Should you pay off your mortgage early or invest in your 401(k)?
In today’s column in Yahoo!Finance, I discuss research that shows some people who pay down their mortgages early may be better off putting that money into a tax-deferred retirement plan, such as a 401(k). Here’s a simple formula to figure out which option makes the most sense for you from a wealth-building perspective:
1. Take your mortgage rate, and subtract your interest expense deduction (your tax bracket multiplied by the mortgage rate) to get the after-tax cost of your mortgage.
2. Look at the rate of return of a conservative investment in your 401(k), such as a government bond fund. Subtract the after-tax cost of your mortgage.
Example: Bill has a 30-year mortgage at 6%, and he is in the 25% income tax bracket.
- 6% – (6% x .25) = 4.5%
- Bill can invest in a conservative bond fund in his 401(k) that yields 5.5%. He effectively earns 1% more on his money by putting it into the 401(k) versus an extra mortgage payment. (5.5% – 4.5% = 1%).
More importantly, if Bill’s employer offers a match on 401(k) contributions, it’s a no-brainer to put the money in the 401(k).
I used to make an extra mortgage payment every year, but switched to investing the money when yields on conservative investments started to rise. For some folks though, this is not a mathematical issue but one of security — they just want that mortgage paid off. For people who are very debt-averse, the peace of mind of paying off the house more quickly is worth the price.
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April 27th, 2007 at 10:30 am
I’m sure it makes numerical sense to not pay off the mortgage early. But, as one of the debt-averse people out there, I decided to pay off our mortage back in 2004. I even took out a $24,000 loan on my 401K to do it. And even though both of these actions are probably not recommended by financial advisors, I would do it over again in a heartbeat. The lack of mortgage payments (and any type of loan payments, for that matter) make life so much more simple and less stressful. Unfortunately, I still get a property tax bill twice a year.
April 27th, 2007 at 11:29 am
Laura Laura Laura… I almost don’t know where to begin. You forgot a few VERY key assumptions. In the article on Yahoo! Finance you noted that your write/publicist from Purdue is 40 years old. While he still has a 20 year time horizon until retirement and can afford to take the long view, there what about those aging boomers (my parents for instance) that read your column? In addition, how many people you know who are aggressively saving put their money into a BOND FUND???? You must be joking. I’m sorry, I’m really criticizing you from both sides. On one hand, people could put the money into an index fund and earn a lot more and on the other hand, people who are closer to retirement are probably marginally better off paying off their mortgage early, if they can continue to save. Ideally, it wouldn’t be an “either or” but a “both and” scenario. For people who are near the end of their mortgage, they will get LESS of a tax shield from their mortgage payments because they are not paying as much interest… they are largely on to principal now. Consider the fact that most people (even near retirement) do not put that much money in bonds and so are looking for growth, and you have a situation where people could lose principal if the market turns south (do you think it will keep setting records?) and be in a more tenuous position with regards to their mortgage. They key here is cost of capital and the potential return (which you highlighted correctly) but you missed some of the details.
Laura’s reply:
Thanks for your post. Of course a bond fund is a not an ideal long-term investment for a 401(k). Re-read the story: As I explained, the researchers used a bond fund as the 401(k) investment specifically so they could do an apples-to-apples comparison. Paying down your mortgage is a sure thing; if you make an extra annual payment on a 30-year mortgage at 6%, that’s a guaranteed 6% return (before taxes; the after-tax guaranteed return depends on your income tax bracket.) They wanted to compare that sure thing to a 401(k) investment that was also a sure thing: government bonds. That’s what makes it an apples to apples comparison. As I mention in the story, most people would probably put the money in something that offers a higher return over time, like a combination of stocks and bonds — making the 401(k) contribution even more valuable than paying off the mortgage early. In an ideal world, yes, it would be a “both/and” scenario — but the point of the article was, if you have a little extra cash to do one or the other, what do you do? As for people who are close to paying off their mortgage, you still have to do the math, figure out the tax arbitrage, and look at what offers the better return. My concern about a couple close to retirement using extra cash to pay off their mortgage is, what happens if the single-family home market nose-dives in their area (i.e., Michigan and some parts of Ohio)? Then your cash is locked up in your mortgage, limiting your options. Would love to hear your thoughts on this.
April 27th, 2007 at 12:18 pm
The topic of mortgage prepay versus any other investment is of great interest to me. I am wondering if financial advice would be different given a choice of prepaying the mortgage entirely. Assume a person in high tax bracket has a 300K worth of mortgage and 6% interest rate. The average monthly interest portion of mortgage payment is roughly $950. Part of that interest is tax deductible. However, an average of $600 a month (for the first few years) is eaten by the bank. If 300K mortgage could be repaid right away would it be recommended to do this ?
By prepaying this mortgage $306,000 of interest would be saved instantly.
Now additional $600 (=about $900) a month can be invested into 401K or outside of retirement account.
April 27th, 2007 at 1:09 pm
I currently pay my mortgage on a biweekly basis. At what point would it be more advantageous for me to invest the additional money into my 401k?
Laura’s reply: It depends on whether you are contributing anything to the 401(k) or if you’re contributing enough to get any employer match; it also depends on your tax bracket and your mortgage rate. In the simplest case, if you’re not contributing enough to get a full match from your employer, go for the 401(k). That free cash from your employer will build more wealth than putting the extra payment in your mortgage. If you’re already getting the full 401(k) match, you need to figure out the after-tax cost of your mortgage versus what you would earn in a 401(k) investment. If there’s not a significant difference, you may be more comfortable staying with paying off your mortgage early.
April 27th, 2007 at 3:20 pm
Laura, I have to admit I chuckle at these kind of “what if” articles, because I have lived “what is”. Having never made over 47k in my life and with my wife the same except for the fact that she didn’t work for ten years when our daughters were growing up, this article, imo, is all wet.
It is always about returns on investment against deductions, but not everything is figured in.
When my wife went back to work in 1991, we didn’t change our lifestyle. True, having built our own house, our mortgage was only 45k, but it was paid in four years. Then her check was put back for college, part money market funds, part CDs, part stock mutual funds.
Just before our first was to start college we inherited 65K. For eight years we paid the burser every six months, mostly out of the wifes’ checks over the previous six months, but did use some of the inheritance.
We are debt free, and so are our daughters. Along the way my wife contributed 6% to her defined pension plan and I put 3% in a 401k to get my employers match. Having never had to touch the money we were putting back for college, our net worth is upper six figures at 52 years old.
The best part is that now I contribute 50% of my pay to my 401K. You can figure out that I no longer make even 47K. 50% puts me right about the limit. How do I get a 100% deduction on 50% of my earnings with a mortgage payment?
Everyone wants to talk about the great deduction that comes from paying mortgage interest. Let’s see, for every $100 you pay the lender you get back $25.
Our deductions are about 4K less that our standard deduction. Let’s see, I don’t pay the mortgage company anything and I get back $1000.
Since 1991 that works out to $16,000, and who knows what we have earned on it. Someone would have to pay their mortgage lender $64,000 to get that deduction.
I think they need to refigure with all the figures included to make a fair judgement.
April 27th, 2007 at 8:31 pm
Laura,
I was wondering that if I am maxing out a 401K,IRA,529,and HSA and my mortgage balance is low (40,000). What’s wrong with pre-paying my mortgage purely from the standpoint of increased cash flow to actually enjoy what I earn?
April 27th, 2007 at 11:24 pm
I read a Laurence Kotlikoff and Jagadeesh Gokhale paper “Who Gets Paid to Save?” recently. As someone who’s been contributing to a 401(k) for nearly ten years, and a mortgage for eight (daycare for five), I was surprised to learn that I’m actually at a disadvantage contributing as much as I do to a 401(k), the tax deductions for mortgage interest and dependent care eating into my tax savings. It was argued one would do better in a Roth IRA faced with the mortgage-daycare-retirement scenario.
Also, I can’t think of any dividends that are guaranteed to beat out my 5% fixed mortgage year over year. Can any of your readers help? My 401(k) and noncontributory IRAs have been near stagnant, despite being properly allocated in index funds, over the past six years, inflation and a lagging stock market eating away at any gains. For many people, change comes only when they are offered something better. People who prefer to pay off their mortgage will likely warm to an alternative that is equally secure, but pays more.
April 29th, 2007 at 7:27 am
We are currently DINKs (dual income no kids), but hopefully with a child soon. We have enough cash to pay off the house. We want my wife to stay home when a lil one arrives, so paying off the house and removing that monthly expense is more important than what can happen to the money if placed elsewhere. Call it piece of mind and one less thing to stress about when comes time to be stressing about raising a child. Sure the housing market stinks at this time in our area, but it will rebound. I have a sound career, so if we had to move it is one less thing to have to worry about for the move too.
The mortgage payoff is the best idea….for us.
April 29th, 2007 at 7:38 am
I have looked at this topic from a few angles. I am a CFP who has worked with all levels of client wealth. The empirical evidence suggests avoiding debt builds more wealth over a lifetime. While we are busy running numbers and showing what will happen 30 years down the road, “life” happens. Those who avoid debt have healthy balance sheets that overcome the unexpected events and allow them to take risks they might not otherwise. One client once said, “When I paid off my house I was able to think about investing in a whole new light.” My second career over the past few years has been building houses with my father and having been on the finance side and the real estate side I always tell people to pay off their house when I am asked. As I said earlier, you can run numbers and show what might happen, but I have come to the conclusion that those who have gone before me and been successful have done it by paying off their debts quickly and then built wealth beyond what they could have imagined. I am 36 and plan on having my home paid off before I hit 40. With a little luck that will happen in the next 24 months and I cannot wait to see a “0″ under liabilities on my net worth statement!
April 29th, 2007 at 8:19 am
The market could have a fall out tomorrow and you lose. I will stick with paying off home early
April 29th, 2007 at 8:50 am
Laura,
This subject has always been a touchstone, I was very excited by your entrance into the fray. From your comments we have seen the gammit in love or hate this idea of mortgage vs savings.
The depression era thinking is very very correct. When a close friend of mine [son of my oldest friend] told me he had a new loan-interest only for 10 yrs I almost had a stroke-but-
We all are in a different place, age, job security, kids,-etc. The knowledge of this option is what is so very important, not the individual decision.
New financial products are changing the way we can plan and take some little control in our lives. Not looking at the options is the worst mistake anyone can make.
April 29th, 2007 at 9:10 am
Laura,
You missed the Standard Deduction part of the calculation. For round numbers, if you figure (given their 50k income) that they owe 100k on the 6% mortgage (i.e., $6,000 interest), pay 2k in property tax, and pay 3k in income taxes, then they get virtually no benefit from the mortgage interest deduction and their real rate of return is very close to 6% on that mortgage. Given that choice – 6% versus 5.5%, I’ll take the 6%. Obviously, as you move up in income, you get more benefit out of the deduction, but for these guys, once I maxed the employer match on the 401k (if applicable), I’d throw all the rest into my mortgage.
April 29th, 2007 at 10:23 am
PAY OFF THE MORTGAGE
Your mortgage deduciton RUNS OUT;YOUR interest paid decrease every year.
Your money out there in the market whether that be equities or bonds are subject to losing value.
A paid off house is a paid off house.
Even if an emergency comes up and you to sell your home whatever you get for your home is what you would get regardless of its paid off or not AND whatever you get will be more of a “profit” to you as you would have paid LESS INTEREST the THE BANK.
Even if your note is for 6% and CD rates were for 12% YOUR NOTE IS FOR 30 YEARS CD rates wont stay that high that long.
April 29th, 2007 at 10:53 am
PAYING DOWN THE MORTGAGE OFTEN MAKES FINANCILAL SENSE
Laura, I cringe when I see advice like this that fails to look at all of the information. People read it or glance at the title and assume that this advice applies to them.
First, you erroneously state that the returns on a 401k investment are tax free. Of course they are not, they are simply tax deferred. When you eventually pay the tax on the investment it will yeild less of a return than paying off a mortgage.
And second, you are assuming that the only two options are contributing to a 401k or paying off a mortgage. Most people can do both, contribute to gain any match that an employer is offering, and also pay down home debt. Beyond the peace of mind, it is a wise thing to do.
Incidently, if you have no home mortgage debt to use as an income tax deduction, it could be that you then can use the IRS standard deduction to your advantage.
Happy Finances to all, but please be careful on the advise that doesn’t include all of the facts.
Laura’s Reply:
Hi Rob: Thanks for your comment. If you’ll read the story carefully, it says “4 in 10 homeowners would build more wealth by putting additional mortgage payments into a TAX-DEFERRED retirement plan…” so I’m not sure what your objection is there. Obviously it would be ideal to do both — save in a 401(k) and pay down your mortgage. But for people who have to choose between one or the other, I thought this research study had some interesting findings that homeowners should know about. I’m not happy with the headline Yahoo put on the column — “Why Debt Can Be Good” — since I think it’s misleading. That wasn’t the point of the story. The idea was to do the math on your savings options, not build up debt. I’m a very debt-averse person myself (I have none, except my 30-year fixed mortgage) and had been making an extra payment every year. A few months ago, I started investing that money instead, because I could get a slightly higher return. I think everyone has to examine their own financial situation and their tolerance for risk before they make the choice — and if they can afford it, do both.
April 29th, 2007 at 11:32 am
Laura,
When looking at the benefit of making extra payments on a mortage why do you not consider the interest savings in the calculation? From an economic standpoint the interest savings is one of the more compelling reasons to pay off a mortage sooner rather than later.
Laura’s reply:
Hi — I completely agree there are significant interest savings when paying off a mortgage early. Bankrate has a terrific amortization calculator that can show you exactly how much you would save. But the interest saved has to be compared with the interest gained by investing that extra payment elsewhere. That’s why I thought the study was worth covering.
Think of a bank – it pays investors 5% on their savings accounts, and then invests those savings deposits elsewhere at a higher rate of interest, and earns the difference. Someone with a mortgage is in the same position: They pay the bank interest for the use of the money, and they may have the opportunity to invest extra money elsewhere at a higher interest rate. A reader emailed me a story about a loan he received at 4.5% in the early 1980s, when yields on savings accounts were 13%. He put the loan money into the savings account, and earned the difference in interest. (He paid off the loan slowly, over time, rather than in a lump sum.) Clearly, interest rates are so low now, we don’t have that same arbitrage opportunity as the early 1980s. But if someone has $1,000 a year to put toward an extra mortgage payment, or $1,000 to put in a 401(k) that an employer will match, that’s a 100% return on investment. You can’t get that anywhere.
April 29th, 2007 at 12:03 pm
Paying off your mortgage
There are other complications that favor paying off a mortgage. Like an increasing number of people I now pay alternative minimum tax, which means my mortgage interest is not tax deductable. Moreover, by having a mortgage I am obliged to buy flood insurance ($1000/year) that I consider total fraudulent.
April 29th, 2007 at 12:12 pm
Either the article omits some assumptions of the study, or the study is flawed. It is far better to pay off the mortgage early. Let’s use some of the facts already presented.
We can agree that if you have a mortgage interest rate at 6%, then you save most of that percentage of every dollar used to prepay the loan depending on your tax rate. But here is where the comparison falls apart, because it compares only the after-tax savings on the pre-pay versus a slightly higher return in a tax-deferred investment. The article fails to mention that you increase equity in the asset (your home) and the home increases in value over time, in nearly all cases. In many markets around the country we can find where real estate has been appreciating in double digit figures annually. My math shows that you earn an immediate 4.5% (25% tax bracket) and if the asset is increasing in value 10% annually, then you are really growing your money at about 15% annually.
Another assumption made in the study is the use of 25 years to compare pre-paying the mortgage versus saving tax-deferred. Many home owners don’t stay in the same home for this length of time. The study should look at average time people stay in their home before they move to a new one.
Lastly, there is no mention that current tax policy allows up to $250,000 single, $500,000 joint ownership tax free gains every two years (two years out of five in the primary residence) regardless of age. This is in comparison to the tax and penalties paid on tax-deferred investments before age 59 1/2. Unless you put all the money gained from the sale of the house back into the new property, you get much richer much faster if you buy and sell your home several times over the 25 year estimated period, while taking the gain made from each sale and putting this money into other, conservative investments.
Laura’s reply:
Good point, thanks for the post. But I have to take issue with the 10% a year home appreciation figure. Although we’ve had a gangbuster market in the last 5-7 years, historically, homes have appreciated only slightly above the rate of inflation. And I distinctly remember friends in 1990-1991 having to write rather large checks to sell their homes — a trend that seems to be increasing lately. See this Associated Press story on “flippers.” You just can’t bank on that kind of annual appreciation. David Crook of The Wall Street Journal wrote an intriguing story on this topic called “Why Your Home Is Not the Investment You Think It Is.”
April 29th, 2007 at 12:58 pm
Thank you for your insight. This strategy has been used for years by many thousands of people. I won’t be elaborate here but it would behoove your readers to read a couple of books that will describe this equity management strategy in great detail. Read Missed Fortune 101 by Douglas R. Andrew from Time Warner and Stop Sitting on Your Assets by Marian Snow. Having said that, there are much better investments for your home equity savings than tax-deferred vehicles that have so many restrictions on the amount you can contribute and the age you have to be to access your funds. Read the books and you will see and understand. I have been successfully teaching this to my clients for years. All the best!
April 29th, 2007 at 1:02 pm
I thought this was a great article. Let me explain why:
First of all, I’ll assume that someone is at the start of a 30-year fixed, paying $1,000/month in mortgage payments ($170,000 mortgage at 6%).
Even if you fall into the AMT, you’ll win.
If you save $1,000 year and can get 5%/year , after 25 years (because if you made the extra mortgage payments, this is when you’d stop paying your mortgage) you would have a little over $50,000. Although you’d have $60,000 of payments left over the next 5 years, your $1,000 monthly payments, adjusted for inflation, is now worth $467. In 5 more years, that $1,000 will be worth $389.
If you stop saving the $1,000/year after 25 years and just keep getting 5% on the $50,000 you’ve already made, you’ll end up with $67,000.
Last step, if you were to now pay yourself $12,000/year (the mortgage you no longer have to pay) you’ll end up with a little more ($69,000), but you essentially still have the expense. You now have to save and you may no longer be in your peak earning years. You may even be retired.
Someone mentioned the risk of losing a job. The extra payments won’t help. If you lose your job 15 or 20 years into your mortgage, how will you finish your mortgage payments? Your forced to sell. On the other hand, if you save the money month after month, after 15 years you have $22,000 saved (close to two years of mortgage payments that allow you the luxury of finding another (probably lower paying) job.
My .008-cents (adjusted for inflation after 30 years)
Dan
April 29th, 2007 at 2:16 pm
Who itemizes with $50K income and a family? The mortgage interest deduction is too small to top the standard deduction, unless the person is just beginning to pay on a very large mortgage for that income.
Money used to pay down the mortgage is money that comes free if and when you have to move. It’s a lot more flexible than money put into a retirement savings plan. If you’re ten years from paying off the mortgage, the money you put in to paying it down faster will come free in less than ten years, in the sense that roughly 8 years down the road, instead of facing another 12 payments, you’re done and paid off and needn’t make any payments. Your interest savings is as good as a bond paying the same interest rate, but tax free.
The only reason you wouldn’t want to go ahead with this plan is if you have a fixed rate mortgage at an interest rate below or near the inflation rate. When a loan is at a negative real interest rate, the bank is paying you to borrow.
April 29th, 2007 at 5:02 pm
Laura:
Can’t agree. We have been mortgage free and rent free since we were in our late 40s. 10 years ago we sold the house we lived in when we were in our late 40s, and from the proceeds bought a house that is now worth 4x what we put into it. My neighbors all think I am a millionaire several times over or that we inherited big bucks. Neither is the case; we just don’t have a mortgage. We have the peace of mind that comes with no mortgage and we buy any toy that suits our fancy and go wherever we please. There is a lot to be said for paying off a mortgage early and your $400 per year doesn’t come close to the mental return on investment we enjoy.
April 29th, 2007 at 7:30 pm
What if someone had a first mortgage and a second mortgage. Say they had a 30 year first mortgage for $300k and a second mortgage for $30k. Would it then make sense to cash is your 401k to pay off the second mortgage since second mortgages have a higher percentage and less of a term? Say the person was in their early 30’s and had enough 401k saved to pay off the second, would you reconsider? I know many a people in this situation since they didn’t have the 20% to put down on a house and needed a second to get the first note.
I loved your article. The best part about the article is that it makes you think about long term savings which many of us dont do enough of.
Hi — You’d have to run the numbers with a financial planner; there are too many factors to give a one-size-fits-all answer on it. Unless someone needs a new kidney, I don’t think it ever makes sense cash in a 401(k) before age 59-1/2 because of the penalties and taxes involved.
April 29th, 2007 at 8:13 pm
Ok, I’m there, but please give me an answer for Scenario C. Self employed – no 401K or anything related to retirement since my theory to date that my best ROI was my house – when I pick a camp, I’m pretty loyal until I need to be otherwise. Now, I have a few friend that have done payouts, usually through windfalls as opposed to incurring tax repercussions, and their monthly nut has become basically insignificant. So factor in the “less stress factor”, the ability to now play, invest, speculate, etc. with any disposable income as well as fortify whatever retirement funds / investments preferred. So, please include that, and anything else you think I should know, into your formula and please let me know the outcome. Thanks in advance, Brett
Hi Brett — I’m self-employed also. I opened a single-K (a one-person 401k) to save for retirement. Business owners with no employees (except a spouse) can take advantage of these plans. It’s a great savings vehicle because you can contribute as both the employer and the employee. As the business owner, you can put away 25 percent of your compensation or 20 percent of your self-employment income (up to $205,000); and as the employee you can put away $15,000 in salary ($20,000 if over age 50, according to 2006 limits). Consider a graphic designer who is self-employed. She earns $60,000. As the “employer,” she can put 25 percent of her compensation—or $15,000—in her self-employed 401K. As the “employee,” she can set aside another $15,000—for a total of $30,000. Most major mutual fund companies offer single-Ks. It’s an excellent option if you’re nearing retirement and have nothing put away. The plan has a number of administrative requirements, including IRS filings. Unlike an IRA, you cannot take withdrawals except at retirement or under other narrow conditions. Given the restrictions involved, don’t opt for this plan unless you’re certain you won’t need the money before retirement.
April 29th, 2007 at 9:26 pm
I just paid off my mortgage as well. Being the owner of my own Corp., we match our 401K $1 for $1, so I have now increased my 401K to the full 12% maximum. This is the fastest tax free way of taking money and inserting it into an account for the future. By removing the mortgage payment, you can also rreduce your income and change your tax bracket issue.
Look the idea of getting a write off for the interest is a joke in itself, this is like 20 year old ideas, the tax rate has increased, as well as the house payments, but the write off is the same? That’s a joke, pay off the house in any way you can.
Just don’t be stupid afterwards, because the idea is the move the money to you in a different tax free way.
April 29th, 2007 at 9:28 pm
Laura,
What is your advice on paying down our mortgage if we are maxing out our 401(k)? My husband is 64 and we would like to have our house paid off or close to it by the time he retires. Any comments?
Hi — If you can afford to do both, go for it. I strongly believe in entering retirement mortgage-free, because it gives retirees greater financial flexibility.
April 30th, 2007 at 8:51 am
This column certainly struck a nerve with readers. My first inclination was to respond with what I would do based on my analysis of the situation, which is to invest in the 401K. After reading many of the comments it seems like people are extremely motivated to eliminate debt. And you are comparing two strategies that are both positive in terms of either increasing savings or reducing debt.
the most compelling reason for not paying off a mortgage early is the unplanned risks– a lost job, a medical problem, or a disaster like Katrina. This is the primary reason I have had to not pay off my house and make additional investments in my 401K and elsewhere. The fact that I’ve gotten higher returns has been a bonus.
I wonder if there is an additional column or two out there to discuss what financial risks people worry about and what some of the most common risks are, and how a person should plan for them.
Great idea, thanks for the post. I’ll look into the story.
April 30th, 2007 at 6:50 pm
WOW! A lot of good stuff here. Reading through most of the posts, I didn’t see anyone talk about the national static of people either refinance or buy a different home every 4-6 years. (can’t quote the source off the top of my head). I get the feeling most people here have been in their home for a long period of time or plan on it. If that’s the case, great! Go for it. But if it’s not, my question is why in the world would you get a 30 fixed rate mortgage if you don’t plan on staying in the home for 30 years? Why not get a 5 year mortgage? A ten year mortgage?
I happen to think Laura’s advice is spot on. Obviously is debatable (as we can see) and there are several people here that have paid off their home, which is great.
The question you have to ask yourself is “is it better to pay a lower interest rate or pay the least amount of interest?” On the surface they both seem the same, but one has to do with how the money is actually applied to the mortgage, (which I won’t get into here) and the other is a mortgage interest rate.
Bottom line, IMHO, if you are debt free and your retirement is fully funded (what ever that means to you), then go for paying of the mortgage. But if your not be very carefull of how/where your money goes.
April 30th, 2007 at 7:55 pm
doctored5
Have a question 4u
Wouldnt it be better to have no mortgage if you lost your job etc.
A car you can always get rid of credit card debt etc are nothing compared to having a house payment and not being able to pay it.
Or if you get a lower paying job but your home is paid -off you can possibley still swing it!
May 1st, 2007 at 11:29 am
I know that the experts have analyzed this issue up and down, but I can’t seem to make things click. For example, if you put extra money into your house then you don’t have much savings, and if you put extra money into your 401k, then you have savings but you can’t access it until 59.5. I was told that there are only 6 ways to access money from your 401k, and the closest way to getting money for a home was to prevent foreclosure, and even then you could only take out the exact amount to prevent the foreclosure. Now there is a 7th way, but you have to lose your job. Maybe I was misinformed about making early withdrawals from a 401k, but it seems that an IRA would be a better idea than a 401k. I know company matching is a great incentive, and I do take advantage of it, but having money that is accessible quickly is a must…I’ve been in a few financial situations where time is not on my side and if I didn’t have an IRA, I would’ve been in a lot of trouble.
Now, from the “Conservative Estimates” section of the article, it states that using the retirement investment over the mortgage prepayment you would end up with $400 a year in your pocket. Even by conservative estimates, this isn’t appealing to me. If you work the numbers for a 30 year note, this is what I found. You can pay off the house in 25 years and not have much of a savings, as opposed, to using the retirement investment and have at least $10,000 in your account. However, after the house is paid off you can put that mortgage money into some type of savings account (IRA, stocks, bonds, etc). For me, that would be putting $1500 a month into an account. So after the house is paid off and 5 years of investing that mortgage payment, I would have $90,000 in my account, and that doesn’t account for any interest. If you look at the retirement investing, I would be sitting on at least $12,000, not too appealing. From the article, it stated that the investors didn’t get a 401k match, so I have no idea what the numbers would actually be if that was taken into account, but it’s going to have to be a big one to close the gap between $90,000 and $12,000.
I’m pretty good at comparing numbers, but I’m not that great when it comes to figuring in long term rates of return, so if anyone can show me some of the gaps in my thinking/calculations, please do.
May 2nd, 2007 at 9:13 pm
to socialismisevil
I slept much better when I had a year’s worth of expenses saved from the sale of my previous house than I would have with a slightly lower mortgage payment. I could pay off my 4.75% mortgage now, but I feel much more secure having the money where I can access it instead of in my house. That is what’s worked for me, but you may feel differently or be concerned about different risks.
May 8th, 2007 at 1:59 am
To me, paying a mortgage off early is NOT cheaper.
This March, I bought an investment property (triplex) for 60,000 cash down, with a mortgage of 110,000. I net more than 12,000 per year on the place (after mortgage, tax, insurance). If I pay off the mortgage early, that is money that I can’t use for a down payment on another investment property (unless I cash in the equity, but then the benefit is cancelled out).
This May, I put another 60,000 cash on another property, also a triplex, with a mortgage of 125,000. This one also nets around 1,000 per month also, so 12 grand per year. That is a 20% return. Which beats the interest I would have saved by paying off my other house earlier.
Having a second investment property provides double the cash flow, so I can payoff, if I want to, twice as fast. But I have no intention of doing so.
I hope to two more properties over the next year, with similar numbers, and finally a principal residence in about 18 months, when my current contract runs out.
The cash flow numbers are just the beginning. The first property was a steal, underpriced in the area. Since March, the building has been reappraised at an increase in equity of 30,000 – a return of 50% on the the deposit I originally made, in about 3 months. The second property also is a good deal, and I could probably sell it for 15 to 20 thousand more next spring – again, an increase in equity of 30 plus percent, in 6 months; not because of speculative bidding (although it is a factor), but because the building’s cash flow numbers would have suggested a higher price in the first place. BTW#2, these are located in Ontario – NOT in the sub-prime self-destructing US South.
Think my mortgage savings would provide that kind of return?
The comments made by folks above, while very detailed, precise and full of expertise, seem to focus on nickel and diming. My suggestion is to look at the big picture. Buy good properties that are under priced, with good tenants and in good condition in a good location, extend your equity and increase cash flow – that is the way to go. Knowing what is a “good property” requires that you have experienced and reliable eyes and ears support, along with a financial network who can find the best financing deals, the best maintenance deals, materials deals, etc.
Passive wealth building, based on a sound network of associates, works for me. I also require myself to have at least a one year buffer of cash to cover both mortgages, in case something goes wrong, and that amounts to *about* 15 thousand cash total, which I put in bonds or GICs, under an RRSP shelter. We also have other investments which are liquid enough to cash in for other life emergencies should they arise.
BTW, I am 36, my gross salary is 70 thousand per year, my wife does not work, and we have a child in kindergarden, so I am talking from a position of strictly middle class. We bought a used 700 dollar car 2 years ago, we go out to eat at cheap but hearty restaurants maybe twice a month, tithe at our church, live in a small 2-BR apartment that my employer provides, and buy groceries on sale. Travel? Maybe go abroad once a year. That’s it. Live cheap, think large.
June 1st, 2007 at 6:27 am
[...] your mortgage, do it. But realize you’re paying a price to do so. (She offers more details at her blog, as well as tips on how to estimate the investment return you need to earn to make it [...]
June 29th, 2007 at 12:37 pm
Can you give me suggestions?
We have 2 mortgage loans, first one is 370k with rate of 6.375. the 2nd one is 70k with rate of 8.5-9.5(home equilty loan). my husband said it is best to only invest 5% of salary to 401k, then w put extra $750 into 2nd loan every month (we are trying to pay off the 2nd loan as soon as possbile), is it wise? or we’d better to put more money into 401k?
thanks for your inputs and suggestions,
Tina
Hi Tina: This strategy is sound. Contribute enough to the 401k to get any company match, because that’s a 100% return on your money. The home equity loan is likely to adjust upward with interest rates in the future, so I think it’s wise to pay it off asap.
Best, Laura
July 3rd, 2008 at 8:19 am
What if you don’t need to make the choice between a 401k and the mortgage? We’re in a good situation where I already contribute the max to my 401k but also have more than enough to pay off our mortgage with a relatively small portion of our *taxable* (not 401k or IRA) savings account. I’ve held off doing that, thinking it was best to keep the maximum amount of our savings invested. But is that wise? We are fairly debt-adverse, with the mortgage our only debt, but I also don’t want to be dumb with my money just to get this off our balance sheet without good reason.
thanks!
Hey Pablocat: I’m assuming you’ve probably done the interest-rate arbitrage calculation and know if you are earning more on the money by investing it than you would by paying off the mortgage. But also consider whether your need liquidity before paying off the mortgage. Do you have six months’ income set aside in the event you lose your job? Do you have a big expense coming up, like college tuition? Then it may make sense to keep the mortgage.
Also, if you’re eligible to contribute to a Roth IRA, think about doing that instead of paying off the mortgage. One of the problems with putting all of your retirement assets in a 401(k) is that you’ll pay income tax when you withdraw the money in retirement, and nobody knows what the tax situation will be in the future. (Personally, given the aging of the population and the entitlement promises the government has made, I think they’re certain to go up.) That’s one reason I keep my retirement funds in a mix of accounts that will be taxable and tax-free upon withdrawal in retirement.
But talk to a financial planner. At Garrettplanningnetwork.com you can find a fee-only planner who charges by the hour. Good luck!