6 Responses

1. Lazy Man and Money

   June 4th, 2007 at 2:27 pm

   1

   J.D. from Get Rich Slowly tackled this subject recently. There were approximately 17,000 comments (I’m exaggerating for effect).

   I fall on the opposite side of the coin with the paying off the mortgage. It has nothing really to do with the tax savings. As you mention, they are not THAT great, but they factor into the overall decision. I’ll number my thoughts below for easy reference.

   1. For a lot of people $100,000 wouldn’t pay off the mortgage completely. If used to pay off as much of that as possible, you run the risk of losing your job the next day, not being able to make the mortgage payments, and losing the home anyway. If invested, you’ll still have access to it. Even if you lose your job and the diversified portfolio drops 50% (pretty rare, especially if he was diversified internationally), you can use the rest of the sum of money to continue to make payments on the home and put food in your mouth. In this case, it’s actually far less risky to invest the money in my opinion.

   2. Some people are hung up on the “guarantee” of paying off the 5% (tax savings should shave at least a percentage on that original 6% mortgage). Invested over a 30 year mortgage, a return of better than 6% is very much guarenteed (if investing costs are kept down, and the investment is diversified, both things that the individual can control). The return is likely to be 8%, 10%, or in some cases, even 12% (see Vanguard S&P 500 performance since 1976 for evidence of this).

   In summary, the decision (as I see it) is basically between: Do I want 100% chance of a 5% return (by paying off the mortgage and foregoing the tax benefits) or do I want 99+% return of 8-10%? Using $100,000 to pay off a mortgage early (using the 5%) saves you $332K in interest over the 30 years, by my math - ((1.05^30)*100,000)-100,000. However, that 100,000 invested at only 8% would make you $900,000 - ((1.08^30)*100,000)-100,000. At 10% over 30 years, it’s 1.6M. That’s the difference of 3-4% interest accumulated over time. You have decided that the risk of removing mortgage debt from your life helps you sleep at night, which is awesome. I have decided that taking the 1% of risk is worth the $550,000-$1.3M dollars. Losing out on that much money and (potentially two additional homes paid in full) would keep me awake at night. I suppose this why they call it personal finance.

   I understand a lot of people might not have confidence in the stock market over the next 30 years. That’s a reasonable fear. However, if that’s the case, I hope those people are putting their 401k and Roth IRAs investments in a “100% guarenteed to not lose money” investment. Risking a whole retirement is a lot worse than risking a home in my opinion. I can always rent a place to small, cheap place live, but I’ve never seen someone rent a retirement.

2. erik.folgate

   June 4th, 2007 at 9:58 pm

   2

   Lazy Man,

   Thanks for commenting. I like fellow personal finance bloggers leaving comments. Your points are well taken. But, there are a few things that I was assuming that I did not convey in my article well enough.

   First, I should have used a number more like a million dollars. You’re right, $100,000 won’t pay off most people’s mortgage.

   Second, you are assuming that someone is going to take the entire 30 years to pay off their mortgage. I was not assuming this, so I was not looking at it with the vantage point of the 3 to 4% interest over 30 years. I was assuming that you would still aggressively be pursuing paying off the mortgage.

   Third, I did not bring up the point about where you are in your life. I am 25, so for me to pay off my mortgage now and not invest it for retirement is perfectly fine, because I have another 40 years to be investing for retirement. If you receive a windfall of money at age 55, then you are absolutely correct, after paying off credit card debt, put the money away for retirement.

   My point with this article is to get people thinking about how powerful their income would be without a mortgage payment. Imagine having an extra $1000 to $2500 per month to play with? You can save up a ton of cash over a long period of time when socking away this kind of monthly investment.

3. Lazy Man and Money

   June 6th, 2007 at 8:04 pm

   3

   First point - well taken. If you use 1 million though, that’s still $80,000 a year in interest. I would invest it for a few years and maybe after awhile decide to pay off my house. In the meantime, $80,000 a year is still a nice $6600+ a month. My point is that it doesn’t really matter if you change the numbers, making 8-10% is better than saving yourself 5%. If you make the numbers bigger, the difference is just more pronounced.

   Second point - This assumption is kind of my point. People should not aggressively be pursing paying off a mortgage. Saving 5% at the expense of 8 or 10% is huge over a lifetime.

   Third point - Being 25 is an even a bigger reason to not pay off the mortgage. The longer you can make 8-10% vs. saving 5% the better off you should be. If someone gave you 9 cents on every dollar under the condition that you had to pay 5 cents to someone else, you’d do that, right? You’d do it all day as much as you can. Because you are 25, you can effectively do this a lot more than most people.

   Fourth - I can imagine how great it would be to have an extra $1000 to $2500 to “play” with. That $100,000 invested will should make you around $750-800 a month. That same $100,000 only saves you $500 dollars in mortgage (the 5% number) - net gain is around $250-300 a month.

   Along similar lines, I know people that have student debt at 2% and they have no intentions to pay it off as long as they can make 5% in a high-interest savings account. They would be better off putting it in at 5% and then on their deathbed, transferring the money over to pay off the 2% debt. This is really not that different, except that the percents are somewhat different and the stock market is less guaranteed - though I argue very, very solid - over the long haul.

4. author

   June 6th, 2007 at 9:04 pm

   4

   Yeah, I guess it just comes down to personal preference. I can see your point about the mortgage. It doesn’t have to be your first priority or your second or third priority. As long as you don’t live in the slums, it will never go down in value, so paying it off isn’t a necessity.

   However, I would personally pay off my student loans as soon as possible. I just don’t understand why you’d rather make net 3% rather than making the full 5%. You and I may have a different view of paying off the debt. I am talking about going crazy and paying off the debt in a year to 18 months. Then, you can start getting more out of your money and never have to worry about a payment.

   The bottom line is that i hate payments. Maybe our agrument is different. I am thinking more along the lines of what is less risky. You are thinking more along the lines of what is more logical in a mathematical sense.

5. Jessie

   June 19th, 2007 at 1:05 pm

   5

   For either of you (Lazy Man or author): What if you are 68 years old and have bought a retirement home and hope to sell the previous home at a, possibly, minimum 200k advantage. Would you pay off your new mortgage or pay down on it and invest the rest to supplement your less than ideal retirement income? New morgage is about $1300 at 6%. Thanks.

6. Jessie

   June 19th, 2007 at 1:23 pm

   6

   Oops! Re my last comment/question. The 200k would not pay off my new mortgage, just most of it.