take out mortgage on paid off home?

**jIM_Ohio** · 09-06-2010, 11:35 AM

If you invest the old mortgage payment, how soon could you get 151k cash?

$5500/mo accumulates wealth fast
If you are worried about replacing house, I would contact an insurance agent.

**Vrooom** · 09-06-2010, 11:45 AM

> If you invest the old mortgage payment, how soon could you get 151k cash?

If I understand your question correctly, what I was saying is over the 15 year life of the mortgage. If the $300k we take out earns 5%, the difference between that growth and the interest expense on the mortgage is $151k over 15 years. If it earns 8%, the difference will be $370k after 15 years.

Of course the risk is also that the cash we take out and invest earns less than 4% (the all-in interest rate of the mortgage) and we'd lose money on this move.

**jIM_Ohio** · 09-06-2010, 12:03 PM

Originally posted by Vrooom View Post

> If you invest the old mortgage payment, how soon could you get 151k cash?

If I understand your question correctly, what I was saying is over the 15 year life of the mortgage. If the $300k we take out earns 5%, the difference between that growth and the interest expense on the mortgage is $151k over 15 years. If it earns 8%, the difference will be $370k after 15 years.

Of course the risk is also that the cash we take out and invest earns less than 4% (the all-in interest rate of the mortgage) and we'd lose money on this move.

If the property was a rental, its a no brainer to cash out
IMO having a paid off house you live in is important. I would not advocate leveraging (house you live in) to invest, the leveraging is what started this financial mess, and IMO the economy has not unleveraged itself yet.

Keep your house paid off
Invest the $5500/mo (if you had a mortgage, you would be investing less) and just practice making good financial moves from this point forward. Taking the mortgage out to invest is a risky financial move, but I would not consider it a good move. Its not a bad move, its a risky move (with leverage) and IMO most investors should steer clear of leveraging their primary residence.

**greenskeeper** · 09-06-2010, 04:07 PM

invest the "mortage payment", keep your home free and clear in your name. After all we've been through is any investment safe?

**dczech09** · 09-06-2010, 04:39 PM

I agree with the logic of keeping your home paid off. The problem with using the bank's money to gain investment income is that while yes your nominal cost of capital could be as low as 3.75%, you're forgetting about inflation and taxes.

Now, economists believe the economy is more at risk for deflation in the near future, followed by rapid inflation to follow. So for the foreseeable future, inflationary risk may be limited. However, if Bush Tax Cuts expire at the beginning of 2011, then capital gains taxes will rise.

Assuming that you keep the investment for long-term, you would have to return 4.41% (if tax cuts remain) or 4.69% (if tax cuts expire) per year, just to break-even. At the same point in time, you have to stay current on your monthly payments and the inherent risk of disaster increases. What would happen if housing values drop further and you owe more than the mortgage? What if stock values drop and your investment value drops below what you owe? What would happen if you become unemployed or disabled?

All of these factors have to be taken into considered when making a decision like this. Arbitrage pricing theory is not accurate enough to make a risk-return assumption that is 100% on par with reality, however I think that with all risk factors (and taxes) taken into consideration, you would realistically have to return 8% or 9% per year in order to make it worth while; this however does not reflect inflationary risk.

If deflation occurs, then you won't have too high of inflationary risk, however the investment will probably have dropped like a rock. If inflation occurs, then the return becomes worth less as every dollar invested has devalued. With all things considered, then you should be looking at returning at least 10% to 11% per year consistently in order for the investment to be worthwhile. The long-term returns of mutuals are historically as high as 12%, for a 20 year period of time. I am going to assume that you will not have the investment for longer than even 10 years. Even with a 12% return, you net about 1% or 2%, MAYBE 3% if risk factors are smaller than I demonstrated; still not a good return for your time spent. If you looked at this simplistically, then yes, your nominal return could be somewhere around 6%, but real return is what we gotta use to make decisions.

Keep in mind that the economic principle of "all things held constant" only applies if our economy were in a vacuum, which obviously it is not. So we must adjust risk and return for ALL of these factors. Ultimately, my conclusion is that trying to create a mortgage arbitrage and take advantage of "free" money will not net you an investment consistent and high enough to compensate for the risk you are taking.

**jIM_Ohio** · 09-07-2010, 06:00 AM

I thought about this more, and your idea has merit. However I would NOT finance 300k (keeping 100k equity) over 15 years because you admitted you might leave house in 5-10 years.

The problem I think you should prevent is this:

Let's say your house is worth 400k in 5 years and move, and in same 5 years interest rates are 8% (I am considering this worst case). If you sold house for 400k and had no loan to pay off, you have 400k to buy a new house, and you would not be subjected to the higher interest rates. If you financed 300k in 5 years you would still owe 270k, so you would net 130k from the sale, and probably need to finance a portion of new house at the higher interest rates, or cash out a (risky) investment to pay down on house (because the investment might be risky, you might be selling at a loss).

In the above situation (300k financed @3.75% for 15 years) you have a $1400/mo payment (really $1389) and have $4100/mo to invest. My advice would be to put most of the $4100 at risk (in equities) and put the 300k borrowed in something more moderate (where the principal remains to pay down loan if something bad happens).

I am going to change how to define the problem to "beat" the worst case above.
Borrow only enough which you can pay back in 5 years. Could be 30k, could be 60k or 100k... just make it a point to borrow only enough which you would pay back in 5 years.

For the loan, take out a 5 year adjustable rate mortgage (such as a 5/1 ARM) and your initial interest rate should be lower than the 3.75%. This way you know the mortgage is paid off when you sell your home and you would not have to time the sales of any investments to either pay off equity before moving or try to beat high interest rates with a leveraged situation.

If you borrowed 100k at 2%, that payment is $400/mo (really $370). You could then invest all 100k aggressively, as well as about $5100/mo just as aggressive. This is because you **know** you will have debt paid off before you move.

If you did not know if debt was paid off before you moved, would you change how you invested? It would change how I would do it, not sure about you.

**jpg7n16** · 09-07-2010, 06:34 AM

IMO - it is a personal decision. If you understand the risks involved, and are trying to go for an interest rate spread like that, the mathematics will work out. It is higher risk than the current method - and to protect against those perils, you should get insurance. I know earthquakes aren't covered under normal policies, but I would think that some company would sell a policy to cover them. Maybe, maybe not.

Originally posted by greenskeeper View Post

invest the "mortage payment", keep your home free and clear in your name. After all we've been through is any investment safe?

Couldn't the same argument be made about the OP's owning a home? Real estate is not a safe investment either (and after all that the real estate market has been through, shouldn't we know that?). And your home is an investment in real estate.

Originally posted by dczech09 View Post

I agree with the logic of keeping your home paid off. The problem with using the bank's money to gain investment income is that while yes your nominal cost of capital could be as low as 3.75%, you're forgetting about inflation and taxes.

I think you're forgetting that inflation benefits debt and mortgage interest is tax deductible.

Inflation and taxes don't affect only the investment side of the equation, they affect the mortgage's side as well.

Since if you itemize, the mortgage interest will be tax deductible, it is as though you are borrowing at an adjusted 2.8125% (25% tax bracket). And in that case, you would only need to earn greater than 3.75% on your investments. And seeing as how long term capital gains are taxed at a reduced 15%, you would even benefit taxwise on the swap. (and would technically profit after adjusting for taxes if your mortgage were at 3.75%, and your investments yielded anything over 3.31%)

Inflation also means that you are paying back a fixed mortgage with future inflated dollars, and inflated income. If income adjusts to match inflation, the debt owed becomes less and less of your income as inflation is higher.

--------

All in all, cashing out your equity by means of a mortgage is a riskier position than just outright home ownership and should be viewed as such. Because although expected returns can easily be over 4%, there are no guarantees that you'll be able to invest at over 4% for any period of time.

**Seeker** · 09-07-2010, 04:51 PM

Thinking, writing aloud here.

Having a home paid off can be a positive or a negative. Having to not depend on employment to keep a roof over your head, is, IMO, a very strong positive.

Depending on when you purchased your home in California (and it sounds like you were probably not among the recent (within the last 3 or 4 years) purchases); a current value of 400k strongly suggests that your particular locality in this state's housing market has not changed too much.

Hopefully whatever caused the medical outlay is not a repeating occurance.

A 2 year old child in this states educational system is a variable, to me at least. Though you feel that the schools are good in your particular area, and they may well be, how would you feel if you lost this new job and then could not find work in another state because your child were tied to this state?

The question I'd very strongly consider, if you do take out a loan on the equity of your home, is the question of job security. Your SO is not working outside the home, and thus everything in the future depends on that one question.

You have enough of an income such that you can be able to save a great amount monthly. So why not continue with your current path?

**ferriwinkle** · 09-16-2010, 05:14 PM

I agree with seeker, why risk your house that is already paid off. If you can invest $5500 a month already, in 15 years that is about a million dollars without any interest, and your house won't be at the mercy of the stock market. IMO you shouldn't take a loan on your house to invest, it seems like too much of a gamble, especially when you don't need to, $5500 a month to invest is more than my wife and I make combined per month, so I think you are way ahead of the curve.

**Vrooom** · 10-03-2010, 09:29 AM

Thanks for the very interesting feedback and sorry for the delay. We haven't moved on this yet but are still considering the option.

> Having a home paid off can be a positive or a negative. Having to not depend on employment to keep a roof over your head, is, IMO, a very strong positive.

Yes, I agree, that is a positive but I don't see us loosing that option entirely. If we needed to pay off the mortgage in a couple years we could do this again with the "investment cash". Of course provided the investment had not dropped in value significantly, but perhaps our strategy could be to always add cash to that investment account to make sure we could always pay off the mortgage. Hopefully we wouldn't need to, but markets can go down... Does that make sense?

> Depending on when you purchased your home in California (and it sounds like you were probably not among the recent (within the last 3 or 4 years) purchases)

We actually just bought the home about 1.5 years ago and paid cash. We paid a little less than half of what the previous owner paid in 2004, so values do vary wildly, but haven't changed much (or any) since we bought the house.

I also like the idea of considering a 5/1 or 7/1 to get a lower interest rate. Since that's the beginning our our "we might move" time horizon we could just plan on paying off the mortgage in 5/7 years (when the rate would adjust) and hopefully appreciate some gains on the cash investment over the next 5/7 years.

**mrpaseo** · 10-03-2010, 12:18 PM

Random notes to ponder to help with your decision:

Let's start without mortgaging your house:
15 years of investing $5,000 per month
4% Earned: $1,249,471.87
5% Earned: $1,359,449.51

Let's assume same info but you want to save $2,500 per month:
15 years of investing $2,500 per month.
4% Earned: $624,735.93
5% Earned: $679,724.75

__________________________________________________ ______________________________________________
Now let's assume you take out $100,000 mortgage:
You leave this money invested and make payments from your income, no additional investments into the $100,000.
15 years, 4%: $180,094.35 (Would be less once considering the interest paid on the mortgage)
15 years, 5%: $207,892.82 (Would be less once considering the interest paid on the mortgage)

Your original proposal, $300,000 mortgage:
You leave this money invested and make payment from your income (To the mortgage), no additional investments added to this money:
15 years, 4%: $540, 283.05 (Would be less once considering the interest paid on the mortgage)
15 years, 5%: $623,678.45 (Would be less once considering the interest paid on the mortgage)

__________________________________________________ ______________________________________________

Taking into consideration the risks of ensuring you earn 4% or 5% to keep ahead of the mortgage interest, the peace of mind of having the house paid in full and not having to worry about a monthly payment, it looks like saving money from your income would be the best way to go, even if you save half of your "Extra Money".

Hope this helps,
Ray

**jpg7n16** · 10-03-2010, 06:09 PM

Ray - why are you basing your judgment on a comparison between a $5000/month savings plan and a $100k one time investment?

At 3.75% (see OP), the OP could borrow the $100k for only $727.22/month. So your argument is that because you would take on a $727 mortgage payment, you can no longer afford to invest the rest of the $5k??

There are serious problems with the scale between your two comparisons.

A $5k/month savings should have been compared to a $687,547 one time investment; and the $2500 to a $343,773 one time investment.

Or you can do the easy thing, and just say: if after adjusting for taxes and risk tolerance, (% earned on investment) > (% borrowed to invest), then it is a good idea.

So in both cases you present: if you can borrow at a tax deductible 3.75%, and invest at either a taxable 4% or 5%, mathematically it is a good idea, and should be done if risk tolerance allows. No complicated math necessary.

take out mortgage on paid off home?