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Anymouse123
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Mortgage or savings  Reply with quote  

I'm guessing you see this question a lot but I'll give you some details. I know the typical recommendation is to save vs paying off a low interest mortgage but I'm curious if the current market or my details changes anything.

In the next few months I will be getting ~250k. My mortgage is ~250k.
Should I pay or invest? If invest what should I invest in?

My details:
37yo
Mortgage ~250k@2.875%
401k - ~400k
No debt
200k in savings
529 funded
No IRA to date

So does it make sense to pay off the mortgage given my savings and the economy where it is or should I just be investing the 250k?

Thanks.
Post Tue Feb 02, 2016 4:45 am
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oldguy
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You are doing a super job, $600k at age 37, plus $250k receivables.

The SP500 index (the generic USA stock market) has a longterm average return of 11%/yr. A $250k lump sum is an awesome opportunity - at 11%/yr it will be $5.5M in 30 yrs. You'll need the patience and the will-power to leave it alone thru the booms/busts. There is risk 0 b ut you have the financial depth to manage/withstand some risk.

Is your $600k invested in stock funds?

Aside - I would do something different with your $250k mortgage, you can get 30 year fixed rate loans for <4% now. The US mortgage is one on the cheapest sources of capital in the world, almost all other countries have resets, shorter terms, VARs, etc. It might be a good time to refi and take advantage of a 30 year-lock. My guess is that there will be several time over the next 30 yrs when you'll be glad to have 4% capital locked in.
Post Tue Feb 02, 2016 3:38 pm
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Anymouse123
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Thanks. It is mostly in stock funds. A good portion is an S&P fund. A little is in a real estate fund. The mortgage has 13 years left at 2.875%. Can you elaborate why I'd want to refi with such a low rate. Fimally if paying off the mortgage now and using the additional cash over time to invest isnt the way to go would now be a bad time to drop such a lump sum into the S&P? Other recommendations? Thanks again.
Post Tue Feb 02, 2016 3:53 pm
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littleroc02us
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I am of different mindset in this situation than Old Guy is. Yes the S&P 500 has returned over 11% and I invest heavily in Index funds myself, but when it comes down to it your wasting money paying interest to the bank. Some people will say, well I should keep my mortgage to get a tax deduction right? Wrong! If you do the actual math, If you had a 100k mortgage and lets say you paid 10k in interest for the year and your in the 25% tax bracket, your only going to get back $2,500. So why pay in 10k to get back $2500. Now not everyone gets 250k to pay off their mortgage. For some people it could take 10 to 20 years, so in that situation as long as your interest rate is low, I'd just ride it out and invest heavily.
But in your case since you can wipe the slate clean, that probably frees up an extra $1,500 to $2,000 a month you were paying for your mortgage. For this example let's say that frees up 2k a month. Why not immediately take the 2k a month an invest that amount into the S&P 500 for the next 25 years making 11%, you'd have over 3 million and a paid for house that could be worth 1 million by then who knows. Plus you would have reduced your overall risk in paying off your home early and saved thousands in interest payments.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Tue Feb 02, 2016 4:11 pm
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oldguy
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quote:
The mortgage has 13 years left at 2.875%. Can you elaborate why I'd want to refi with such a low rate. Fimally if paying off the mortgage now and using the additional cash over time to invest isnt the way to go would now be a bad time to drop such a lump sum into the S&P? Other recommendations? Thanks again.


The sooner you put a lump into a 11% fund, the sooner it works.
Example.
A. A $100k loan at 4% for 30 yrs - you pay $477/m ($172,000). The $100k invested at 11%/yr grows to $2,300,000.
B. You payoff the $100k loan. And place that $477/m into that same 11%/yr fund, it grows to $1,265,000 in 30 yrs.

In both cases, your cost is $477/m. And in both cases you are investing in the same SP500 Index. But the return is about $1M more by getting the money "in the oven" sooner.

As for a "bad time" to inveszt, it is liberating to learn that the Market cannot be timed - so you are free to invest based on your own availability of funds. For longterm investing, you are mostly interested in the value in 2046 (no matter how it gets there.)

As for the refi - VARs, 15 yr loans, etc, limit your ability to maneuver. Eg, say that 13 years from now, you wish to pull equity from your house and buy some rentals - but now mortgages cost 14% (Jimmy Carter) - so your equity is now locked into your home for the distant future. And you can't sell the home, cuz no one else wants a 14% mortgage. With my rentals, I use only 30 yr FR loans, no balloons, no VARs, no carry-backs, yada, I need to be certain of my capital source because I invest that capital elsewhere.

quote:
Some people will say, well I should keep my mortgage to get a tax deduction right?

Littleroc - yes, never borrow money to get the tax break. But borrow to get the arbitrage, that turns out to be a large return.
Post Tue Feb 02, 2016 4:56 pm
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littleroc02us
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quote:
Originally posted by oldguy
quote:


Littleroc - yes, never borrow money to get the tax break. But borrow to get the arbitrage, that turns out to be a large return.


In his situation I believe it best he not borrow against his home or not pay of his mortgage to invest. Most people aren't going to take a paid for home and put a mortgage back on it just so they can invest in vehicle that may or may not result in a profit but a loss within a specific time zone. IMO, he's better off getting the gaurenteed rate of return and then turn around and have more disposable cash to become wealthy with and a paid off home. I realize this isn't your philosphy, but what works for one man, isn't for everyone.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Tue Feb 02, 2016 9:53 pm
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SCEngineer
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Just to chime in. I think your age and time left on the mortgage (as well as the intrest rate) play a huge role.

If that 2.875% is fixed rate (which I kinda doubt) I'd lean towards oldguy's plan. Youve got 13 years left on it so you'll be paid off by age 50. With the bank you've already got I'm seeing a beautiful early retirement on the horrizon.

If it's a variable rate the game changes a bit. Locking in a lower fixed rate would be worth while if you're going to keep it. Although it doesn't look like the rates are going up anytime soon, you never know and 14% isn't the top you could see. Still you'll end up paying a refinancing fee to the bank for the privlage of locking in your rate and setting up a new payment structure. Rather than paying the bank, I'd just drop that on the mortgage and be rid of the whole thing. You can always take out a loan on the house later if you want the equity back.

One method I hear all the time is would you be willing to borrow against your house to invest in X. If so go ahead and invest instead of paying off the mortgage, if not pay off the house.
Post Wed Feb 03, 2016 1:23 am
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Anymouse123
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Thanks everyone. In response to the question about the mortgage rate it is a 2.875% fixed 15 yr mortgage. I have 13 years left (good guess SC). I get a 1% cash back on the interest paid on top of that so it is a really good rate.

I guess I should have known that financially it makes sense to put the 250k into an S&P fund although I would like the emotional win of retiring the mortgage. I was hoping someone would say that the market is high so go for it or I have too much in the market so go for it.

I guess I will put my eyes on an earlier retirement and have to to avoid the temptation to spend it on something stupid. Smile

So.. What else should I be looking at for investment? I don't own rentals (I have been a landlord, don't want to do it again). Should I be talking to financial managers? And if I were to plan an early retirement (2029 - 50 yr old) would that change your advice? Thanks again.
Post Wed Feb 03, 2016 6:10 am
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oldguy
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quote:
So.. What else should I be looking at for investment? I don't own rentals (I have been a landlord, don't want to do it again). Should I be talking to financial managers? And if I were to plan an early retirement (2029 - 50 yr old) would that change your advice?


The plan that you have is near optimal -

Rentals - I bought/accumulated rental houses thru the 1970s & 80s, they did well - ie, $40k houses appreciated to the $150k / $175k range over 35 yrs, kept them rented, kept them leveraged (refi'd regularly) - but the bigger success was from investing that refi seed money in stocks.

IMO, you are correct to skip the RE part, you already HAVE the seed money - you need only to keep it rolling at 11%/yr - and have the patience to allow the longterm power of compounding work for you.
The equation: F= 1.11^Y If you wait 20 years, F is 8, so your $850k will be $6.8M. If you wait 30 years, F=23, the $850k grows to $19.5M.

Check this site, put in some 30-year-time blocks, and see the history. Do the same with 20-year blocks, you'll see that the statistical averaging converges on about 11% at 30 yrs, has more scatter with 20 years - patience.
http://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html#.VrIa81IkDSZ

As for retiring at 50 - that doesn't have much affect on the outcome - the $$19.5M at age 67 is mostly driven by the $850k that you already have in place, your income stream at that point has only a small effect. I'm age 76, retired young, I was surprised that my NW kept right on climbing.

Financial planner: Hard to say, there is the risk is that the planner feels the need to suggest things to earn his fee - and your investing becomes fragmented.. Or you, as a 37 yr-old millionaire, will be taking advice from a 30-yr-old planner that is struggling to make his boat payments - seems backwards?
Post Wed Feb 03, 2016 3:36 pm
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littleroc02us
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quote:
Originally posted by Anymouse123


I guess I should have known that financially it makes sense to put the 250k into an S&P fund although I would like the emotional win of retiring the mortgage. I was hoping someone would say that the market is high so go for it or I have too much in the market so go for it.

.


Again, by doing that your only looking at the math and not your comfort level. Having a paid for mortgage is something most people cannot do and now you have this gift of 250k and you, yourself seem to be emotionally sure that paying off your mortgage will give you comfort. Isn't that enough? So I ask you, what is wrong with having over 3 million dollars in investments, a paid for possibly million dollar home and no more interest payments that are wasteful? Oh and I forgot, nothing but disposable cash to invest, donate and do all of the things you want in retirement. The fact is that by keeping all of this debt is much more riskier then the possible rewards from investing.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Wed Feb 03, 2016 4:54 pm
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SCEngineer
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just to argue with littleroc a bit, 250,000 invested in a taxable account with the very conservative 4% withdrawl rate for retirement should net about $8,500 per year or $708.33/month. Compare this to your mortgage payment. If it's less you could litterally invest the 250k and let it pay your mortgage off for you.

You can worry about the market being too high, but I've found analysis paralysis is more likely to set in.

Though do weight the emotional benefits of a paid off house. It's only a bad decision if you stop paying yourself and investing. As long as you keep building your nest egg and don't increase your lifestlye you won't go wrong with either choice.
Post Wed Feb 03, 2016 11:26 pm
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littleroc02us
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quote:
Originally posted by SCEngineer
just to argue with littleroc a bit, 250,000 invested in a taxable account with the very conservative 4% withdrawl rate for retirement should net about $8,500 per year or $708.33/month. Compare this to your mortgage payment. If it's less you could litterally invest the 250k and let it pay your mortgage off for you.

You can worry about the market being too high, but I've found analysis paralysis is more likely to set in.

Though do weight the emotional benefits of a paid off house. It's only a bad decision if you stop paying yourself and investing. As long as you keep building your nest egg and don't increase your lifestlye you won't go wrong with either choice.

I don't like to argue, but would rather express my opinions and life experiences that have built my networth. Not quite sure what your example was trying to prove, but let me give you a real life example.
Say in 2006 you only owed 250k on a 400k home that only had 13 years left with an interest rate of 2.78% and were just given a gift of 250k. The question is, would you pay that mortgage off or would you invest it? If you pay off the home you've now freed up your mortgage payment which is approximately $1,600 a month and you save thousands on interest. Plus like I said previously mathematics isn't everything when making a decision, now you can sleep at night and have plenty of money to invest with per month. Plus you have a guarenteed return on investment.
Now lets say you'd rather invest the money and keep the debt for 13 more years. Now 2007 comes and using the website http://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html#.VrLPBvHDE4C and the market dips 25%. Your 250k has just lost 25% of it's value in 2 years and now it's only worth $188,000. Now if this continues for a few more years, paying off the mortgage may look better. Plus if you lose your job and cannot make your mortgage payment, now you have to take out money from your investment and it's taxed at 15% Capital gains tax rate and it lowers the value of your investment account even more. The problem is that people who don't calculate risk properly, could lose substantially. Most people only calculate for the upside.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Thu Feb 04, 2016 4:37 am
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oldguy
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quote:
now you have to take out money from your investment and it's taxed at 15% Capital gains tax rate and it lowers the value of your investment account even more. The problem is that people who don't calculate risk properly, could lose substantially. Most people only calculate for the upside.


How about a capital gains Tax LOSS?

But you are right about bad luck, risk, etc. If someone is not a good manager, unable to assess, quantify, and manage risk - then they need to avoid risk. But, the Law applies for ALL of us, risk and return are directly proportional. If you want zero risk, then you cannot be wealthy, a wage earner cannot save fast enough - that can only be done thru investing. You just need to pick one that you like & understand.

In this case, the writer has $600k at age 37, plus $250k in receivables - carrying a $250k loan does not add much risk to his way of life. But if he is risk averse, a Dave Ramsey follower, he may prefer to payoff the house, for some, emotion is the bigger part of it.
Post Thu Feb 04, 2016 4:51 pm
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littleroc02us
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To believe that by paying off your mortgage with an inheritance and taking those payments and investing them for 30 years won't bring you great wealth is a complete fallacy. I already did the math in a previous post when you take those payments and invest in the S&P 500 for 25 years you'll have way more then 3 million and a paid for house, plus you didn't waste your money on interest payments. Yes there is a possibility the 250k could be worth more in the end, but all it takes is one bad life event to change those numbers and that is called Risk. It's much easier to bounce back from a catastrophe when you don't have a ton of debt.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Thu Feb 04, 2016 8:44 pm
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christcorp
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Why not do BOTH?

If you have 13 years left on the mortgage, paying down half of the loan doesn't bring the loan time to half, it's actually better than that. (Interest is compounded on the remaining principal).

So put half into the mortgage, and pay it off in the 5-6 years, and invest the rest. Comfort and risk. You can have it both ways. Plus, it doesn't put ALL your money at risk, should you have a bad few years with the markets. Plus, you already have $600,000 in investments.

P.S. I'm in the camp that would pay off the mortgage, and then invest the house payments each month. Then again, you have to be disciplined to do that. If you can, that's what I would do. If not, then do as I suggested in the first part of this post.
Post Fri Feb 05, 2016 2:55 pm
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