Okay, I want to pay my mortgage off early, but...

[RayJay]

Why do you think Charlotte and all of NC is becoming the next NJ? Seriously, they are all moving down here. I think that most of our newly opened elem. school is comprised of NJ/NY/PA folks! The principal quoted 90% newcomers to the area, all New Englanders!

Dawn

Dawn

I prefer to be called "Damn Yankee", I'm getting use to it.

Recently moved from CT to VA. And your right we'all are
moving down to you'alls states.

Seriously though it's bad up North, I can even begin to tell you what I'm saving by moving to VA.

RayJay

 

[dcfromva]

This is sort of the risk reward scenario - if you manage to pay off your mortgage your biggest bill (for most people) has disappeared. You need to keep enough income coming in for taxes and insurance, plus your other expenses. For my husband and I that means - if we HAD to, we could live on about $20k a year - not comfortably, but we could - and still live in the same house and send the kids to the same school. They'd notice, but they wouldn't notice to the "we have to move" level. For me, this is a huge relief.

However, had we both become unemployed after putting a bunch of savings towards the mortgage, we'd still have some mortgage left to pay - so we'd still have a house payment on top of that $12k. Refinancing without employment would have been awkward. Had we put the money into savings and become unemployed, we could use the savings to keep the house while we looked for new employment.

In our case there was a lot of money available that we could pay off our mortgage and not short our savings. So we seized the moment in time to get that done. But it is wrong to imply its always risk free - the idea of leaving the money in savings so you have a cushion is a good one and that should be done first before you start paying down your mortgage - even if you don't want to play the interest/tax/investment return differential game.

crisi,
I don't think paying extra on the mortgage to the exclusion of other funding intititives is ever a very good idea. I agree you have to have a cushion/emergency fund too.

-DC

 

[crisi]

bellarella,
The point I am making is that in real terms (after the tax deductions depending on the tax bracket) you may actually have less money if you elect to save money keeping it liquid vrs pre-paying your mortgage. I don't think it is as simple as looking at historical ROR on the market and comparing it to the mortgage interest rate.

While the tax rate is currently lower for long term capital gains that might not be the case in 11 years or 26 years from now. ( Plus, cashing in stocks with gains, etc could end up putting a person in a higher tax bracket and place them into a higher marginal tax rate and maybe even subject to the lovely AMT rules.)

There are lots of ins and outs and what have yous and what nots to consider.


-DC

I'm currently taking a tax class right now from a guy who does individual income taxes for private individuals - and a lot of people end up with a big tax bill by trying to outsmart the system and not taking tax consequences into account. They pop themselves into a higher bracket and lose their gain, they do something to end up in an AMT situation, they create a situation that raises audit flags - that cost them time and money with a tax professional getting resolved. One of the things that can trigger AMT is exactly this game - having a lot of investment generated income and having a lot of deductions. And the "lot of deductions" is usually the mortgage. Congress isn't giving you a mortgage deduction so you can make more money on the market with your cash on hand - and AMT is set up to catch that.

AMT was originally set up to catch rich people who had lots of non-wage income all taxed at small capital gains rates - really rich people who paid almost no taxes. But more and more, it catches the middle class.

Don't run the numbers without looking at the tax impact, unless you want to pay more tax. And tax planning (projecting out five years or ten years) what the tax impact might be is a job for professionals - and even professionals can't tell what Congress might do next year to the tax code.

 

[bellarella]

bellarella,
The point I am making is that in real terms (after the tax deductions depending on the tax bracket) you may actually have less money if you elect to save money keeping it liquid vrs pre-paying your mortgage. I don't think it is as simple as looking at historical ROR on the market and comparing it to the mortgage interest rate.

While the tax rate is currently lower for long term capital gains that might not be the case in 11 years or 26 years from now. ( Plus, cashing in stocks with gains, etc could end up putting a person in a higher tax bracket and place them into a higher marginal tax rate and maybe even subject to the lovely AMT rules.)

There are lots of ins and outs and what have yous and what nots to consider.


-DC

I agree that there is a lot of complexity in running the numbers. But an obvious error in the way these were run is that it assumes that the person who is saving outside of the mortgage company continues paying the mortgage payment minimum throughout the life of the mortgage. It fails to take into account that at the point at which the person who send the extra towards principle each month would pay off their mortgage, the person who sent that money to a separate account would *also* be able to pay off the mortgage. So to compare apples to apples you need to redo the calculus to show both scenarios paying the mortgage off in full as soon as it is possible to do so.

There are lots of ways to slice and dice the numbers, but I don't think you can get around the fact that when your interest rate on your mortgage is close to what a HYS account earns *during the pay down period* you expose yourself to much more risk if you actually send your money to the mortgage company rather than keeping it in the bank. Once you have enough money saved to pay off the mortgage in full, then yes, you can completely eliminate mortgage payments (which may or may not be the best option on paper, but I understand the psychological pull that can tip the balance in favor of paying it off regardless). But I have lived in more than one market where job loss and housing market shrinkage has occurred at the same time and people who where in the process of paying ahead on their mortgage got in quite the pickle, needlessly.

 

[Jon99]

When I say "real interest rate" I mean the rate after you account for the tax deduction of the interest.

If you pay 5% interest and are in the 25% tax bracket, at tax time, 25% of that interest gets deducted from your taxes. So if you paid $1,000 in interest, your taxes would be reduced by $250. That means in reality, you only paid 3.75% interest (5%-1.25%).

As crisi pointed out, though, everyone's situation is different. We aren't all in the 25% bracket. We don't all qualify to deduct our mortgage interest. So you need to run the numbers for your own circumstances.

When looking at the real rate, doesn't that vary from person to person, depending on their tax return and how many other deductions they have? This year our mortgage deduction will probably vanish because
we will take the standard deduction for the first time.. So to figure out the real actual interest rate, doesn't the formula need to be something like: Mortgage rate -(mortgage interest - standard deduction)= real rate?

 

[starwood]

When we were paying our mortgage we just added in any additional money we had that month. We paid off our 30 year mortgage in around 10 years. We didn't worry about making the same amount of additional payment every month. Some months it was more - some months less.

 

[MrsPete]

Why do you give people credit for making the right decision when it benefits your view but discount it on mine?

LOL. I believe I asked you (could've been another poster) the same thing yesterday!

Financing a car you *need* or kids braces while having extra equity in your home really doesn't make sense. The interest rates on those items are likely to be higher than your mortgage interest rate, so you will be coming out behind in the long run.

Of course interest rates vary, but the only mortgage I've ever had was at 10.5%. The last car I financed was 6%; I occasionally see 0%-2% financing on TV commercials (of course, I know there are serious strings attached to those offers). I was in the orthodontist's office a few weeks ago, and they were offering 6% discount for paying cash upfront. I understand that interest rates are better now than they were back in the early 90s when I bought my first house; however, they are variable -- so the "value" of paying off your house'll go up and down. Owning those bricks though is ALWAYS owning those bricks.

But still, if your mortgage interest rate and a high yield savings rate are close, then while you may psychologically feel like you are doing the "safe" thing by sending the money to your mortgage company, the math rarely supports that.

On paper, it can be made to look good, but real life doesn't always follow those hypothetical plans! Putting aside cash to pay off the house does sound like a great idea, but not many of us'll finance a car or braces while we have $100,000 sitting there; the reality is that the house probably wouldn't be paid off through this method; other things -- things that really do matter -- would interfere.

I still see NO downside to owning your home outright (providing, of course, that one hasn't ignored other financial needs to do so -- diversification is a good thing). Since it is both an investment AND a necessity, it serves double-duty and it should be one's most protected investment. Yes, there's a psychological "feel good" to it, and a large part of that does come from the fact that as a child we sometimes wondered where we'd live, but it's ALSO a sound financial investment.

 

[MrsPete]

I know some folks who paid off their home using money from company stock (in the technology sector). Maybe about a year after selling the stock, the whole technology sector took a nose dive. (Didn't they look like geniuses with impecable timing?)

Yeah, timing certainly plays a part in the game! Sometimes we win, sometimes we lose . . . and part of it is the pure luck of being in the right place at the right time.

Other times we screw up because of timing. For example, when we were first married and bought our house, interest rates were moderately high -- no way around it, that's what was available. We talked about refinancing our mortgage a hundred times, but we never did because "we're only going to stay in this house one more year, and we'd never break even on the refinancing costs". We used that excuse for about five years. In retrospect, we should've refinanced; it would've saved us a bundle.

 

[MrsPete]

crisi,
I don't think paying extra on the mortgage to the exclusion of other funding intititives is ever a very good idea. I agree you have to have a cushion/emergency fund too.

-DC

I don't think anyone has suggested otherwise. I advocate paying off the mortgage as quickly as possible AS A PART of the OVERALL FINANCIAL PLAN.

 

[disneysteve]

not many of us'll finance a car or braces while we have $100,000 sitting there

As usual, I'm the exception. My daughter had her braces put on last September. We are financing it, despite having more than enough money to pay it in full upfront. Why? The cash discount was only 5%. The financing is interest-free. I ran the numbers, with help from folks here and/or savingadvice.com, and determined that I'd do better to keep my money invested earning a higher return and make the monthly payments. The 5% cash discount wouldn't have saved me enough to make it worthwhile. Pretty much the same argument I've been making about prepaying a low interest mortgage. I can do better keeping my money elsewhere.

We can run projections as much as we want with a theoretical 8% return, but keep in mind that there are times when the market does worse and there are times when it does far better. In the last 12 months, my best mutual fund is up 29.42% and my "worst" fund is up 18.22% so I'm quite pleased that I chose to finance DD's braces rather than pull money out of savings to pay for them in full. And I'm certainly not pulling money out to prepay my 4.4% mortgage. If the market takes a serious downturn, I might change my mind, but for now I'm doing far better this way.

 

[Grumpy's Gal]

but not many of us'll finance a car or braces while we have $100,000 sitting there;

we did "finance" the braces when we could have paid cash.

WHY? They only offered us 3% discount to pay cash upfront and the financing for 18 months was free!

So, yes, it all depends on the individual situation what works best for you. For us, it was taking the financing (for FREE) and putting that money elsewhere.

edited to add: and the orthodontist charges our monthly payment automatically to my Disney Visa every month....and since I pay it off, it costs me no more. And I earn a few disney dollars that way too.

 

[MrsPete]

As usual, I'm the exception. My daughter had her braces put on last September. We are financing it, despite having more than enough money to pay it in full upfront.

I'm trying to make this decision right now, and I'm going back and forth on it.

It's a pile of money, and the 6% they'll deduct for paying up front is just a drop in the bucket. I'd take it out of my short-term savings /vacation account, which isn't going to be invested anyway -- so it's just sitting there gathering a small amount of interest.

The larger concern is that DH has medical-account money deducted from his account pre-tax, and he hasn't had nearly the cost of the braces deducted this year; in fact, even if I finance, I'll spend everything (well, actually I think we'll have $25 left in the account) he has had deducted all year on the ortho-downpayment. So if I wait, he can "up" his deduction in January and it can ALL be pre-tax -- I think that's going to be the deciding factor. I don't actually have to make this decision until August 20th, which is welcome-to-braces-day for her.

And DH is concerned about paying everything up-front because his job is a little shakey right now -- it happens every couple of years, and so far he's dodged the bullet. His skill-set is very much in demand, and he'd pick up another job right away, but it might not be right here! What happens if you've paid for your braces in full, and you're forced to move before the treatment is completed?

 

[disneysteve]

So if I wait, he can "up" his deduction in January and it can ALL be pre-tax

What happens if you've paid for your braces in full, and you're forced to move before the treatment is completed?

If you can pay it with pre-tax money, go for that option.

I agree about the other concern too. I wasn't worried about moving but I was concerned that we'd have no leverage to complain if we were unhappy with the treatment but had already paid, or if the doctor closed up or got sick and couldn't practice. Sometimes a discount isn't worth it.

 

[Marie17]

As usual, I'm the exception. My daughter had her braces put on last September. We are financing it, despite having more than enough money to pay it in full upfront. Why? The cash discount was only 5%. The financing is interest-free. I ran the numbers, with help from folks here and/or savingadvice.com, and determined that I'd do better to keep my money invested earning a higher return and make the monthly payments. The 5% cash discount wouldn't have saved me enough to make it worthwhile. Pretty much the same argument I've been making about prepaying a low interest mortgage. I can do better keeping my money elsewhere.

We are also financing our daughter's braces. 5% discount wasn't worth it to us to pay in advance. I asked if they could some how offer a higher discount - I would have paid with cash and not a credit card (so they would pay the cc fee) if they would have discounted it 15% but it was a no-go. I even explained that I would be making my payments via credit card if the discount was not given. Hence, I am no interest financing my portion and still qualifying for my cc rewards and they are actually going to lose more money this way. Every month, they will have to pay the cc processing fee out of their pocket.

Financing was free and our orthodontist actually gives you a "credit" of one month's payment if you refer a new patient that decides to go with the practice. If I would have pre-payed I highly doubt that I would get my "refund" check since the account would have a zero balance.

 

[FayeW]

DisneySteve, as usual, I agree with you.

I am a mortgage broker, so I have this conversation with clients all the time!

Carrying a mortgage is not only a financial cost, but an emotional cost as well. For many years the mindset has been that you have to own your home. I have clients selling homes and using 100% of the equity for down payment on the next home so they can be mortgage free faster, but when I ask them about their RRSPs (Registered Retirement Savings Plan, a tax deductible investment in Canada) they don't have any! I always counsel them to make sure they look after the rest of their portofolio because "if life happens to you, and your are driving down the road and the transmission goes in your car, it's going to be tough to get the money you need for repairs from your equity...make sure you keep some money in liquid investments for emergencies". That is my standard phrase, but it drives home the point that there are other options than just paying off the house early.

In Canada, we are allowed to contribut a certain percentage of our income to RRSPs and that amount gets deducted dollar for dollar from our taxable income. If I earn $60K, and contribute $20K, then I am taxed on $40K. Most of us pay 30-40% tax, so that represents a mimimum tax refund of $300-$400 per $1000 of contribution. So, right away, by contributing to an RRSP we are effectively earning a 30% return, mimimum. Add to that the compounding interest of any half decent investment and there is a significant advantage to fully funding the RRSP.

I frequently recomment to my clients to take some of the equity from the sale of their home, top up their RRSP contributions (any unused contributions from previous years are added to the next year's limits. Some people have NEVER contributed, and might have $20K,$30K or even more that they could contribute all at once, if they have the resources to do so) and then use the substantial tax refund to make a lump sum payment on the principal of the mortgage. That way they have the best of both worlds...some retirement savings that could be accessed in an emergency AND a lower mortgage balance. It's a pretty easy sell when I point out the 30-40% tax refund they are going to get in the spring!

With our RRSPs, we pay tax on the money when it is withdrawn. The idea is that by the time you withdraw it you will be in a lower tax bracket than when you earned it so you will pay less tax, and you've had the benefit of compound interest for all those years as well.

We have a whole stategy for helping people access their equity. In Canada, we do not receive a tax break on our mortgage interest because we do not have to claim capital gains, on a principal residence, when we sell. Our profit is non taxable. HOWEVER, we do earn a tax break on the interest from loans taken out for the purpose of investing (as long as it is not invested in the tax sheltered RRSP). I have several clients taking secured credit lines or brand new mortgages for the sole purpose of investing, as then they have a tax break writing off the interest. Example: I had a client who was purchasing a new home, and he planned on having a mortgage of $200K. Upon discussion I discovered that he had enough in his liquid investments to pay for the house in full. We then did a "refinance" of the property about 2 weeks after closing and gave him his $200K mortgage, which he promptly used to re-fund the investments. He still has the same mortgage he was going to have, the difference is now the $900 in interest, that was just going to fly out the window every month, is now a tax write off. He will pay tax on the interest he earns in his investments (when he cashes them in) but in the meantime he can use his tax refund every year to either pay down his mortgage or make further investments. I got him a rate of 5.14% fixed for 5yrs so the interest he earns in the investments will far out pace what he would pay on the mortgage even if it wasn't a tax deduction!

 

[MrsPete]

If you can pay it with pre-tax money, go for that option.

I can pay it with pre-tax dollars, but I cannot do it until 2008. DH hasn't had enough withdrawn this year, and he cannot change his "cafeteria plan" until January.

Hence, I am no interest financing my portion and still qualifying for my cc rewards and they are actually going to lose more money this way. Every month, they will have to pay the cc processing fee out of their pocket.

With the prices they charge, I don't think they'll miss the 3-4% on the credit card fee! Seriously, I'm sure that the financing cost and the credit card fee are already built into the cost of the braces -- they aren't going to lose money.

I never considered paying for braces with my credit card, but the reward points would certainly add up to something! I'll have to find out whether my orthodontist takes plastic.

Financing was free and our orthodontist actually gives you a "credit" of one month's payment if you refer a new patient that decides to go with the practice. If I would have pre-payed I highly doubt that I would get my "refund" check since the account would have a zero balance.

Wow. That's a great deal! If I had that offer, I'd be passing out xeroxed flyers, "Try Dr. X -- here's his phone number and a map to his office. Can I give you a ride?"

 

[MrsPete]

Carrying a mortgage is not only a financial cost, but an emotional cost as well. For many years the mindset has been that you have to own your home. I have clients selling homes and using 100% of the equity for down payment on the next home so they can be mortgage free faster, but when I ask them about their RRSPs

I've said a couple times that I wouldn't suggest that anyone pay down their house while ignoring other financial needs; however, with some attention to the budget, it doesn't have to be an choice between the house or retirement.

I own my modest house outright; however, I also have four months of living expenses in an account which I can access immediately; DH and I have both been maxing out our 401Ks at work for not-quite two decades. Plus I have a traditional pension. We have IRAs and short-term savings as well. We have no credit card debt, and we drive inexpensive paid-for cars. Not bad for a research engineer and a teacher.

 

[LadyShiva]

I've said a couple times that I wouldn't suggest that anyone pay down their house while ignoring other financial needs; however, with some attention to the budget, it doesn't have to be an choice between the house or retirement.

I own my modest house outright; however, I also have four months of living expenses in an account which I can access immediately; DH and I have both been maxing out our 401Ks at work for not-quite two decades. Plus I have a traditional pension. We have IRAs and short-term savings as well. We have no credit card debt, and we drive inexpensive paid-for cars. Not bad for a research engineer and a teacher.

I think you and I are in different age ranges. I haven't had a 401k for that long! I get the feeling your hubby works for the feds and you work for the local government? Maybe that's why our experiences have been so different.

Outside those spheres of work is quite different nowadays. You don't have many layoffs in the feds or local government. Corporate culture... wooo-wee. Nasty.

Brandie

 

[MrsPete]

I think you and I are in different age ranges. I haven't had a 401k for that long! I get the feeling your hubby works for the feds and you work for the local government? Maybe that's why our experiences have been so different.

Outside those spheres of work is quite different nowadays. You don't have many layoffs in the feds or local government. Corporate culture... wooo-wee. Nasty.

Brandie

I'm 41, my husband is 43.

I'm a teacher, so I'm a state employee. He works for a private non-profit research company. Just like clockwork, his company has lay-offs every two years; however, in this work climate and with their skills, the guys find new jobs quickly. We are each still in our first professional jobs; I've been teaching in the same county for 15 years, and he's been with his company for 18 years (though the name /owner changed once, so his resume shows two professional employers).

 

[LadyShiva]

I'm 41, my husband is 43.

I'm a teacher, so I'm a state employee. He works for a private non-profit research company. Just like clockwork, his company has lay-offs every two years; however, in this work climate and with their skills, the guys find new jobs quickly. We are each still in our first professional jobs; I've been teaching in the same county for 15 years, and he's been with his company for 18 years (though the name /owner changed once, so his resume shows two professional employers).

*nod* I've been through 4 layoffs in 9 years. I'm 31. My hubby, also in IT, has been through 6 takeovers, with only one layoff (where they hired him back as a consultant with no benefits, then got bought out, and he got hired again as an employee). His company is finally owned by the biggest bully on the block. I'm taking shelter working IT at a bank. Figure they'll never run out of money, at least.

This scenario isn't unusual for Denver, though. LOTS of job churn, resulting in a decreasing real estate market, made worse by incredible on-going residential investment.

I've also worked for the feds and state government. NICE benefits, but they don't pay well for IT. Advancement is also problematic.

Brandie