Pros and Cons of paying off house early

[KTP]

Originally Posted by skimom

Do you know where you would go about looking for a true no-cost refi? I called our local bank that our current loan is through and they have a 3.25% rate now with no points, but we would still have to get an appraisal and they said to estimate about $1500 cost associated with refinancing.

When we refinanced, we first tried to get a 15 year no cost refi through Wells Fargo, but they wanted to charge for the appraisal and a few other fees...around $1200 to $1500 like you mention. We then went to BECU (a credit union) and they happily gave us a 12 year absolute zero cost loan for an even lower rate that Wells Fargo. You usually have to have pretty good credit for a credit union loan, but if you do, it might be worth checking out.

[Like2Plan]

Originally Posted by skimom

This is another question I have. I'm not sure how I feel about our retirement savings. DH and I both have a defined benefit plan at our company. We will receive about 60% of the average of our last 5 years of earnings when we retire. Most online calcuators that I've found show what you need to have as a lump sum when you retire, but we don't have the option of a lump sum, just the monthly payments. Is there anywhere that I can put in an estimate of the monthly payment that we will receive and see what we will need to have saved in addition to this? I'd love to find somethink like that!

Try this Vanguard calculator, it lets you put in values for a pension based on a percentage of your income: Vanguard Retirement calculator


Vanguard Retirement nest egg calculator

[skimom]

Originally Posted by Like2Plan

Try this Vanguard calculator, it lets you put in values for a pension based on a percentage of your income: Vanguard Retirement calculator

Vanguard Retirement nest egg calculator

Wow, this is just what I was looking for!

One other question - do you usually do two calculations - one for you spouse and one for yourself? DH is 6 years older than me and will probably retire before I do, so do I put his information in and calculate and then do one for me?

[Like2Plan]

Originally Posted by skimom

Wow, this is just what I was looking for!

One other question - do you usually do two calculations - one for you spouse and one for yourself? DH is 6 years older than me and will probably retire before I do, so do I put his information in and calculate and then do one for me?

Yes, I would probably do two calculations. (Are you going to let your DH retire before you ? LOL)

[thekid]

I was in a similar position to you (money to prepay mortgage and defined benefit plan). I prepaid the mortgage, but there were considerations that would not apply to you (I'm canadian and tax consequences were different).

For me, it's simply a question of expected return on investment. In Canada, mortgage payments aren't tax deductible and my marginal taxation rate is 45% (Canada, eh). My mortgage was at 4%. My differed income tax plans where near maxed. So, it was either get a 4% after tax return by prepaying mortgage or invest in out of tax sheltered retirement vehicles...where I would need (at my marginal taxation rate) returns of about 7.5% to match my 4% after tax mortgage prepayment return. With upside only available on attaining returns above 7.5%, it was clear to me that the wise bet was to pay the mortgage.

I think you have to do a similar analysis, but as applicable to your situation. I believe your mortgage payments are income tax deductable and you have room in differed tax retirement vehicles. If that's the case, that changes the game. Since your 4.5% interest rate is tax deductable, your real rate is 4.5% - [marginal tax rate * 4.5%]. Lets say (for arguments sake, you will have to plug your real numbers) your marginal rate is 35%, then your effective mortgage rate is 2.9%. If you have space in differed tax vehicles, you would only need to "beat" returns of 2.9% to be better off by contributing and investing in those retirement vehicles.

On your question regarding how much retirement savings you will need considering you have a DB plan, you need to work it backwards sort of speak. What will your annuity be? Compare that to expected expenses. Will it be enough? If not, how much more will you need per year to "top off" your annuity? Once you get that annual amount, the safe rule is to multiply that by 25 (especially if you are retiring at a youngish age) to ensure an annual drawdown of not more than 4% of initial retirement nest egg amount. For example, if you figure you need an additional $1000/month on top of your annuity to live, then your retirement nest egg should be (at year 1 of retirement) $12 000*25 = $300 000.

[bennyhoff]

Originally Posted by photo

It isn't how much you make but it's how many assets you have. If you are a saver, then FAFSA punishes you because you have to divulge all amounts in IRAs, savings, and other investments. It's a bad deal for students whose families have assets but who decide they will not finance their children's educations.

I could be wrong (and I'm not researching this!) but I thought I heard many schools that give out their own financial aid don't look at home and retirement accounts when determining family contributions. If your kids have any preferences at this point, you might want to contact these universities and find out what is considered when aid is determined. If the home (or 401k) is not counted, then you might consider paying off the home early (or maxing out the 401k) to make you look poorer. Hard to say if it will work, but at least do research and determine your best plan of attack.

[dawnwes]

If we were in your situation we would pay off the mortgage.

We are paying more towards our mortgage now and I really wish we had a smaller mortgage.....hindsight and all that.

[jpg7n16]

Pros:

-Save 4.5%/year interest
-Reduces monthly expenses
-No more lien against the home
-May qualify for the standard deduction which MAY be more than other itemized deductions (and therefore increase tax efficiency)
-Feels good to have a paid off home and no mortgage payment

Cons:

-Significantly reduces cash on hand
-Hinders retirement savings
-Forgoes potential investment income of expected 7-11%/year (could cost your net worth several $1000's over time)
-Loss of tax deduction on interest
-Ties up majority of net worth in a less liquid asset
-Unable to access the bulk of your net worth in an emergency, short of selling your home
-If lose your job, may be unable to borrow against the equity in your home (as no income to support the loan)
-Doesn't feel good to have $100k less investments

Personally, if you gave me the choice between having A) a mortgage free $300k home, or B) a $300k, 3% mortgage and a $300k investment portfolio, I would choose option B every time.

Originally Posted by artwest

Cons:

None.

I strongly disagree.

[thekid]

Originally Posted by jpg7n16

Pros:

-Save 4.5%/year interest
-Reduces monthly expenses
-No more lien against the home
-May qualify for the standard deduction which MAY be more than other itemized deductions (and therefore increase tax efficiency)
-Feels good to have a paid off home and no mortgage payment

Cons:

-Significantly reduces cash on hand
-Hinders retirement savings
-Forgoes potential investment income of expected 7-11%/year (could cost your net worth several $1000's over time)
-Loss of tax deduction on interest
-Ties up majority of net worth in a less liquid asset
-Unable to access the bulk of your net worth in an emergency, short of selling your home
-If lose your job, may be unable to borrow against the equity in your home (as no income to support the loan)
-Doesn't feel good to have $100k less investments

Personally, if you gave me the choice between having A) a mortgage free $300k home, or B) a $300k, 3% mortgage and a $300k investment portfolio, I would choose option B every time.

I lurk from time to time. Your posts are always great jp[letters and numbers]. I appreciate your input and would like to pick your brain if you don't mind.

You still have confidence in long term average 7-11% returns (on broad indexed stock funds)?

Regarding liquidity, when I paid off the mortgage (very recently) I figured I'd open up a HELOC and pull if need be (I still have an EM).

Basically, I see keeping a mortgage while having the money invested as borrowing to invest. Didn't want to do that (wasn't overly optimistic on market returns over the next 7-10 years -time remaining on my mortgage- and decided to bank the interest savings).

[disneysteve]

Originally Posted by thekid

Basically, I see keeping a mortgage while having the money invested as borrowing to invest.

I can understand thinking that when you are talking about credit card debt at 17% or maybe a car loan at 8%. I have trouble agreeing on a 4% mortgage which, after the tax deduction, is an effective rate of 3% or even less. If you can't outperform 3% with your investments, you're doing it wrong.

Even Dave Ramsey, a strict anti-debt proponent, puts investing for retirement and investing for college ahead of prepaying the mortgage in his baby steps.

[thekid]

Originally Posted by disneysteve

I can understand thinking that when you are talking about credit card debt at 17% or maybe a car loan at 8%. I have trouble agreeing on a 4% mortgage which, after the tax deduction, is an effective rate of 3% or even less. If you can't outperform 3% with your investments, you're doing it wrong.

Even Dave Ramsey, a strict anti-debt proponent, puts investing for retirement and investing for college ahead of prepaying the mortgage in his baby steps.

Sure. That's what I posted in reply to the OP.

Guess I forgot again that the situation is different between Canada and the US when I asked the question a few posts later, sorry.

In Canada, mortgage interest is not tax deductable and my marginal rate is at 45%, so the 4% mortgage interest meant that a non tax sheltered investment would need to return over 7.3% to be advantageous. Made sense for me as the interest is not tax deductable and I had very little tax sheltered investment space.

We all agree that mortgage prepayment vs savings is simply a question of estimating which offers higher expected returns or am I still missing something? With rates around 4% (plus tax deductability in the US) and tax sheltered space, it's a near no brainer to go with the investment. With higher rates or no tax sheltered space, you'd have to revisit.

[jpg7n16]

Originally Posted by thekid

I lurk from time to time. Your posts are always great jp[letters and numbers]. I appreciate your input and would like to pick your brain if you don't mind.

It's my initials "JPG" and my 2 fav numbers 7 'n' 16 . Thanks for the props!

You still have confidence in long term average 7-11% returns (on broad indexed stock funds)?

Of course I do. What reason would I have not to? I'm talking long term returns. And since the thread is comparing paying off your mortgage, pros and cons, you can use 30 year time periods (like a standard mortgage). When evaluating the compounded average of all the possible 30 year period since the market opened in 1871 (n=112), the minimum compounded return is 5.09%/year and the max 13.82%. Over a 30 year time horizon, the market has never been below 5% on average. And 87 of those 112 times (78%) it has returned an average over 7%/year. The average 30 year period yielded 9.4%.

Those timeframes include the Great Depression, the 2008 market fall, a few world wars, etc. And still, never worse than 5% so far. Why should I lose my confidence about 7-11% returns? Because the media is creating drama so you'll tune in? Or because politicians are creating fear so you'll vote for them? History tells me there's nothing to worry about.

CAGR of the Stock Market: Annualized Returns of the S&P 500

Regarding liquidity, when I paid off the mortgage (very recently) I figured I'd open up a HELOC and pull if need be (I still have an EM).

I'm not too familiar with HELOCs so I could be wrong on this - it was my understanding that there may be points charged up front, minimum balances required to be kept out, possible annual fees, closing costs, etc. for just getting a HELOC. Also subject to credit approval at the time of origination. Meaning that you'd have to get approved while you weren't in need of the funds (and would pay interest and fees for something you didn't need). But if you lost your job and needed it, you would be subject to credit based on your income when applying, and may not even qualify for a HELOC at that time.

Now if you could get a line of credit against your equity with no fees, no interest, while having your current income, and a good interest rate - that certainly reduces/eliminates two of my main cons.

From: What You Should Know About Home Equity Lines of Credit

Costs of establishing and maintaining a home equity line

Many of the costs of setting up a home equity line of credit are similar to those you pay when you buy a home. For example:

• A fee for a property appraisal to estimate the value of your home;
• An application fee, which may not be refunded if you are turned down for credit;
• Up-front charges, such as one or more "points" (one point equals 1 percent of the credit limit); and
• Closing costs, including fees for attorneys, title search, mortgage preparation and filing, property and title insurance, and taxes.

In addition, you may be subject to certain fees during the plan period, such as annual membership or maintenance fees and a transaction fee every time you draw on the credit line.

You could find yourself paying hundreds of dollars to establish the plan. And if you were to draw only a small amount against your credit line, those initial charges would substantially increase the cost of the funds borrowed. On the other hand, because the lender's risk is lower than for other forms of credit, as your home serves as collateral, annual percentage rates for home equity lines are generally lower than rates for other types of credit. The interest you save could offset the costs of establishing and maintaining the line. Moreover, some lenders waive some or all of the closing costs.

Basically, I see keeping a mortgage while having the money invested as borrowing to invest. Didn't want to do that (wasn't overly optimistic on market returns over the next 7-10 years -time remaining on my mortgage- and decided to bank the interest savings).

I'd just refer to DS's response to this, because he said everything I was thinking.

[thekid]

It's my initials "JPG" and my 2 fav numbers 7 'n' 16 . Thanks for the props![/quote]

Nice to meet you.

Originally Posted by jpg7n16

Of course I do. What reason would I have not to? I'm talking long term returns. And since the thread is comparing paying off your mortgage, pros and cons, you can use 30 year time periods (like a standard mortgage). When evaluating the compounded average of all the possible 30 year period since the market opened in 1871 (n=112), the minimum compounded return is 5.09%/year and the max 13.82%. Over a 30 year time horizon, the market has never been below 5% on average. And 87 of those 112 times (78%) it has returned an average over 7%/year. The average 30 year period yielded 9.4%.

Those timeframes include the Great Depression, the 2008 market fall, a few world wars, etc. And still, never worse than 5% so far. Why should I lose my confidence about 7-11% returns? Because the media is creating drama so you'll tune in? Or because politicians are creating fear so you'll vote for them? History tells me there's nothing to worry about.

CAGR of the Stock Market: Annualized Returns of the S&P 500

Ah, this is the stuff I wanted when I asked the question. To get me some optimism (I'm naturally fairly conservative with my investments and the past years have tested my couch potato resolve -although I have stayed the course).

I guess my main concern is not so much while looking back at past performance of the US economy, but future performance. Past 15 years, CAGR is at 6.5%. Past decade it's 1.5%. This while rates have generally been low and inflation in check (usually good for stock market performance). My (generally uninformed) opinion is that growth in the future may not be as high as in the past. Could well just be a bad stretch, could be the US economy won't grow at the same rate it did til now.

I guess where I really wanted to pick your brain is regarding what you anticipate as future US growth. Similar to past?

Originally Posted by jpg7n16

I'm not too familiar with HELOCs so I could be wrong on this - it was my understanding that there may be points charged up front, minimum balances required to be kept out, possible annual fees, closing costs, etc. for just getting a HELOC. Also subject to credit approval at the time of origination. Meaning that you'd have to get approved while you weren't in need of the funds (and would pay interest and fees for something you didn't need). But if you lost your job and needed it, you would be subject to credit based on your income when applying, and may not even qualify for a HELOC at that time.

Now if you could get a line of credit against your equity with no fees, no interest, while having your current income, and a good interest rate - that certainly reduces/eliminates two of my main cons.

When I shopped HELOCs prior to prepaying, I was offered no fees (opening or standby) or closing costs. Rates (applicable on drawings) where generally prime -0.5%. I didn't actually open one. Still have good EF and other out of retirement account savings and my savings rate is great (like 40-50% of net pay) with the free cash flow opened up by not having mortgage payments.

Still, I get your point. If there are costs, those have to be priced in.

[Petunia 100]

The terms of my last HELOC included a $50 fee to open, no minimum amounts to draw, and interest on any outstanding balance was prime minus .5%. Not too shabby at all.

However, I would not want to rely on a HELOC as my EF. The lender can freeze it, reduce your limit, or even close it altogether at any time for any reason. Cash in an FDIC (or NCUA) insured account is the best EF.

[thekid]

Originally Posted by Petunia 100

However, I would not want to rely on a HELOC as my EF. The lender can freeze it, reduce your limit, or even close it altogether at any time for any reason. Cash in an FDIC (or NCUA) insured account is the best EF.

I agree.

[LivingAlmostLarge]

So are you on track to have enough saved for retirement with a pension? Rule of thumb is 4%=$40k a year pension for $1 million annuity. So if you get $48k/year it's something like $1.2million annuity for life or you saved $1.2M. At least that's how i explained it to my mom.

[ecoadapt]

One of the most controversial subjects around the family finances is the decision to payoff the mortgage early. Some say you should keep the mortgage around as long as possible, citing low interest rates and tax deductions as opportunities you are giving up by paying it off early. Others enjoy the freedom that comes from no mortgage payment, and the huge amounts of disposable, monthly cash that comes along with being mortgage-debt free.

[snafu]

I made the decision to pay off the mortgage purely based on the numbers. I ran the figures to determine how many dollars would clear the mortgage in it's 15 year [180 months] contract. It was a no brainer due to the way amortization payments work. Lump sum payments were credited to the principal and that act alone saved huge sums.

We have two sons currently in university [bad family planning 20 years ago]. We require them to pay their own tuition from summer and p/t work so that they have 'skin in the game' and understand the value of an education. They have some awards, grants, an allowance from us, birthday and bonuses [provided by late grandparents] and now are nearly able to cover their costs by providing tekkie services.

[I was so reluctant to allow them take p/t work at a nearby restaurant while in high sch. but it had unexpected benefits as they worked with the guys as dishwashers and realized without an education, this could be the best they would get. Marks and attitude picked up smartly as a result]

Nearly half of the people who live in our older condo complex are retirees. They complain a lot but live comfortably on about 45% of pre-retirement income. I'm pretty sure they don't carry mortgages or car loans and the place nearly empties out as snow-birds fly off to warmer climes after Christmas.

[Hector]

It’s great that you guys are putting money into college accounts for your kids. Just make sure that you are funding your retirement account with the amount which is necessary before funding kids’ college accounts. The reason behind doing this is kids would make sure to go to college if that is something they really want to do. Even though they might not be eligible to get scholarship because of your income level, they can get part time jobs and some student loans and will make it somehow. But you won’t have many options in your retirement if you are short of money.

If I need to save $2,000 a month for my retirement and I can save only $2,200 a month, I would put $2,000 into retirement accounts and put only $200 into kids college accounts.

You mentioned that you are not fully funding your retirement accounts, fully funding your retirement accounts should bring down your adjusted gross income. I am not sure that would be enough to qualify for scholarships or not.

[PetMom]

I will share one aspect of what not owning your house does: enforces discipline on what you need.

When a bank tells you to have insurance - you have no choice.

Property taxes also have to be paid - no question.

When you have paid off your home those things become technicially optional with some people.