Does it ever make sense to pay off a home that you will not stay in forever?

[ScrimpAndSave]

I was just wondering this...as I look at my financial goals for the future.

If I am maxing out my Roth IRA and have a years worth of income in emergency savings...would it make sense for me to try to speed up my payments on my house? I love the house...but it is a condo...not that there is anything wrong with that. I absolutely love not having anything to worry about on the outside of it...but I don't know what life holds ahead of me and I am only 29.

I know that most people would say that it is smarter to invest in mutual funds because there is a usually a higher rate of return over time...

Also, if I pay off the condo (let's say in 10-15 years), I guess it is possible that the property could lose value and I will lose my money...even though this isn't probable - right?

I currently owe $143,000 at 5.375% for 29 more years (bought the condo almost a year ago). I currently put $50 extra toward the principal each month.

Thanks

[disneysteve]

Your mortgage rate is 5.375%. Assuming you are in the 25% tax bracket, after the deduction, the effective interest rate is 4.03%. You can invest fairly conservatively and outperform a 4% return. A portfolio that is 80% bonds/20% stocks or maybe 70/30 would probably beat that with pretty low risk. Tilt the mix more toward stocks, like 50/50, and the chances of beating a 4% return climb even higher.

Real estate, especially your primary residence, is an illiquid asset. If something comes along that you need money for, like a down payment on a house or a wedding for example, you can sell stocks and bonds with a few clicks of your mouse. Getting money out of your condo's equity is a lot more difficult. While it is very nice to be in the position you are in, I'm not sure I'd recommend tying up a bunch of money in your condo. I think making extra payments isn't a bad idea and if you wanted to up that $50/month to $100/month, I wouldn't argue. I just don't think I'd pour lots into it.

[ScrimpAndSave]

Thanks Disneysteve. I guess I am tempted because not having a monthly mortgage just seems SO sweet.

I am going to up my contribution from $50 - $100 starting August...I just feel better paying more toward the principal each month.

I'm also questioning whether my 403b is a really good idea since it is just a annuity. Unfortunately, I don't have any other options through my school district at this point with 403bs...it is through AXA Equitable.

[MonkeyMama]

Mostly agreed with Steve.

I am also not a fan of tying up a bunch of liquidity in a home.

That said, if you can be mortgage free and have the cash saved for your next home, you would be in a high bargaining position, as a cash buyer. Or even just as a buyer who will borrow less than you put down on your next home.

If it were me, I'd go 50/50. The extra money I had? Maybe 50/50 to mortgage/investing.

Since we don't rely on my spouse's income, and it comes and goes, we generally use it to pay down the mortgage. The benefit is not dealing with a lot of investments, and ironically, the complicated tax implications of investments. (The tax benefit of the mortgage decreases very slowly with time, even with pre-payments, so is not an issue). To me, it's the easy way to go, though I would think it would be foolish to put ALL our extra money in our house. Thus, a 50/50 approach.

[ktmarvels]

I'm glad you asked this question, DH and I had a discussion about this just yesterday! I'm with you in that I feel I MUST put money toward the mortgage and want to pay it off as soon as we can. However DH realizes that the money could be put to much better use. Maybe I should book mark this page, because every few months or so I get the urge to throw a bunch of our savings at a mortgage we wont have for very much longer!

[jIM_Ohio]

Your mortgage rate is 5.375%. Assuming you are in the 25% tax bracket, after the deduction, the effective interest rate is 4.03%. You can invest fairly conservatively and outperform a 4% return. A portfolio that is 80% bonds/20% stocks or maybe 70/30 would probably beat that with pretty low risk. Tilt the mix more toward stocks, like 50/50, and the chances of beating a 4% return climb even higher.

Real estate, especially your primary residence, is an illiquid asset. If something comes along that you need money for, like a down payment on a house or a wedding for example, you can sell stocks and bonds with a few clicks of your mouse. Getting money out of your condo's equity is a lot more difficult. While it is very nice to be in the position you are in, I'm not sure I'd recommend tying up a bunch of money in your condo. I think making extra payments isn't a bad idea and if you wanted to up that $50/month to $100/month, I wouldn't argue. I just don't think I'd pour lots into it.

SnS-

I agree with every point Steve made, but my other comment is he did not recommend anything directly, just pointed out the important part of making this decision.

My take is this...

if you are already saving 20%- for example 15% to workplace retirement plans and Roths, and another 5% to short term savings, then anything above the 20% could be used to pay down whatever debt you want and improve your personal balance sheet.

Steve and I both pay extra on our mortgages, but we also both save 20%+ to retirement as well.

My concluding comment would be the $50 extra you send is part of that 5% savings (if you see the 15%-5% from my above comment). Because you have 12 months expenses in an EF, its likely that you could put all 5% to mortgage payment and stop making that extra payment when you need the money (like for a car, vacation or wedding).

I don't think you will ever regret paying off your primary residence. The issue is in how aggressive you are trying to reach that goal (I would NOT short change retirement accounts to pay down the mortgage). If 15% of your pay is going to retirement accounts, then anything beyond that is a side dish (do not include pension or employer contributions into the 15%).

**edit to add**

the real issue is in the cash flow tied up to paying down the mortgage.
For example if you have a $1400 payment for 15 years, and apply another $300/mo to that payment, you are tying up $1700/mo which is not liquid as Steve and others have pointed out. Once the house is paid off you have $1700/mo which is liquid, so the risk is in the "in between" state as you are working to pay off the house.

So the 15% you put into retirement is not liquid (cannot access until close to retirement)
and the next 5% or 10% is also being put into something which is not liquid (the mortgage payment)
and you have 12 months expenses in cash (which I assume is in savings or money market?)
if that is not enough liquid cash, fix that risk. Bump up EF higher so you have the liquidity you want and manage the risks as you see them.

As long as you understand the liquidity risk, and see it, realize its there, and realize the only way you can deal with it is add more to savings, then paying down mortgage is OK.

That's how I see it anyway.

[jIM_Ohio]

Mostly agreed with Steve.

I am also not a fan of tying up a bunch of liquidity in a home.

That said, if you can be mortgage free and have the cash saved for your next home, you would be in a high bargaining position, as a cash buyer. Or even just as a buyer who will borrow less than you put down on your next home.

If it were me, I'd go 50/50. The extra money I had? Maybe 50/50 to mortgage/investing.

Since we don't rely on my spouse's income, and it comes and goes, we generally use it to pay down the mortgage. The benefit is not dealing with a lot of investments, and ironically, the complicated tax implications of investments. (The tax benefit of the mortgage decreases very slowly with time, even with pre-payments, so is not an issue). To me, it's the easy way to go, though I would think it would be foolish to put ALL our extra money in our house. Thus, a 50/50 approach.

good post, agree

[disneysteve]

the $50 extra you send is part of that 5% savings

This is an important point. Prepaying debt counts as savings with a return equal to the interest rate on the debt. You just need to keep in mind that it is illiquid savings. You can't easily tap it to pay for a new car or a vacation or a home repair. So it should only be done in addition to your liquid savings. If all of your other financial needs are being handled and you still have surplus cash and want to prepay the mortgage, that's great. Go right ahead. That's exactly what Jim and I do.

[EEinNJ]

To answer your question in a word, YES.
There's a couple of things not being considered here. One is the total of payments over the term of the loan. You owe 143K, but in reality you will pay much, much more. Worse, the amortization of a mortgage is such that early in the loan you are paying mostly interest. The longer the term, the worse it is.

If and when you pay off the loan, you will instantly get a return of hundreds of dollars a month in cash flow, guaranteed, risk free. Contrast that with the stock market, where if you invest 10k now, 10 years from now you might very well have....10 thousand dollars. Or less. It's happened.

You could split the difference, pay extra principal and also invest. Then in 5 or 10 years, if your investments do well, you could refinance at a shorter term, or even pay off the loan.

That's sort of what I did. I paid off my mortgage last month.

One other thing, whatever the current or future market value of your condo is, or whether you're staying or not, is irrelevant to whether you pay the principal down or off. You owe the money either way and will have to settle up with the bank. At least, that's the way it used to be!

[jIM_Ohio]

This is an important point. Prepaying debt counts as savings with a return equal to the interest rate on the debt. You just need to keep in mind that it is illiquid savings. You can't easily tap it to pay for a new car or a vacation or a home repair. So it should only be done in addition to your liquid savings. If all of your other financial needs are being handled and you still have surplus cash and want to prepay the mortgage, that's great. Go right ahead. That's exactly what Jim and I do.

The only way to tap it is to STOP the extra payments.

If you stop paying $50 extra, your budget won't notice... if the extra payment is $200 you might notice more ($200 is $2400/year which is 5% of 48k)- by notice I mean having the ability to stop the extra payment and have liquidity.

I do this- from time to time I stop IRA contributions because I need $1000 or $2000 cash and prefer not to tap savings.

You may decide that is a decent strategy too- pay $200 extra most months, but from time to time you may want to stop that payment for a car repair or something other expense (like a vacation).

This goes to Steve's original point. If you have a vacation line item in a budget, is this an expense or savings? If you put money in savings, and it earns 1% or you could pay down mortgage and get 4%, the return on the mortgage is higher. So if you budget $200/mo for vacations and also $200/mo for short term savings, you could put all $400/mo to the mortgage, then when you take a vacation stop the extra payment for a month or two, accumulate $2000 and go on vacation.

This works if you can pay for vacation when you come back. For example pay for airline tickets 1 mo before vacation- stop mortgage payment then, pay for hotel month of vacation, then come back and pay the credit card with the food on it, so for 3 months you stopped extra payments and paid vacation in cash, the other 9 months was $400/mo extra to mortgage.

[disneysteve]

The only way to tap it is to STOP the extra payments.

If you stop paying $50 extra, your budget won't notice... if the extra payment is $200 you might notice more ($200 is $2400/year which is 5% of 48k)- by notice I mean having the ability to stop the extra payment and have liquidity.

I do this- from time to time I stop IRA contributions because I need $1000 or $2000 cash and prefer not to tap savings.

You may decide that is a decent strategy too- pay $200 extra most months, but from time to time you may want to stop that payment for a car repair or something other expense (like a vacation).

Same here. Last month, I paid an extra $1,000 on our mortgage. We had accumulated a bunch of cash above and beyond all of our other savings and spending needs so I wrote a big check (actually made a big electronic payment) to the mortgage company. Two weeks later, I blew an exhaust pipe on my car and needed an expensive repair. Guess what. This month, the mortgage will get a small extra payment but nowhere near what I sent in last month. That will let me replace the savings that went for the car repair.

[feh]

Your mortgage rate is 5.375%. Assuming you are in the 25% tax bracket, after the deduction, the effective interest rate is 4.03%. You can invest fairly conservatively and outperform a 4% return. A portfolio that is 80% bonds/20% stocks or maybe 70/30 would probably beat that with pretty low risk. Tilt the mix more toward stocks, like 50/50, and the chances of beating a 4% return climb even higher.

Real estate, especially your primary residence, is an illiquid asset. If something comes along that you need money for, like a down payment on a house or a wedding for example, you can sell stocks and bonds with a few clicks of your mouse. Getting money out of your condo's equity is a lot more difficult. While it is very nice to be in the position you are in, I'm not sure I'd recommend tying up a bunch of money in your condo. I think making extra payments isn't a bad idea and if you wanted to up that $50/month to $100/month, I wouldn't argue. I just don't think I'd pour lots into it.

I generally agree w/ Steve, although I suggest making higher payments on the principal such that the effective length of the loan is 15 years. It won't take that much per month, and a 15 year loan is so much more attractive than a 30.

[disneysteve]

I generally agree w/ Steve, although I suggest making higher payments on the principal such that the effective length of the loan is 15 years. It won't take that much per month, and a 15 year loan is so much more attractive than a 30.

Agreed, as long as your other savings are taken care of.

[ScrimpAndSave]

Thank you all so much.

I really need to decide if I want to max out my 403b or aggressively pay down my mortgage.

My Roth IRA will be maxed each year, and I the most that I am allowed to put in the 403b is $16,500 a year. So I need to decide what is smart...a tax sheltered variable annuity 403b - or paying down my mortgage.

I am saving about 30% of my income currently.

[Ima saver]

Well, speaking as someone who did pay off her mortgage at a very early age, I must say I am veryy happy that I did it. I bought my first home at age 21 and had it paid off by age 32. I have since built two more new homes and have paid cash for them each time. I have not really made much money on any of the older homes I sold, but it was so nice not to have a mortgage or rent payment for over 30 years.
However, homes are so much more expensive today, so that probably makes a big difference.