Would you pay off mortgage?

[JuniorTT]

Our mortgage balance is ~$174k @ 5.375% and we've got ~$177k in the bank @ 1.1%. We are thinking about moving sometime in 2011.

This is the first time that our bank account has exceeded the mortgage balance and boy am I tempted to pay off the mortgage. Without the mortgage, a 6 month emergency fund would be ~$15k so we'd be at some risk while we re-build savings.

I calculate the delta between paying off the mortgage vs staying in savings is ~$450/month (after taxes) at this point in our amortization.

Other info: we max out 401k, IRAs, and HSA every year; we have ~$10.5k in student loans @ 1.625%; no other debts

So, would you bypass an emergency fund in the short term to save $450/month?

[greenskeeper]

Since you are moving in 2011, I would not pay off the mortgage.

What is the realistic value of your house?

[fiscallyprudent]

i would not pay it off either, just yet. It sounds like you're very well disciplined at saving. Once you've built the emergency fund, I'd pay it off. Keep in mind that the extra 450/month is an interest write off ... you want to make sure to maximize that so you can take the itemized deduction vs the standard deduction.

Great question.

[Drac]

If you are planning on moving next year I would not pay off the mortgage of your house right now. What you could consider is instead of selling it when you move, you could rent it and have some additional income that will pay for the current mortgage and then some more. We have done this with my family and it has worked very well for us.

[jpg7n16]

What??? Why is anyone considering when OP will move as part of this decision?? That is completely irrelevant. When you sell the house, you get back all the money anyways. And save loads of interest in the meantime.

If you need some cash for moving expenses, that's one thing. But continuing to owe $170k, because you might move?

And the tax break is misguided too. Congrats, you save $100/month on taxes by paying $450/month in interest. yay. You're still losing money that you shouldn't be. (and your 1.1% is taxable)


Why in the world do you have that much in cash????? You are completely underutilizing that money. (unless this is less than 5% of your total investment portfolio) If $15k is a 6 month EF, then you have almost 71 months of income held in cash. Which is out of control.


I would need a lot more information before I could suggest what you should do. But it's between one of these options:

a) pay down $155k on the mortgage (leaves $15k EF + $7k extra for moving expenses)
b) keep mortgage as is, and invest the $157k in something projected to earn more than 6%
c) some combination of a & b

That depends on your time horizon for investments, your risk tolerance, family situation, other investments, etc.

[JuniorTT]

Originally Posted by greenskeeper

Since you are moving in 2011, I would not pay off the mortgage.

What is the realistic value of your house?

It was appraised for $325K 18 months ago. I think $300k is realistic.

[JuniorTT]

Originally Posted by fiscallyprudent

i would not pay it off either, just yet. It sounds like you're very well disciplined at saving. Once you've built the emergency fund, I'd pay it off. Keep in mind that the extra 450/month is an interest write off ... you want to make sure to maximize that so you can take the itemized deduction vs the standard deduction.

Great question.

It's actually ~$780/mo of a "write off" for the interest but after taxes the bottom line is that keeping the mortgage (and using itemized deductions) costs us ~$450/mo compared to paying it off (and using the standard deduction).

[JuniorTT]

Originally Posted by jpg7n16

What??? Why is anyone considering when OP will move as part of this decision?? That is completely irrelevant. When you sell the house, you get back all the money anyways. And save loads of interest in the meantime.

If you need some cash for moving expenses, that's one thing. But continuing to owe $170k, because you might move?

And the tax break is misguided too. Congrats, you save $100/month on taxes by paying $450/month in interest. yay. You're still losing money that you shouldn't be. (and your 1.1% is taxable)


Why in the world do you have that much in cash????? You are completely underutilizing that money. (unless this is less than 5% of your total investment portfolio) If $15k is a 6 month EF, then you have almost 71 months of income held in cash. Which is out of control.


I would need a lot more information before I could suggest what you should do. But it's between one of these options:

a) pay down $155k on the mortgage (leaves $15k EF + $7k extra for moving expenses)
b) keep mortgage as is, and invest the $157k in something projected to earn more than 6%
c) some combination of a & b

That depends on your time horizon for investments, your risk tolerance, family situation, other investments, etc.

$15k is what the EF would be after paying off the mortgage. With the mortgage it's $25k.

This account used to be a 6 month EF ($25k) but when the economy got bad we grew it to a 12 month EF ($50k). It has grown from $50k to what it is now in about 18 months. It's about 30% of our net worth. We had some crazy income for a while there but we're back to normal earnings again now (instead of growing it by $10-12k/mo it's growing by $2-3k/mo again). While I agree it's a crazy amount to have in cash, the reason it's not invested is that we're saving it short term for our next house so we want it safe and liquid. Now that it has managed to grow beyond the balance on our current house, I'm thinking why not just pay it off.

[HappySaver]

How much do you plan to spend on your next home? I would want to have 20% of that sitting in savings in 2011, for the down-payment. You might be able to avoid a contingency on selling your home first, and you could use the cash from your home sale to pay down the next mortgage, which you'll benefit from longer term.

So, if you're purchasing a $500,000 home, that's $75,000 now (you'll build it up to $100,000 again by 2011). Add to that your EF, moving costs, and extra funds in case you need to pay two mortgages while your first home sells. I wouldn't be comfortable with less than $50k.

So that leaves $52k that you could use to pay down your mortgage and reduce your interest payment. Doesn't make sense to pay it all off at once and leave yourself with so little cash.

Another consideration in my state (MA) is that home sale and mortgage records are public online. So by paying off the mortgage, potential buyers of your home would be able to see that you have no mortgage. I'd rather keep it private, and accomplish that by paying the mortgage down without paying it off.

[jpg7n16]

Originally Posted by JuniorTT

$15k is what the EF would be after paying off the mortgage. With the mortgage it's $25k.

This account used to be a 6 month EF ($25k) but when the economy got bad we grew it to a 12 month EF ($50k). It has grown from $50k to what it is now in about 18 months. It's about 30% of our net worth. We had some crazy income for a while there but we're back to normal earnings again now (instead of growing it by $10-12k/mo it's growing by $2-3k/mo again). While I agree it's a crazy amount to have in cash, the reason it's not invested is that we're saving it short term for our next house so we want it safe and liquid. Now that it has managed to grow beyond the balance on our current house, I'm thinking why not just pay it off.

If 177 is about 30%, then your net worth is around $590k. Of which, 177k is in cash, and 155k is equity in your home. So of your non-residence portfolio, you are holding about 40% in cash.

I believe you should put some of that excess to good use.

And you seem like a more conservative person; "want it safe and liquid" - plus you said "the economy got bad" even though you were earning record incomes (so the economy couldn't be that bad where you live). These tell me you'd be more conservative than most.

In that respect I think you should pay off a substantial chunk of your mortgage, but not completely.

So "why not just pay it off?" - Because you should always keep an adequate EF in place. And paying off the entire mortgage would leave you without an adequate EF. That just won't do.

If $25k is 6 months expenses w/ mortgage, you should keep $25k + a reasonable amount needed for moving expenses. So maybe pay down about $142-147k (leaves 30-35k in cash)

[jIM_Ohio]

Originally Posted by jpg7n16

What??? Why is anyone considering when OP will move as part of this decision?? That is completely irrelevant. When you sell the house, you get back all the money anyways. And save loads of interest in the meantime.

If you need some cash for moving expenses, that's one thing. But continuing to owe $170k, because you might move?

And the tax break is misguided too. Congrats, you save $100/month on taxes by paying $450/month in interest. yay. You're still losing money that you shouldn't be. (and your 1.1% is taxable)


Why in the world do you have that much in cash????? You are completely underutilizing that money. (unless this is less than 5% of your total investment portfolio) If $15k is a 6 month EF, then you have almost 71 months of income held in cash. Which is out of control.


I would need a lot more information before I could suggest what you should do. But it's between one of these options:

a) pay down $155k on the mortgage (leaves $15k EF + $7k extra for moving expenses)
b) keep mortgage as is, and invest the $157k in something projected to earn more than 6%
c) some combination of a & b

That depends on your time horizon for investments, your risk tolerance, family situation, other investments, etc.

There is a risk with liquidity when buying new house.

I would advise OP to keep as much cash as needed to close on new house (meaning 25% down payment, plus enough for closing costs).

The alternative is pay off current house, then when OP needs money to buy new house, he may have to borrow at higher rates.

The OP's net worth will not change when cashing out savings and paying off (or paying down) mortgage. The only thing which changes is cash flow and liquidity of the money. If OP knows he (she?) will not be in house long term, he (she?) should not pay off the mortgage.

[littleroc02us]

If you have that much money in the bank, why do you still have school loans. Pay those stupid things off. What is the point of keeping them around forever? Then use the remainder to pay off most of the mortgage with the 167k. 15k for emergencies should be enough since you no longer have much of a mortgage left. You stated that you are saving heavy for retirement, so concentrate on putting 100% down on your next house by saving more and get rid of the debt. No amount of interest deduction from the IRS is ever worth it. I envy the position your in.

[jpg7n16]

Originally Posted by jIM_Ohio

There is a risk with liquidity when buying new house.

Can you justify OP needing liquidity for the full $177k?

I would advise OP to keep as much cash as needed to close on new house (meaning 25% down payment, plus enough for closing costs).

The alternative is pay off current house, then when OP needs money to buy new house, he may have to borrow at higher rates.

That's not the only other option.

Pay down mortgage substantially, make sure current home sells before buying new home, all cash is liquid and available upon sale of the current residence, interest has been saved in the meantime.

And the OP's rate on the new loan is independent of how much he owes on his former home.

The OP's net worth will not change when cashing out savings and paying off (or paying down) mortgage. The only thing which changes is cash flow and liquidity of the money. If OP knows he (she?) will not be in house long term, he (she?) should not pay off the mortgage.

That's not exactly true.

OP's net worth will not change immediately, but will change over the period with the lower balance. Because cash flow and liquidity aren't the only things that change. Interest expense goes way down too.

So scenario 1 - doesn't pay down mortgage at all: incurs about $9,352 interest expense in a year
Scenario 2 - pays down say... $100k of the mortgage: incurs about $3,977 interest expense.

At the end of one year, OP's net worth will be about $5,375 higher just by paying down the mortgage in the meantime. Adjust that for the deductible nature of the interest, and OP is better off by around $4k somewhere.

Which on $100k is a 4%(tax free) return, which is better than the 1.1% (taxable) he's currently earning.

[nick__45]

Well, one thing to keep in mind is that the less you still owe on your house, the more likely they bank will foreclose on you if you are in financial trouble. Same for the property tax and/or HOA fees. For example, bank will much more likely to foreclose on a guy owning $100k on a $300k house than they are to a guy owning $300k on a $100k house. While it's good to pay off your mortgage, just don't go broke doing it.

And don't go dumping it in GM or any stock. Stock can go from bang to bust shortly and playing stocks is like playing lottery. Don't buy into the hype of 10% average return on long term history. Don't give your hard-earn cash to other people to party with. Stock value fluctuation is just a scam by insiders to manipulate the market for personal gain. A company worth should not fluctuate many times each day.

[disneysteve]

Originally Posted by nick__45

Well, one thing to keep in mind is that the less you still owe on your house, the more likely they bank will foreclose on you if you are in financial trouble.

You posted this on another thread a couple of weeks ago and several of us contested it but you didn't respond. Where did you come up with this theory? If you don't pay your mortgage, the bank will foreclose. It doesn't matter how much you owe or what the house is worth. All that matters is that you don't pay your mortgage. And in this case, OP has enough in savings to pay off the house so foreclosure isn't even remotely an issue.

[jIM_Ohio]

Originally Posted by jpg7n16

Can you justify OP needing liquidity for the full $177k?

Yes, new houses cost money, and many people will not enter into contracts with conditions. Fewer conditions also improves negotiating power.

Originally Posted by jpg7n16

That's not the only other option.

agree, more than one option exists

Originally Posted by jpg7n16

Pay down mortgage substantially, make sure current home sells before buying new home, all cash is liquid and available upon sale of the current residence, interest has been saved in the meantime.

The issue here is OP would need to move twice in a short amount of time, and might not be able to enter contract to purchase until the contract to sell closes.

Originally Posted by jpg7n16

And the OP's rate on the new loan is independent of how much he owes on his former home.

Originally Posted by jpg7n16

That's not exactly true.

OP's net worth will not change immediately, but will change over the period with the lower balance. Because cash flow and liquidity aren't the only things that change. Interest expense goes way down too.

So scenario 1 - doesn't pay down mortgage at all: incurs about $9,352 interest expense in a year
Scenario 2 - pays down say... $100k of the mortgage: incurs about $3,977 interest expense.

At the end of one year, OP's net worth will be about $5,375 higher just by paying down the mortgage in the meantime. Adjust that for the deductible nature of the interest, and OP is better off by around $4k somewhere.

We both agree OP should not use all the cash to pay down current house.
I am suggesting keep 25% of next house price available as down payment- maintain liquidity and maintain flexibility with when OP can close on new house- gets OP the best price point and negotiating power.

That is probably between 50k-125k depending on price range of house purchase (200k-500k).

Your suggestion was 6 months expenses, which (just guessing) is about 15k-20k (much less than my suggestion).


I agree with your earlier suggestions OP is financially conservative. That is OK, OP just needs to determine what makes them feel better-

no mortgage or interest and higher cash flow in current house
or
optimum purchase situation on the new house with lower cash flow until either the house is paid off, or the move happens.

I would also suggest to OP that paying down a mortgage and paying off a mortgage are two very different things.

Paying down mortgage (as in taking 50-75k and paying down mortgage, but still having a mortgage balance) does not
a) increase cash flow
b) increase net worth
c) reduce your mortgage payment

Over time all 3 of those things are true (the longer the time, the more favorable the outcome), but short term the impact of those variables will be very similar to the previous month or previous year.

Paying off mortgage will
a) increase cash flow
b) eliminate mortgage payment

Paying off mortgage will not
a) increase net worth
OP's net worth will only change if mortgage payoff creates more cash flow, and some of that cash flow is put into assets which appreciate in value.





Which on $100k is a 4%(tax free) return, which is better than the 1.1% (taxable) he's currently earning.[/quote]

[jpg7n16]

Originally Posted by jIM_Ohio

Yes, new houses cost money, and many people will not enter into contracts with conditions. Fewer conditions also improves negotiating power.


agree, more than one option exists

The issue here is OP would need to move twice in a short amount of time, and might not be able to enter contract to purchase until the contract to sell closes.

agreed that moving twice might be a hassle, but I thought the 2nd sentence is what you should shoot for. Always make sure home #1 sells before purchasing home #2. And avoid being stuck with 2 homes, one of which won't sell.

I thought that was the goal, not a setback.

That is probably between 50k-125k depending on price range of house purchase (200k-500k).

Your suggestion was 6 months expenses, which (just guessing) is about 15k-20k (much less than my suggestion).

okay, so I can see if you're trying to purchase before the home sells you'd need cash for the downpayment. I just thought avoiding that situation was the goal. And if house #1 sells, that's where you get the cash for downpayment on house #2. So no extra cash needed - hence my 6 months max recommendation.

But even with your range, that still leaves 25-100k underutilized.

Paying down mortgage (as in taking 50-75k and paying down mortgage, but still having a mortgage balance) does not
a) increase cash flow
b) increase net worth
c) reduce your mortgage payment

Over time all 3 of those things are true (the longer the time, the more favorable the outcome), but short term the impact of those variables will be very similar to the previous month or previous year.

Paying off mortgage will
a) increase cash flow
b) eliminate mortgage payment

Cash flow is a process that happens over time. Paying off the mortgage will not improve cashflow immediately either. It takes 1 payment cycle for it to start affecting your cash flow. In fact, the act of paying off the mortgage is a negative cashflow item.

Also, cash flow and interest are not equal. The cash flow may be identical in dollar amounts, but the effect to your net worth could be drastically different.

Paying off mortgage will not
a) increase net worth
OP's net worth will only change if mortgage payoff creates more cash flow, and some of that cash flow is put into assets which appreciate in value.

That is not true. Of each mortgage payment, X% goes to interest based on the balance remaining. If the balance owed drops substantially, less goes to interest, more goes to equity. Any interest paid directly lowers net worth. Any transfer to equity has no effect on net worth.

Paying off or paying down the mortgage will begin to increase net worth at the next payment cycle (well technically, it will slow down the reduction of your net worth). Just like with cashflow. Both describe events that happen over time.

Just like if you switch to Geico and save 15%, you do not save 15% immediately, you save it over time.


And by lowering your expenses, over time you will raise your net worth. In this case, that expense is interest.

[disneysteve]

Originally Posted by jpg7n16

And by lowering your expenses, over time you will raise your net worth.

Only if you don't spend the money. Lots of people pay off a loan and then just add the money that was going to the loan payment to their daily spending so they end up no better off than they were. In the case of paying off a mortgage, they actually end up worse off because at least before part of the payment was going toward building equity. If they aren't saving the former payment, they are losing ground.

What we've always done when we paid off a debt was to put most of the former payment toward additional savings and left some of it, maybe 25%, for additional spending. So if a payment was $200/month, I'd add $150/mo. to savings and leave $25/mo. for whatever came along.

[jpg7n16]

well yeah, if you spend the money elsewhere, you haven't lowered your expenses

[MonkeyMama]

Depending on how much you need for down payment on new home, moving expenses, etc., etc., I don't see this as an all or nothing scenario by any means.

Pay off a chunk of the mortgage and hold onto some of the cash too. May be $100k pay-off and $77k saved for the move, or any combo that makes sense for your situation.

If you pay off say, $100k, you will save a significant amount of interest without completely sacrificing your liquidity. Which is what I would do.

In general, I would not advise buying a new home before you sell the old one, but I think OP's situation is a little unique in that he has the cash to completely pay off home #1. In that situation, I probably rather not move twice, either. IT just depends on the whole scenario.