Is it smart to carry a big, long mortgage?

[msnln]

I think this depends on the financial situation of each member. I used to be with invest the money camp up until recently but since beginning of the year, I started paying down mortgages instead of adding to my investment portfolio. I am fully aware of higher potential returns of investments and low after tax rates on mortgages but I have two main reasons for conversion.

1. Monthly payment amount
My monthly mortgage payments are approximately $4000. My rate is 5.25%for 30 year mortgage and I am very happy with the rate but if I or my wife loses job, we will have some difficulty with the payment. We have savings to fall back on, but that will only carry us so far and then we will have to rely on credit lines. As we are both approaching 40, chances of landing good job would be difficult. (Also, God forbid, if something happened to either of us, which would prevent us from working.) If I stuck with my payment plan, I would be able to repay the mortgage by end of 2010 and there will no longer be this large bill hanging over us every month.

2. Amount of interest paid monthly
Of the $4000 mortgage payment, interest portion is about $1,800 a month. Yes that is tax deductable amount but my tax rate is in the mid 30% meaning I am still out about $1,300 every month out of pocket. There may be stock gurus that can make consistent returns after tax in up and down markets (you must still pay taxes on stock gains) but I feel better knowing I am making guaranteed return by paying off my mortgages.

After the mortgages have been paid off, I will start to aggressively adding to my stock portfolio but I have made my decision that less debt is the way to go.

[PetMom]

They don't mention the long mortgage and how long one plans to stay in the home.

People rarely tend to buy for the full 30 years. A lot of people just stay
in a home for an average of 3 to 5 years.

If one gets a long 30 year mortgage on a home that is quite modest
and stays in it - then the situation can be quite good financially. In
fact, for some who cannot save this is the only way they indirectly
'save'.

We have been in a small home for 15 years and have some equity
built up. The house payments are now near what some apartments
are. But and this is something people rarely tack on, this is reality:
the cost of upkeep. Wait until you price that fence that is falling
down (especially with the cost of wood now). The a/c quit? You get
to pay for it. Ditto the leaky roof, etc... Those real estate investment
schemes never mention these realities of home ownership.

If you are a 'do it yourselfer' and get a modest home and build up
equity and never get an equity loan - then a long mortgage is very
good.

One can always pay down a mortgage (always check for a pay down
penalty clause though) that is 30 years and turn it into a cheaper
15 year mortgage just by merely paying it down. We have never paid an extra dollar on the mortgage ourselves though. What good is a paid down
house in disrepair. Investment must be made in actual upkeep.

Also, a Reverse Mortgage is an option for retirement years for some
people who end up paying and staying in their long mortgaged home.

[Coleroo]

This is a good topic.

One thing i've noticed people tend to skim over when discussing paying early versus investing it instead, is that thats giving the unspoken assumption that that money invested will not be touched - not one penny - in the same amount of years. The majority of people do not have the willpower to save, save, save tons of money for 12+ years with the only thought of paying it in one lump sum on the mortgage one day. Somewhere along the line probably more than 80% of those who tried this would end up running into an emergency and cashing out that money little at a time, which would wittle away at their plan over the years. If the money went STRAIT to the mortgage instead, it would be paid - and fewer people are likely to spend that money than they are if it was sitting available in a mutual fund somewhere.

....Also most people get a big head and come up with huge unrealistic figures like making 10 to 12% or better returns. They forget to factor in various fees, the fact that NO money invested can be spent, 12+ years is a long time, AND finally, what they dont consider - in order to make huge returns, the typical person will be investing in the stock market... what if the market crashes 2 years... 1 year... 6 months before you planned to "pay off" that mortgage with your investing? Then what? To me the benefits of peace in having no mortgage asap outweighs the thought of "perhaps" being able to invest the extra money in better ways.


Oh and a sidenote... Im not saying Jim of Ohio up there is in the "can't do it" category - his post simply touched on something I've always thought about... In the same passion I view this issue, Im sure there are people opposite of me with lots of willpower and stamina TO invest better and come out ahead.

[disneysteve]

One thing i've noticed people tend to skim over when discussing paying early versus investing it instead, is that thats giving the unspoken assumption that that money invested will not be touched - not one penny - in the same amount of years.

....Also most people get a big head and come up with huge unrealistic figures like making 10 to 12% or better returns.

what if the market crashes 2 years... 1 year... 6 months before you planned to "pay off" that mortgage with your investing?

I think you are making some assumptions that don't hold true.

1. It doesn't matter if you save indefinitely. All that matters if that you are getting a higher return by investing. If I save for 5 years and then spend that money on a vacation, I will have more to spend than if I had put the money toward the mortgage instead.

2. A 10% return is not a "huge unrealistic" figure. It is the historic average annual return of the market since 1926.

3. I'm not investing the money to use to pay off the mortgage at a later date. I'm still making my scheduled monthly payments for the full course of the loan. I'm just not putting any extra toward the loan, choosing to invest it instead.

[creditcardfree]

I second this.

1) Pay off debts'
2) invest for retirement (401k/Roth) to at least 10% of gross income
3) fund emergency fund
4a) pay down mortgage
4b) invest

4a vs 4b becomes an issue with "risk", vs rates of return, vs leverage

By the time a person hits this point, they are probably saving enough based on 2) and 3).

We paid off our debts, have an emergency fund, invest for retirement at 15% of growth and are paying down our 30 yr mortgage like a 15 year. I expect that when my husband is promoted next year, we will use some of that extra income to invest beyond the retirement and keep paying the house like a 15 year. Our goal is to have enough money to retire in 15 years and a paid off mortgage is a plus at that point.

[jIM_Ohio]

....Also most people get a big head and come up with huge unrealistic figures like making 10 to 12% or better returns. They forget to factor in various fees, the fact that NO money invested can be spent, 12+ years is a long time, AND finally, what they dont consider - in order to make huge returns, the typical person will be investing in the stock market... what if the market crashes 2 years... 1 year... 6 months before you planned to "pay off" that mortgage with your investing? Then what? To me the benefits of peace in having no mortgage asap outweighs the thought of "perhaps" being able to invest the extra money in better ways.

10-12% returns are not needed for a meaningful comparison.

A 5.5% apr on mortgage can be beaten with a 5.5% CD (factoring in mortgage interest deduction).

The issue is paying off mortgage is "risk free". Biggest risk I can see is "opportunity cost" of the money (as another poster pointed out).

the 5.5% CD has inflation risk
a 6-7% bond has interest rate risk and inflation risk
a 8-10% stock mutual fund has market risk.

It is about managing risks, IMO.

[disneysteve]

A 5.5% apr on mortgage can be beaten with a 5.5% CD (factoring in mortgage interest deduction).

Actually, those two would come out about even because the interest on the CD is taxable.

[LivingAlmostLarge]

How do you calculate the returns of maxing out a retirement account with the 15-25-28% tax break over a 5.5% tax deductible mortgage?

Also most people such as creditcardfree is trying to pay off the mortgage faster. I wonder how much ahead he would be if they maxed out retirement options above 15% then through the rest on the mortgage?

[disneysteve]

How do you calculate the returns of maxing out a retirement account with the 15-25-28% tax break over a 5.5% tax deductible mortgage?

Let's say you are in the 25% tax bracket.

The real interest rate on the 5.5% mortgage is 5.5 x (1- 0.25) or 4.125%.

So if your tax-sheltered investment account is earning more than 4.125%, you come out ahead. It is quite simple to beat a 4.125% return.

If you are investing in a taxable account, you need to have an after-tax return greater than 4.125%. That means the pre-tax return needs to be greater than 5.5% (4.125/0.75). Even being quite conservative, that isn't tough either. You can get a 2 or 3 year CD right now paying up to 5.8%.

So in either case, without getting involved in stocks at all, you can come out ahead investing rather than prepaying the mortgage.

[cicy33]

You know what I find amazing? Your mortgage payments!!!!!!!!!!!! We pay $400 per month on our mortgage. We paid $50,000 for our home, actually borrowed $62 but we did some work on it, but the house was $50. I would be sick in the head if I had a $200,000 mortgage, that I could not handle. Of course we also don't make what I am sure most of the people with this high of payments make. If I paid that kind of price for a house around here I would have an absolutely KICKING HOUSE.

[disneysteve]

You know what I find amazing? Your mortgage payments!

Of course we also don't make what I am sure most of the people with this high of payments make.

I think income is part of the issue. Local economy and cost of living matter a lot too. There is no such thing as a $50,000 house in my area. We bought a very modest older home in 1994 for $142,000. Townhouses at the time were running $110,000-$120,000. Today, comparable single homes like ours are selling 275-300K and the townhomes are around 250K. And these are the cheap homes around here.

That said, there are a LOT of people here and elsewhere who are spending way too much on their homes. The rule of thumb is to not exceed 2.5 times income when you buy a house and to keep your home debt under 28% of income. A great many people exceed those limits. That is part of the reason we are seeing the bubble deflate and seeing the problems surface in the subprime lending area. Hopefully, they will stop letting people buy homes with nothing down and stop making all the ridiculous interest-only and ARM loans to people who really can't afford the homes they are buying.

[Magicman]

I say that by investing in the early retirement of your mortgage, you are in essence gaining a return of the interest you would be paying on the outstanding principal of the mortgage.

Although if you plan to move within 3 years, you should probably just rent or lease a place. Magic -

[Coleroo]

I think you are making some assumptions that don't hold true.

1. It doesn't matter if you save indefinitely. All that matters if that you are getting a higher return by investing. If I save for 5 years and then spend that money on a vacation, I will have more to spend than if I had put the money toward the mortgage instead.

2. A 10% return is not a "huge unrealistic" figure. It is the historic average annual return of the market since 1926.

3. I'm not investing the money to use to pay off the mortgage at a later date. I'm still making my scheduled monthly payments for the full course of the loan. I'm just not putting any extra toward the loan, choosing to invest it instead.

Hrm.. I guess its all dependent on how you look at it then...

When I answered this, I was answering solely on the assumption that the person saving is doing it so that the they would end up with MORE money to pay of the mortgage sooner -nothing else. Thats where my bias came in.

Personally, for me, I would rather not have "more money to spend" (on vacations, etc) yet still be tied to a large monthly payment for 30+ years. Im only 24 yrs old - i sure as heck do not want this mortgage payment to continue til Im 54... WOW. It's only been a year and Im tired of "payments" in general. Its like prison to me. And I certainly do not like the thought of paying 230k for a house worthy ONLY 83k!

I would rather knock out the entire mortgage - and free up that large monthly cashflow sooner than to be tied to the burden of a payment. I would feel freer having that large payment cashflow FREE to do something else with entirely. I hate payments! And I know that 10% is the average market return over the past 75+ years - but those returns do not always appear in the shorter time span I was speaking of (10-20 years) (think of many of the stocks thru the 70s and early 80s). If someone has all that money earmarked with a set "return" in their mind and the thought of paying their house off at a given date, then trouble may loom ahead.

So, i believe that if someone thinks they should "invest" the "extra principle" money with the hopes of ending up with "more principle" - they may be better off paying STRAIT to the mortgage instead. I do see where you are coming from though. If the goal is to create "more money" to spend elsewhere, then yes, I agree with you.

[jIM_Ohio]

Hrm.. I guess its all dependent on how you look at it then...

When I answered this, I was answering solely on the assumption that the person saving is doing it so that the they would end up with MORE money to pay of the mortgage sooner -nothing else. Thats where my bias came in.

Personally, for me, I would rather not have "more money to spend" (on vacations, etc) yet still be tied to a large monthly payment for 30+ years. Im only 24 yrs old - i sure as heck do not want this mortgage payment to continue til Im 54... WOW. It's only been a year and Im tired of "payments" in general. Its like prison to me. And I certainly do not like the thought of paying 230k for a house worthy ONLY 83k!

I would rather knock out the entire mortgage - and free up that large monthly cashflow sooner than to be tied to the burden of a payment. I would feel freer having that large payment cashflow FREE to do something else with entirely. I hate payments! And I know that 10% is the average market return over the past 75+ years - but those returns do not always appear in the shorter time span I was speaking of (10-20 years) (think of many of the stocks thru the 70s and early 80s). If someone has all that money earmarked with a set "return" in their mind and the thought of paying their house off at a given date, then trouble may loom ahead.

So, i believe that if someone thinks they should "invest" the "extra principle" money with the hopes of ending up with "more principle" - they may be better off paying STRAIT to the mortgage instead. I do see where you are coming from though. If the goal is to create "more money" to spend elsewhere, then yes, I agree with you.

You need to factor in inflation in two ways to get a better comparison. Add into that "increased earning power" 10-15 years into mortgage as well.

I made ~45k when I bought my first house. The ~$1000 payment was tight. More than 25% of my gross salary was to my mortgage. Got raises
to 55k by time I moved out. mortgage reduced to ~20% of my gross salary.

Add into this inflation. If I kept that $1000 payment, in 30 years that cost would appear small relative to what a dollar bought, and compare favorably to purchasing a similar (appreciated) property which would cost $2000/month in 24 years (assuming 3% appreciation with same interest rates).

So if the goal is a higher overall networth, having a mortgage makes sense. Not paying it off early makes sense. If the goal is to reduce risk, then paying off debt makes sense.

But even people with high net worths prefer to pay off debt. I remember reading in Magic Johnson's autobiography how he bought a 4.5 million mansion. His accountant told him to finance (so he did). Accountant told him to put standard 20% down and finance the rest, Johnson followed that advice, but being debt averse, Magic paid off the loan within 2-3 years.

Donald Trump would probably do the exact opposite.

[disneysteve]

When I answered this, I was answering solely on the assumption that the person saving is doing it so that the they would end up with MORE money to pay of the mortgage sooner -nothing else. Thats where my bias came in.

Understood. In that case, you are correct that you could invest the money, have your investments do poorly and end up with less money than if you had prepaid the mortgage.

From a long-term perspective, though, prepaying the mortgage doesn't make sense from a strictly financial perspective. That's not to say, however, that it doesn't make sense emotionally or psychologically. I did prepay my student loans 13 years ahead of schedule. I hated having those loans and if I hadn't prepaid them, I would have still been paying off my own education when my daughter was in college and that just seemed ludicrous to me.