I call this 50% deductibility.
- In addition, as you pay down your mortgage over time, your interest paid will decrease and make it gradually harder to itemize.
- On the flip side, if your investments are stocks, then your long-term capital gains tax rate may be lower than your ordinary income tax rate.
- The ability to avoid some taxes and thus increase your effective return is also why it is generally advised that you shouldn’t pay extra towards your mortgage unless you’ve maximized your tax-advantaged accounts (401k, IRA) and definitely any 401k employer match. An employer match is often a 50%-100% instant return, so you definitely can’t leave that on the table.
- Bottom line: People think their mortgage interest is saving them lots of money in taxes, but it often isn’t. Each person should add up their other deductions and figure out their own percentage of deductibility.
Assumption #2: You’ll won’t refinance or sell the house before the end of the mortgage term.
- Let’s rewind and just assume that paying down your mortgage will effectively earn you 4%. Hmmm… 4% for 30 years, that’s too low for too long! I would point out that the current yield on a 30-Year Treasury bond is about 3.2%. Not impressed? Me neither. How about the fact that people rarely keep their mortgage for 30 years. Let say you sell your house or refinance in 5 years. Now you earned 4% a year guaranteed over just 5 years. A 5-year bond only earns about .90%, and the top 5-year bank CD only earns about 1.5%. Now things look better!
- “But wait, my mortgage payment stayed the same! How did I earn 4% over 5 years?” As you make additional payments, more of your monthly payment is applied toward the principal and less towards interest. You just got moved forward in your amortization schedule. When you sell or refi, you’ll get your money back and realize that return.
- Bottom line: Your mortgage holding period matters.
Assumption #3: You can handle the additional leverage.
- “Whatever, stocks will earn so much more than 4%, who cares?!” Now, if you asked me if stocks were going to return greater than 4% over the next 30 years, my answer would be yes. Would I bet with even money odds? Sure. Would I bet my life on it in order to win a Twinkie? No. I think the odds are good, but not a sure thing. It’s always hard to compare a guaranteed fixed return with a highly volatile return.
- What I’m trying to get to here is that intentionally putting even more money in stocks while effectively using borrowed money is called leverage, which amplifies both potential gains and losses.
- Let’s say your house is worth $250,000, your mortgage is for $200,000, and you have $100,000 in stocks. Now let’s say you had a $100,000 windfall and instead of paying down your mortgage, you put it in stocks so now you have a $250,000 house, $200,000 mortgage, and $200,000 in stocks ($250,000 net worth). If the stock market went up 50%, you’d be up $100,000 (40% increase in net worth). But if the stock market went down 50%, you’d be down $100,000 (40% drop in net worth). If you’d just paid down the mortgage, your swings would have been only 20% of your net worth. Trust me, that’s a lot less Pepto Bismol. Sure, those swings may work out in the end, but it may take a decade or more. Can you handle the wilder ride without asking to get off?
- Again, holding period matters. Over a 30-year period, I like my odds of the stock market averaging being better than 4%. Over a 10-year period, I would like the odds a lot less.
- Bottom line: Leverage increases risk and stress. It may be worth it, but consider it carefully.
Assumption #4: You’ll invest properly.
- I don’t think it’s a coincidence that if you look at most US households, their largest asset is often their home. A mortgage is quiet, regular, “forced” savings. You can’t sell your house with a few mouse clicks. Real estate transactions are expensive, so people tend to buy and hold for relatively long periods. Nobody on the TV is yelling at you to SELL SELL SELL your house and BUY BUY BUY the other house across the street. This is a good thing.
- Some people will indeed put the money that could be tucked away for a 4% guaranteed return and put it in the stock market for decades and get a higher return in the end. But the behavioral component certainly isn’t guaranteed, as there is an entire financial industry out there trying chip away at your money.
- Bottom line: How’d you do during 2008 and 2009? Did you buy MORE stocks? If so, you may have the proper make-up for investing. If you quietly switched to bonds, you need less risk.
Detail #1: Inflation hedge!
- “Isn’t a mortgage a great inflation hedge?” Yes, if inflation goes sky-high (over 4% in this example), your monthly payment will effectively decrease over time. Inflation tends to be good for debtors. However, like other forms of insurance, hedging costs money. What if inflation is tepid, just meeting the market expectations of 2-3%? Are you willing to pay the premium for this insurance?
- Alternatively, take the wait-and-see approach. As long as you have a mortgage, you’ll still have some inflation hedge. If one day interest rates rise high enough and you can earn more than 4% (or whatever your rate is) with equally safe investments, then by all means do so and stop paying extra. I have some 10-year CDs at 5% APY that I view as a “mortgage offset” holding. Sure, I could cash them out and pay down my mortgage, but why not pocket the higher rate as it’s FDIC-insured?
Detail #2: Cashflow
- When you pay off a mortgage completely, you go from a required chunk of money every month to nothing but property taxes and homeowner’s insurance. This can be useful if you are at a point where you may be dependent on a pension, annuity, or other fixed income.
- If you’re not paying down your mortgage and putting money in stocks instead, you might be in a bear market when you want the house paid off. You don’t want to be forced to sell low.
- For this reason, I like the idea of timing your mortgage payoff date to the date of your retirement, or a date where you want lower monthly recurring expenses (“semi-retirement”). If you plan on retiring in 10 years, then try and get your house paid off by then. If you are a long ways off from your retirement, then you have many working years left and don’t have to worry much about cashflow.
- Paying off your house is saving for retirement. Without a mortgage payment, you’ll need less income and thus a smaller portfolio.
Detail #3: Home Value Exposure
- I occasionally read that paying down your mortgage gives you too much exposure to real estate. This always confused me as you are fully exposed to changes to the value of your house whether or not you have a mortgage.
- The exception to this is if you want to be able to walk away from your house in the event that your home becomes worth less than your mortgage (short sale or strategic default). In this case, you would make a minimal downpayment and keep as little home equity as possible to minimize your downside risk. I’d make sure you live in a non-recourse state as well.
Detail #4: Bond Replacement Therapy
- Often, the focus is on stocks vs. mortgage. This is because it is quite hard to find any bonds that safely yield as much as your mortgage interest rate. However, another option exists. These days most investors have embraced at least little bond exposure in their asset allocation. Well, why not simply decrease your position in bonds and put that money instead towards paying extra towards a mortgage? Right now the Vanguard Total Bond Market Index Fund only yields about 1.7%. Wouldn’t you rather yield 4%?
- There is a loss of liquidity. A bond mutual fund or bond ETF can be sold nearly instantly for cash, and you can just sell a small portion if you want. You can’t do that with a house. HELOCs are an option but have their own costs. However, if this is your retirement portfolio, how much liquidity do you really need? My 401ks and IRAs are also less liquid, but I still like them.
- As long as you don’t replace all your bonds with mortgage payments, you can still rebalance between asset classes.
- This method will force you do to some mental accounting when the stock market drops, remembering that you have money tucked into your home equity.
Conclusion
I hope you agree that there is no clear answer to this question. The devil is in the details. It’s a mix of math, balancing future probabilities, and personal “sleep-well-at-night” risk tolerance.
Let me know in the comments if there are even more details that I forget to mention (quite likely).
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Very well written and comprehensive treatment of the topic from many angles. One thing I question. You state:
“I occasionally read that paying down your mortgage gives you too much exposure to real estate. This always confused me as you are fully exposed to changes to the value of your house whether or not you have a mortgage.”
Isn’t this a question of leverage? In an extreme case where you have no investments other than your home, If you place all your non-expense related resources into paying down your mortgage, you are 100% vested in a non diversified real estate position. If on the other hand you pay the minimum on your mortgage and invest the difference in other investments you are less than %100 invested in a single real estate investment. Of course you are still fully exposed to that investment, but you also now have exposure to other investments.
I realize this is an extreme case, but it shows the point. In the end, as you point out, it comes down to risk/benefit. In this example you must weigh risks and benefits associated with leverage and diversification.
Doesn’t this explain the concern with exposure to one specific real estate investment?
I think another dynamic to consider is looking at your home as both an investment, and a necessary expense. I think you’ve appropriately covered the investment aspects in the context of a personal investors blog. The aspect of the living expense of providing shelter is interesting as well. What level of shelter meets an individuals needs is not a constant. This is a slippery slope which tails off into living within your means.
I think the bond replacement therapy is an interesting angle in times where one could perceive rates to be low, and there is concern about raising rates compromising the value of bond investments.
For me personally, I’ve decided to tolerate some leverage in my home as an investment. I’ve worked this into my expense projections when calculating my future income needs. In self reflection though, it is interesting to consider why I can tolerate this level of leverage, but am not really comfortable with the thought of creating leverage by buying stocks on the margin. In effect I’m actually doing the same thing, less the mortgage interest deduction.
MMB,
Do some of these arguments apply to federal student loans. Rates today are roughly 7% via stafford subsidized/unsubsidized loans. It seems like paying off the principle with that amount of interest is much safer than investing unless cash is needed
This is right up my alley as I just paid off my mortgage 2 weeks ago. And let me tell you it is a great feeling. We worked hard, paid extra toward the principle whenever possible, and saved a bunch of interest and time in doing so. Knowing I don’t have that debt hanging over me AND knowing that I’ll have an extra $10,000 to add to my cash flow — It is truly great. Now, I’ll be able to pay off other small debts twice as fast and by the end of this year will be debt free.
I think one element not addressed is the emotional impact of moving toward zero debt. Depending on a person’s financial situation it may, indeed, be slightly more advantageous to keep the mortgage. However, once you include the emotional element I think it will often change the equation.
There is no clear answer. It comes down to risk tolerance. Some people definitely assign more utility to owning their home outright, which is fine. I take the other view, which is to try to maximize my long-term expected wealth, which leads me to pay the minimum towards my mortgage and lock in a historically low interest rate.
My personal opinion (and although I like to believe it is informed, it is only my personal opinion) is that rates are much more likely to go up in the next 5-10 years than to go down, and they may go up quite a bit. So given that, I’m happy to keep as much borrowed in my sub-4% 30-year jumbo mortgage with the expectation that in 5-10 years I will be able to buy a 25- or 20-year bond that yields more like 6-7%, which is a long-term historical average yield for something like that. As recent as 2007, cash was paying between 4-5%, so I try to take a longer-term view and lock-in financing at a time of very low yields when and then be willing to wait (with some risk) for higher investment yields in the future.
Also, one other point on your Assumption #1 of tax deductability. Don’t forget that for incomes over $200k (single, $250k married filing jointly), itemized deductions begin to phase out, which can reduce the value of the mortgage and other deductions. These PEP and Pease phase outs were in the tax code under Clinton and the Bush tax codes phased them out, and they’ve come back this year.
If you include the state income taxes also in the itemized deductions, then most of the mortgage interest should tax deducible. Am I missing something?
Simple argument for some to not pay mortgage early is not having enough of cash reserves.
Good Points.
My overall feeling is that I don’t like to put all my eggs in one basket, so I would never be an either/or type. Though I have always applauded you for paying off your mortgage quickly with your high income situation (I know you get a lot of flack for that). I would do the same in your shoes. Because, obviously you aren’t putting all your eggs in one basket. I also think it is wise to pay off a mortgage if you can very quickly (like 5 years). If you have to pay an extra $1,000/month for 15 years to pay it off, that is tying up a lot of cash flow for little short-term benefit. I would not do that.
I have also personally never gotten the “have a mortgage forever” mentality. I know a LOT of people who never pre-paid a dime on their mortgage, but because they invested well, the average payoff for these types is around age 55. At that point they have a large nest egg, and just write a check for the last $50k or less. When they were 20 or 30 they might have thought they wanted a mortgage forever, but is not usually how it pans out for the more investment-disciplined. At some point you do so well that it’s not a big deal to just pay it off and be done with it.
Great points. My thinking is that paying down a mortgage and being debt free gives you a TON of flexibility to ride out bad markets. You are not forced to sell in a bad time, worst case you can get a renter and in case you need a new loan in a hurry, not having existing debt matters a lot in todays environment.
However there is an implied order on when you should fund it.
First – Fund Short term expenses (1-2 yrs of living expenses). Getting a new job is hard so 1-2 years is conservative.
Second – Fund 401k/IRA. Max it out get the tax benefit.
Third – If you have cash left over – fund the house.
Bang on on the tax myths – I had done a post on my blog as well on this exact same topic ->http://blog.thesharmas.org/2012/10/15/buying-a-house-dont-fall-for-the-myths/ let me know what you think.
“At some point you do so well that it’s not a big deal to just pay it off and be done with it.”
That’s a great statement.
Great write up with a lot of good points.
There really isn’t a simple yes/no equation that is a ‘one size fits all’ answer on this. One of the biggest reasons to pay off a mortgage is psychological, as most people feel totally unburdened to have their house paid off.
Personally I’m not paying down our mortgages at this point. I figure rates will go up so in a few years it will be relatively easy to find safe fixed income paying >4%. But I totally understand if others decide to pay their mortgages off. I wouldn’t however sink a large % of your assets into doing so. But if you’re already maxing your retirement and want to put extra money somewhere then paying off a house is a good tactic in general.
Mosambi,
For married couple the example is compariong the standard deduction of $12,200 to what you can itemize for. If you have just a mortgage then thats a $10,000 itemization and you’d do better with the minimum $12,200 standard. If you have the $10,000 mortgage plus $7200 of other deductions then your total itemized deductions would be $17,200 and you’d want to itemize. So then the comparison is between having a mortgage deduction of $10,000 or not. If you paid off the mortgage you’d then be left with just the $7200 in other deductions and instead want to take the $12200 standard deduction. But if you keep the mortgage then you’d get the $17200 itemized deduction sum. The difference is $5000 worth of deductions. Therefore in this example you’re really only benefiting from deducting 50% of your $10,000 in interest paid.
Of course it depends. If that same person was single then theyd’ get 100% of the interest deduction no matter what since the single person standard deduction is $6100 and their state income & property taxes already put them above that.
@Alan – You can still view the house and mortgage as separate things. Even if you have no investments other than your home, you could look at that as the same as a person with $200,000 of mortgage debt at 4% and $200,000 in bonds paying 4%. If you replace the bonds with instead then that’s just $200,000 in debt at 4% and $200,000 in stock at ???%. Like you said, it’s like buying on (cheap, long-term) margin.
@AKmmbfreak – Yes you could definitely extend the argument to student loans. One wrinkle is income-based repayment where you may actually be able to pay off much less than the total principal and have the rest forgiven. Old article:
https://www.mymoneyblog.com/income-based-repayment-of-federal-student-loan-debt-starts-july-1st.html
@Jimmy – Congratulations on the payoff! You must sleep better at night. 🙂
@Andy – Good points about the new itemized deduction phaseouts. I forgot to include that.
@Mosambi – It all depends on how much state income tax that you pay. In order to pay over $10,000 in state income taxes, you’d have to be making safely over $100k a year in every state that I can think of. Most people don’t make that much.
If you earn $100,000 gross in California with 1 allowance, you’re only paying about $7,000 in state income tax per PayCheckCity.com (single or married).
@Alex – Yes, great point, cash reserves are important and should definitely be a bigger concern.
@Alexandria – Well-reasoned comment as always! 🙂
@Rohit – I would agree with the general order of your list.
Another point you allude to only indirectly (cash flow) is marginal tax rates. Carrying a mortgage into semi or full retirement will mean you need more income in those periods and therefore may lose some tax arbitrage advantage (investing pre-tax during high income working years and withdrawing at lower rates). With Obamacare and the 400% poverty line threshold, requiring more retirement income could also push you past that threshold, increasing health insurance costs.
One thing we did was to rent for four years after we were married before we bought a house. When we rented we had less space and overall a lower housing budget. That allowed us to save like crazy for a down payment and we bought our house with 50% down. We did pay off our mortgage early, but I agree that for many people it really is a matter of taste. There is nothing like the feeling of being mortgage free. On the other hand, it helps that we are naturally thrifty because we just saved what used to be our mortgage payment. I could easily see how someone could pay off their house, go back to old spending habits and be back in trouble soon.
I’m confused by: “However, like other forms of insurance, hedging costs money. What if inflation is tepid, just meeting the market expectations of 2-3%? Are you willing to pay the premium for this insurance?”
You’re allready paying a premium for insurance in your interest rate. The premium is Actual rate paying-expected inflation(plus some overhead and profit for banks). Now, make the calculation on whether you think you can earn more than your interest rate to decide whether to pay off loan or not. It doesn’t matter why the rate is what it is, the calculation should be the same.
In regards to the itemized deduction, one thing I don’t think most people consider is that by paying off your mortgage early you still get the standard deduction (SD), which is basically free money from the government. I’ll use the #s from your article as an example:
Assume mortgage with $10,000 in interest and $7,200 in other expenses. If the mortgage is paid off early, you still have the $7,200 of expenses (because property taxes and state income taxes aren’t going anywhere), however, the SD of $12,200 gives you an additional $5,000 deduction for free. This increases the return of paying off a mortgage early.
Great article, and thank you SO much for clarifying your “Assumption #1.” That is a mathematical battle I’ve faced so many times with people who think paying $10,000/yr in mortgage interests = $10,000 deduction.
One question for the folks who do the pay down method, does that mean you do not fund your 401k at the max rate (35k for a couple) and thus surrender corporate matching (maybe 5-10k extra)?
That may not sound bad for 2-3 years but I cannot see how this works out better for a home with a large mortgage.
Very good piece, Jonathan. And you are right there is no one size fits all in this question, but I would like to mention a few things that I have learned some about investing and some about myself. First I am 50 years old and about to pay off a motgage that I took out and refinanced 2 times over the years. I was gung ho and wanted to pay it off as soon as possible. My friend and accountant told me no you will always make more in the stock market over the long run and for the most part I went along. Then the crash of 08 and 09 happened and I learned some things. First my appitete for risk was noit what what I thought it was. Seeing the value of my investments go down that much made my stomach churn, but I still believed in stock investing. Another thing was that I did not have much extra cash to invest at the lows of the market and anything I sold I would have lost quite a bit on. When all was said and done my new prospective was: 1. As you always say keep a safetynet of 6-12 months emergency fund 2. Keep debt other than mortgage well under control. I payoff every credit card every month except the 0% deals. 3. Put into retirement at least what is matched more if ya can. But the dirty little secret about retirement money is that we have always been told that in retirement when we pulled the money out our tax rates would be lower but with the country 16 trillion dollars in debt and running yearly deficits of 1 trillion and with the medicare and social security unfunded liabilities I am not sure I believe this lower taxrate theory. Also there are far left leaning politicians that are already proposing the nationalization of 401’s and all retirement plans to redistribute. Some say this would never happen but there are parts of Obamacare that 15 years ago people said would never happen. 4. So what to do: I lean more towards balanced funds these days, but keep an allication to foreign and commodity/gold style funds. But more importantly if I had it to do ove again I would allicate differently after the emergency and retirement were taken care of by dividing what was left 3 ways and put it trowards ! stock investing 2. pay off mortgage 3. cash not emergency fund cash but cash for purchasing real bargins or at least dividing between the first two. One more thing and it is something that is something that I am sure most mymoneyblog readers do that most others don’t and that is to live on less than you make.
Greg
PS I also want to add that I think most readers are like I used to be in that they are maximizers in that they want to make the most return every time , make the absoloute best decision every time, but there are too many unknowns and it is not possible. Spread the risk have some insurance. If I had done what I presented here long ago my home would already be pid off and there is a good chance I would have the about the same net worth.
Greg,
That is what made me lean toward paying off the house — the fact that there really are so many unknown variables that you cannot control. I can control when/if I pay off my house early. It is a known quantity and will get paid down/off based on decisions I make. I think, too, that my 6.375% rate played a roll when compared the rates of today…… I did end up doing the math and figuring out how much extra I’d have to pay toward principle at this rate to mimic a 3% loan (interest paid). It worked, but I’m happy it is over with. Now, I’m getting letters from my bank trying to entice me to get another loan 🙂
This is a timely discussion for me as my wife and I just closed on our refinance. We like others that have posted put a good chunk down ~40% and over the first 2 years of the mortgage have managed to pay down 80% of the cost of the house. We refinanced the 20% that was left at 3.5% for 30 years. I have no intention of paying down this mortgage as aggressively as the last.
IMO there is no sense paying down a mortgage that will cost me ~75000 over 30 years or an average of 2500 a year. Our original mortgage had us paying ~16000 a year at first in interest, or nearly 300k over the life of the loan. In two years we managed to save roughly 200k in interest on the loan and now have the flexibility of an extra 1200 a month saved in mortgage payment plus the ~7-8k a month that was going towards the mortage. All of this will be invested and we were thankfully in a position to contribute the max to both of our 401ks and invest in a taxible account during this time period.
The extra money will go to stocks and one could do something as simple as in investment in MO, COP, PM, MCD, etc and get a 4-5% div payment on that cash while only paying 3.5 or ~2.3% after taxes on a mortgage ( we are in 33% tax bracket). Not only will those stocks tend to appreciate in a slow persistent manor but your yield on cost continues to rise yearly as the divs are raised.
In 10 years your yield on cost in a name such PM could be 8-10% on that cash your originally invested as opposed to the flat 3.5% or 2.3% after taxes of the mortgage.
IMO in this scenario its a no brainer unless you can find a mortgage that will sequentially decrease the interest rate in the opposite fashion and degree as a good dividend paying stock. (Impossible I know)
Replacing bonds with mortgage repayment might be a risky bet. The idea behind equity/bond splits it that you can rebalance, since these two asset classes tend to move opposite each other. In years when your equities are performing well, you can “lock in” some of those gains, transfer the money into bonds, and then wait for equities to drop (and bonds to rise). When that happens, you have the liquidity (in the form of bonds) to move back into equities, capitalizing on the market movement. If, however, you opted for a mortgage pay-off rather than bonds, you’d lose that liquidity.
That doesn’t necessarily mean that you shouldn’t do it … it’s just another factor you should consider.
@Someguy – Good point, when done with a paid off house, early retirement should be a period of very low marginal taxes.
@Kevin – I see where you’re coming from, but was just trying to address the idea that you should just hold a mortgage due to the inflation hedge argument. As you suggest, what it really boils down to is if the nominal return on your alternative investment will beat 4% or whatever (not to mention how bumpy that return would be). Consider that right now you can’t even get inflation protection for free with TIPS or Treasuries, you’d have to settle for a negative 1.5% real yield with a 5-years TIP!
@bdgc – We still max out the 401ks, but some people may not have a 401k available. We do pre-tax because we think our marginal income tax rates will be much lower in retirement.
@Greg – Diversification is definitely a good thing. I think it’s a much safer bet that those with a lower income will still be subject to much lower taxes than high income. Without a mortgage, I can get by with creating a lot less income. 🙂
@Jimmy – Congrats on the payoff!
@Mattym – That is certainly one reasonable option, but remember that even big megacap dividend paying stocks get cuts so I’d be careful not to be too concentrated.
@Billguard – I agree, that’s why you should replace all your bonds with mortgage payoff, just some of it.
Thanks for the tip on paying closer attention to the tax benefits from a mortgage. I was sure that we were getting a good deal because we (my wife and I) always itemize deductions. I had not really thought about meeting the minimum so it forced to run the actual numbers for my 2011 and 2012 forms just in case. While I did meet the minimum (hence making sense to itemize), it also allowed me to think about the year in the future in which it would start making sense to just pay off the mortgage. Unfortunately, given the high principal for mortgages here in Hawaii, that year is long, long away. Still, it was a good tip. Thanks!
I’d like to add the discussion the tax effects that are created by the AMT. With the AMT you get a large deduction that is susceptible to a phase out based on income, but the tax is calcuated on a higher income base due to having to add back certain itemized deductions, most notably property taxes and state taxes. However mortgage interest is still deductible under this scenario. AMT rates for us are 28%.
We are very conservative investors and are now only earning a blended rate of 1% on our taxable accounts (was significantly higher until recently). I had the foresight to see the some of the effects of the Fed’s monetary policy and have expected deflation, hence our cash-like positions, but did not truly understand the lengths they would ultimately go to to interfere in the money markets and not allow deflation, as our government would then be paying back past debts with more valuable current dollars. This was a good lesson learned about diversification. In essence, given our financial decisions, we are even with those who rode out the crisis, but we gave up a substantial opportunity to do really well.
We would like to pay off our mortgage. So, by my calculations, it would make sense to pay off my 3% mortgage and thus lock into a gain or become self-financed. I.e, my after tax effective rate would be 2.16% (3% * .72). I understand the downsides to this transaction, i.e loss of liquidity, and loss of higher return opportunity etc., but this is only minor concern for us. Since 2.16% is higher than the 1% generated, I am locking into a gain at least in the short term, and will invest the monthly cash flow hopefully as rates start rising.
Thank you for your blog, I am a new fan. I am not a money expert and wonder if our home is truly an investment. Aside from property taxes etc. a home incurs expenses such as repairs, maintenance, and updates (to be sellable). I’d like to hear what you think about funding an home improvement project. It does not make sense to dip into our cash reserves, nor to borrow home improvement/home equity loan since it contradicts to our goal of paying off the mortgage.
Thank you.
How about reducing to a close to hisorically low rate to shave a couple years off? For example:
12 years remaining on a 15 @ 3.375% to a 10 year (no cost) at 2.99%. However, this would be for the purpose of accumulating max equity for one more move/purcahse/upgrade within that time frame. The goal being to accumulate as much equity as possible for one more 15 year loan on a different home before retirment. The refi would add roughly $380/month to the existing loan payment and build equity much quicker (+$500/month…$2,000+ towards principal per month) while significantly reducing the amount of interest paid over 10 years.
Looking to retire from myNYS teaching job in 7 years. Currently, I have 127,000 saved in my 403b, teachers pension will be aprox. 51,000, a rental property valued at 80,000 with a 28,000 mortgage balance at 5.75 percent. Also, my home valued at 132,000 with a 74,000 balance at 3%. I am currently putting 8000.00 a year into my 4o3b but considering taking that money and paying my mortgage off in 5 years not 12. What should I do…continue to put this money into 4o3b or pay off my mortgage.