Invest or pay down mortgage?

[zahc]

Does it make sense to pay extra on my mortgage?

I have a 15 year 4.25% loan on like 140k. I calculated that if I make the minimum payment, I will pay about $50k in interest over 15 years.
If I pay $500 extra/mo then it works out to like $30k total interest over 8.5 years.
If I pay $1000 exta/mo then it’s something like $20k over 6.5 years.

At first glace, I can minimize the total amount of money I spend on interest by paying extra on the mortgage. So my first instinct is to live small, and put every penny I can toward the principle of my loan. This is the way that I think. However, many people are telling me that since I’m young, I should only make my minimum mortgage payment and instead invest. Am I better off putting extra money toward my mortgage principle or investing it? If I invest $1000/mo for 6.5 years, will that really earn me 30k over the next 15 years (breakeven with putting that amount toward house)?

In a simple analysis, I think (correct me if I’m wrong) that the following statement is true: If I can make 4.25% on my investments, then I break even between putting extra money on my mortgage versus investing it, right? Then the question is, do I think I can average 4.25% on my investments over the next decade?

How does inflation change this? If I expect inflation to be high, it shouldn’t change the equivalence above, but in times of high inflation one can expect to make more off stock investments, possibly tipping the balance toward investing.

I can write off money paid as interest. Therefore if I make my minimum payment I can deduct 50k from my income taxes (maybe, depending on standard deduction) but I get taxed on capital gains if I make 50k from investments during the same time. Taxes avoided through deductions seem small compared with the unavoidable capital gains taxes, tipping the balance toward paying down debt.

[roo_ster]

Dumping money into your house ATM is not a wise course of action.  Most houses' values are declining.  Given all the $$$ and programs gov't has tossed at the issue, it is extending/exacerbating the problem of the housing market finding the bottom.  IOW, there is more de-valuing to go.

Invest in just about anything else.

[Brad Johnson]

Dumping money into your house ATM is not a wise course of action.  Most houses' values are declining.

Incorrect.  As much as the politicians, doom-and-gloomers, and talking heads in the news would have you believe otherwise, most of the housing markets around the country have remained relatively stable.  The decline in values is actually rather limited.  Unfortunately the majority of it is in high-profile areas like Vegas, Florida, CA, and NY, so gets a lot of airtime, inferring that the entire nation's housing marking is caving in on itself.


Zahc

Look at it long-term... using multi-decade averaging you see investments returning 7-10% depending on which sector of the market you're analyzing.  Your house is costing you a fixed 4.25% that won't change.  Ever.  If you're looking at it on a 30+ year basis, the dollars are better invested. 

As much as I like to espouse getting out of debt, you're in a perfect position to begin investing now.  You have a very low mortgage rate, the investment market is a little depressed (which historically points to a 8-12 yr rebound of impressive gains), and you obviously have decent income.  If you have an extra grand a month to play with, I'd put $250 towards principal reduction on your home and plow the rest into investments.  The first thing is to start a ROTH (if you qualify) and max it out each year.

By the way, you might consider a refi.  I'm seeing fixed 15 yr rates as low as 3.25%.  It wouldn't save you a bunch of money on a monthly basis, but that $70 a month difference is $12,600 over the 15 year life of the mortgage.  In addition it would save you about 25% in interest over the life of the mortgage. (from $49500 in total interest to right at $37,000).  That's right at $25 grand in total savings over 15 years from a refi that will cost you, at most, a couple grand (which they will convenienctly roll back into the principal balance).

Brad

[HankB]

Everyone's situation is unique . . . there are a lot of questions you need to ask yourself:

* At your age, how much risk is prudent? (A 25 year old's perspective is different from a 55 year old's.)

* How secure is your employment?

* Do you have an "emergency fund" tucked away now?

* How many of YOUR current investments have given you 7%-10% annual returns?

* What level of risk are you willing to accept, and what level of return is likely for that level of risk? (Redundant, but still important.)

* What tax bracket are you in, and do you maximize the value of your deductions by "bundling"  deductions into alternate years - assuming it makes sense for you?

* Do you have state as well as federal income tax to consider?

Some years back, I had a 15 year mortgage I paid off early . . . I did a lot of "what if" analysis via an EXCEL spreadsheet and at the time, for my own situation, it made sense to pay things off. Believe me, there's a LOT to be said for being debt-free.

[zxcvbob]

Do a little of both.

Paying down your mortgage will give you a guaranteed 4% rate of return.  Try to find anyplace else to get that right now.  OTOH, if we go into hyperinflation, you'll get to pay your mortgage back with worthless dollars -- unless the .gov lets the banks adjust the principal balances on the loans.

The S&P has been negative for about 15 years now.  That doesn't necessarily mean it's "due" for a big run-up. 

[slingshot]

There is definitely something to be said for paying off a home mortgage.  The house could become a source of capital backing for financing another home, starting a business, or simply a hedge against a dubious future.

If I had all these things in place, I would pay off my mortagage:  6-month emergency fund, car's paid off, credit cards paid monthly with no balance carried forward except in isolated situations, normal payoff of the loan is before you would likely retire, and you are stable from an income point of view. 

With interest rates so low on homes (and this is an anomoly), I would be more inclined to invest in stocks and bonds with the expectation that inflation will eventually set in and interest rates will rise toward more typical 7-9% area.  Your income would slowly inflate and you would be paying off the loan with less valuable dollars.

[roo_ster]

Brad:

I agree with most of what you wrote, yet come to a different conclusion.

I've read Sailer's investigations into the problem locations, so I am not ignorant to the highly localized nature of most of the housing market crash(1).  Still, there is plenty of collateral damage to go around.  Also, changes in lending practices in and of themselves would cause the housing market as a whole to decline a bit, given the reduced demand due to the tougher (traditional) lending standards that keep marginal borrowers out of the market.

Even the good housing markets are seeing a decline.  The Dallas/N Dallas 'burb market held steady for quite a while, but even we are seeing a decline in home values. Nothing huge, like the problem neighborhoods in the problem states, but real nonetheless.  My particular neighborhood still has (v e r y  s l o w l y) rising values, but we are exceptional: established for decades(2), sized for starters/empty-nesters/down-sizers, municipality takes no prisoners WRT neighborhood upkeep, and hard to beat location.

We have done better and will do better than the rest of the country, but that places us in the least bad situation.  Given economic realities, everyone has to think "What if?" because the probabilities of awful economic events are greater now than most any time since the end of WWII. 

What if zahc's employer fires him a year from now and his personal financial situation was such that he needed to walk away from the house and set his credit rating on fire?  That extra $500/$1000 month he paid off the loan would be wasted and that $6-$12K would sure come in handy moving to N Dakota or wherever he may have to move to find work.

What if zahc's employer fires him a year from now and he might be able to hold what he has until re-employment?  That $6-$12K would sure come in handy during unemployment to keep making the mortgage payments for a few more months, keep the house, and keep his good credit.

Increasing one's investment in something when that something's market is most likely to decline is not something I would do.

Paying down your mortgage will give you a guaranteed 4% rate of return.

Not if he:
1. Walks away from the house.
2. Sells the house before the end of the mortgage.
3. Pays off the mortgage with 2011 USD but the USD devalues to any significant degree over the life of his mortgage.

IMO, "guaranteed rates of return" hang out with unicorns an leprechauns.  Ain't nothing guaranteed on Earth.




(1) It gets the most air time because the loudest & liberalist congrescriters come form those areas.

(2) No great swaths of new homes can be built nearby.

[zahc]

* At your age, how much risk is prudent?
I don't understand when people say this; I think that since I don't have a large net worth at this point in my life, that people would say I have a higher risk tolerance.

* How secure is your employment?
I don't think anybody's employment is super secure right now. I think I'm good for the next couple years but you never know after that, but as an engineer I'm fairly employable.

* Do you have an "emergency fund" tucked away now?
I have about 6mo living expenses. That's a small emergency fund, but I'm semi-ok with that considering inflation. I've been thinking moving my emergency fund partially into physical gold but I don't know how to buy.

* How many of YOUR current investments have given you 7%-10% annual returns?
I have no investments, other than my company-matched 401k, which is negative I believe.  I'm sure that with inflation, my bank balance is too.

* What level of risk are you willing to accept, and what level of return is likely for that level of risk? (Redundant, but still important.)
I like money. I'm emotionally risk-averse with investments. If it was a business venture of my own, then I would be more risk tolerant, but I don't like seeing investments lose money.

* What tax bracket are you in, and do you maximize the value of your deductions by "bundling"  deductions into alternate years - assuming it makes sense for you?
I don't know anything about bundling deductions. Last year, we took the standard deduction because we were renting. With my wife working, we get hammered on income taxes.

* Do you have state as well as federal income tax to consider?
I live in Texas so I have no state income tax yet.

[zahc]

Not if he:
1. Walks away from the house.
--I understand this one
2. Sells the house before the end of the mortgage.
--Why not? I still have my equity. If I have to sell the house at a loss, its still less of a loss if I have a smaller mortgage principle at the time.
3. Pays off the mortgage with 2011 USD but the USD devalues to any significant degree over the life of his mortgage.
--I'm hearing you here

If it makes any difference, I just bought the house about 10 months ago and thought I was getting the bottom of the market and the best interest rates. Not so sure now, and I have paid off 9k of my principle so that I could remove my PMI insurance.

[roo_ster]

2. Sells the house before the end of the mortgage.
--Why not? I still have my equity. If I have to sell the house at a loss, its still less of a loss if I have a smaller mortgage principle at the time.

Example:
1. You pay off an extra $1000 this month.
2. Next month you sell your house and get out every cent of equity.

Did you make ~4% off the extra $1000 you invested?  No.  You made a very tiny fraction of ~4%.  The longer you hold on to your house, the larger that fraction grows.

FTR, I am very much a "pay off all your debt" kinda guy.  But, one has to understand that a whole lot can happen during the life of a 30 or 15 year mortgage.  During hard times, increase the likelihood of Something Bad Happening.  I think that it is times like these where having cash on hand or easier to get at than in good times is more important that paying off large low-interest debt.

If you had the cash on hand to pay of the note completely, then I'd be inclined to say "pay it off" for peace of mind, even if the math indicates a sub-optimal outcome.

But, that last bit's just an opinion.

[Tallpine]

there's a LOT to be said for being debt-free

You can say that again 

[Brad Johnson]

FTR, I am very much a "pay off all your debt" kinda guy.  But, one has to understand that a whole lot can happen during the life of a 30 or 15 year mortgage.  During hard times, increase the likelihood of Something Bad Happening.  I think that it is times like these where having cash on hand or easier to get at than in good times is more important that paying off large low-interest debt.

Actually, the longer you hold onto the house the less likely you are to take a loss even in a down economy as ups and downs tend to average to the positive over time.  From a purely historical perspective, there has never been a 30 year period where homes were not worth more at the end of that period than they were at the beginning.  In his case the market is down, the mortgage is cheap, and his mortgage period is half what most people's is.  In other words he bought at the right time.  It is also the "right time" for him to put some money into long-term investments and take advantage of what history shows will likely be a period of good economic growth over the next 10-15 years.

I agree that having cash on hand is good, and should be part of any financial strategey.  However, in Zahc's case his age, the current economic climate, and his ability to long-term his investmens, puts him in very good position for his long-term investments to perform very well.  It makes sense to take advantage of that.

Brad

[geronimotwo]

the one advantage to the devaluation of money, is that the money owed on your house essentially decreases at the same rate.  say inflation is 3%, you are essentially making money by not paying it back today, as the money at a later date is worth less than the money of today.  so even though you are being charged 4.25%, you would essentially only pay 1.25% the first year, and less later (even if the inflation rate stays the same) as the depreciation of the dollar builds with each year.  lets use the infamous infamous Reichsmark of the early 20th century as an example.  if you purchased a home for 1,000,000 in 1900 it would have only taken 1/2 loaf of bread to pay it off in 1923.

that being said, i would likely pay off the mortgage as quickly as i could.

[HankB]

* What tax bracket are you in, and do you maximize the value of your deductions by "bundling"  deductions into alternate years - assuming it makes sense for you?
I don't know anything about bundling deductions. Last year, we took the standard deduction because we were renting. With my wife working, we get hammered on income taxes.

Here's a simple example of bundling deductions, focusing on property taxes alone:

I live in TX, so I can pay my 2011 property taxes in January 2012 with no penalty.

So lets imagine the standard deduction is $5000 and my property taxes are $6000. I pay both 2011 and 2012 property taxes in the year they're due. So for 2011 I itemize and get $6000 deduction, and for 2012 I itemize and get $6000 deduction, for $12,000 in deductions over 2 years.

Now, let's. say I pay my 2011 property taxes in January 2012, and pay my 2012 taxes in December 2012. For 2011 I take the standard deduction, $5000. For 2012, I itemize and take $12,000 in itemized deductions, since I paid property taxes twice in 2012. So now I have $17,000 in deductions over 2 years.

Bundling gets me an additional $5000 in deductions over two years, in a perfectly legal & documented manner. I also use this for charitable donations and timing stock sales.

It works for me, maybe it will work for you.

(BTW, the numbers I used are not real, I just made them up to illustrate the concept.)

[sumpnz]

Did not read more than one or two responses, so appologies if this is repetitious.

If you are not debt free (except the mortgage) pay that all off first.  If you are otherwise debt free but do not have an emergency fund of 3-6 months worth of expenses put that aside second.  Then make sure you are putting at least 15% of your gross income (excluding company match on a 401k) into retirement savings.  Do your 401k (or equiv) up to the match, then Roth IRA's.  If you max out Roth IRA's before getting to 15% then go back to the 401k or a traditional IRA if available. 

If you are out of non-mortgage debt, have an emergency fund, and are funding retirement investments, then put anything extra against the mortgage.

If you have kids, then fund their college accounts (ESA or 529) before paying extra on the mortgage.

[slingshot]

"Bundling" depends on how significant the taxes are relative to the interest paid.  In my case, unless there is something unusual going on, the standard deduction is all I can effectively utilize.  I can do that regardless of whether the mortgage is paid off or not.  So, other priorities move to the forefront of my financial planning.  The biggest is maintaining a 6 month emergency fund.  That is quite a bit of money.

[De Selby]

As Roo_ster pointed out, a house is highly illiquid.

Apart from that, it's an investment like any other.  It certainly can decline in value, and there's no evidence that it's more protected against that than other investments.  Home ownership being seen as such a great thing is largely the product of Government policy that privileges homes over other investments, not some economic magic associated with homes.

[zxcvbob]

Example:
1. You pay off an extra $1000 this month.
2. Next month you sell your house and get out every cent of equity.

Did you make ~4% off the extra $1000 you invested?  No.  You made a very tiny fraction of ~4%.  The longer you hold on to your house, the larger that fraction grows.

Yes you did.  (you picked about the worst possible example to try to make your point.)  You get back your $1000 plus one month's interest on that $1000 -- about $3.55 -- because you reduced the amount owed to your bank at closing by that much.

[Ben]

Home ownership being seen as such a great thing is largely the product of Government policy that privileges homes over other investments, not some economic magic associated with homes.

There is a school of thought that having a roof over your head that you can say is (for the most part - taxes and regulations not withstanding) yours, is a high value investment.

[Tallpine]

There is a school of thought that having a roof over your head that you can say is (for the most part - taxes and regulations not withstanding) yours, is a high value investment.

That, plus 40 acres and a well with a hand pump and a standing supply of firewood. 

We're working on it - been making triple/quadruple principal payments this year since I started working again. 

[sumpnz]

As Roo_ster pointed out, a house is highly illiquid.

Apart from that, it's an investment like any other.  It certainly can decline in value, and there's no evidence that it's more protected against that than other investments.  Home ownership being seen as such a great thing is largely the product of Government policy that privileges homes over other investments, not some economic magic associated with homes.

On top of all that, the amount you owe had no bearing at all on the value of the house.  It has a huge effect on your bottom line when you go to sell it of course.  If your house declines in value, but it is paid off you can still sell it without any particular problem.  But if you owe more than it is worth you have to either get the bank to agree to a short sale or write a check at closing.  But either way the value is lost.

[De Selby]

There is a school of thought that having a roof over your head that you can say is (for the most part - taxes and regulations not withstanding) yours, is a high value investment.

That is the problem - those things that can make a roof no longer yours matter quite a bit.  If you couldn't afford rent for some reason, it's unlikely that mortgaged home ownership will solve your problems.  And if you have the cash to own outright, well, rent is unlikely to ever be a problem.

[KD5NRH]

Believe me, there's a LOT to be said for being debt-free.

Tell me about it; in addition to my family, I have a vested interest in keeping Dave Ramsey alive so his ghost can't torment me. 

[slingshot]

Unless the mortgage is at an abnormally high interest rate, it is the last debt I pay off.  That pretty much fits with the Dave Ramsey approach.  I can hear the crunch of credit cards as they are being cut or otherwise decimated.  The Ramesy yell... I'M FREE-EEE.  Wish I was.  The mortgage is usually one of the larger debts and financed at a much more competitive interest rate.  From experience, the 6-month emergency fund is critical to peace of mind, a more stable marriage and home situation.

Reducing the principal to remove the PMI insurance was a most excellent choice!

[Tallpine]

We're living on less than half of my income right now.  About half of the remainder is going towards extra principal on our mortgage and the other half of the remainder is going into savings.

I'm not crazy about most "investments" right now, other than beans & bullets