Prepay all monthly Principal or invest in I bonds

**zetta** · 06-06-2007, 04:15 PM

At first glance it sounds like a good plan -- what is the interest rate of your house and of the I bonds? As long as you are putting the money in a safe vehicle that earns more interest than your current loan you should do ok.

**autoxer** · 06-07-2007, 05:14 AM

Sounds like a good plan, as long as there are no other higher interest debts & your retirement savings are on track.

**jIM_Ohio** · 06-07-2007, 08:03 AM

Originally posted by flatrock View Post

I would be interested in anyones thought on a strategy Im considering. I want to pay my house off in 10 years from now. If I make an extra $100 payment per month I will owe $36,916 in 10 years. I could pay an additional $300 per month for a total of $400 per month and it would be zero balance in 10 years. I have an interest in timberland which is due for harvest in approx. 10 years. Barring an act of god the best estimate of my part of the proceeds will be 30K to 50K. Having said all that I really dont want to lock up the money in the house if I will get the future harvest payment. I am considering paying the extra $100 per month and then buying $300 per month of I bonds and stashing them for 10 years. If the timber burns up or is hit by a tornado I still can pay my house off. I dont want any risk for this particular money and the taxes due grow deferred. Is this a good or bad plan?

I think you are limiting yourself. You have goal (pay off house) and you are suggesting only 2 ways to do it, with not much information (loan interest rate affects the advice). I see the two choices as mediocre at best.

I-Bonds real rate of return is around 4%?
Is you loan interest rate less than 4%?
Do you itemize taxes? what is your highest marginal tax bracket?

**disneysteve** · 06-07-2007, 08:08 AM

I'd want to know a few things:

Interest rate on the house
Interest rate on the bonds
Reason you want to pay the house off early
Your age
What the rest of your investment portfolio looks like re: retirement savings, EF, etc.

**flatrock** · 06-09-2007, 06:51 AM

questions

Sorry, didnt get back sooner I was out working like a dog trying to make some money. Mortgage fixed interest rate 7% I bonds vary depending and the interest changes semi-annually tied to CPI now paying 3.74% couple months ago was paying 6.32%. Only pay federal taxes when redeemed no state so they interest grows tax deferred until you cash the bonds. For a plug figure I used 4% interest in the I bonds. Tax rate is 25% married filing jointly currently max out my 401K wife is in the process of maxing hers out own other real estate free & clear worth 125K have a 6 figure 401K balance and other savings & roth. I am 46. My goal is to pay my house off in 10 years so that by the grace of god I somehow have amassed enough money I will quit. I have a good pension that kicks in at 60. As I mentioned before I may have other money coming in around that time but its timberland subject to some risk. I dont want my money tied up in the house more than an extra $100 per month. I also dont want to invest the difference in stocks for a 10 year time frame I want to know for certain that I will have the money to pay it off if the timber harvest doesnt materialize. In my calculations I multiplied the pay-off amount by 1.25 to account for taxes. In the event I use the bonds to pay off the house I am exploring whether I might be ahead to take out a home equity loan just prior to quitting work pay off the house and get the interest deduction and gradually paying off the home equity loan with the bonds over a 3 to 5 year period when Im in a lower tax bracket.

**zetta** · 06-09-2007, 07:58 AM

It sounds like you're pretty certain you do not want to tie the money up in the house for the next 10 years, even if the return is better. In that case, the question becomes, what is the best way to invest about $400/mo for the next ten years that has a low risk of principal loss. Are you sure that I-bonds have the best returns of your options? Have you checked on the returns of things like treasuries, municipal bonds, and CD's? Would you consider a bond fund, or a balanced mutual fund (the managers invest in a mix of stock and bonds, which lowers the risk considerably)?

My other question is whether you have run the numbers to see if it makes sense to refinance your house to get a lower interest rate. If you took out a 10/1 ARM (which is fixed for the first ten years) you may be able to lower the interest rate significantly.

**autoxer** · 06-09-2007, 09:33 AM

Originally posted by flatrock View Post

... I am exploring whether I might be ahead to take out a home equity loan just prior to quitting work pay off the house and get the interest deduction and gradually paying off the home equity loan with the bonds over a 3 to 5 year period when Im in a lower tax bracket.

Why? Most home equity loans carry higher rates than a first mortgage. And the interest deduction isn't worth as much when you are in a lower tax bracket.

**jIM_Ohio** · 06-09-2007, 01:36 PM

Originally posted by flatrock View Post

Sorry, didnt get back sooner I was out working like a dog trying to make some money. Mortgage fixed interest rate 7% I bonds vary depending and the interest changes semi-annually tied to CPI now paying 3.74% couple months ago was paying 6.32%. Only pay federal taxes when redeemed no state so they interest grows tax deferred until you cash the bonds. For a plug figure I used 4% interest in the I bonds. Tax rate is 25% married filing jointly currently max out my 401K wife is in the process of maxing hers out own other real estate free & clear worth 125K have a 6 figure 401K balance and other savings & roth. I am 46. My goal is to pay my house off in 10 years so that by the grace of god I somehow have amassed enough money I will quit. I have a good pension that kicks in at 60. As I mentioned before I may have other money coming in around that time but its timberland subject to some risk. I dont want my money tied up in the house more than an extra $100 per month. I also dont want to invest the difference in stocks for a 10 year time frame I want to know for certain that I will have the money to pay it off if the timber harvest doesnt materialize. In my calculations I multiplied the pay-off amount by 1.25 to account for taxes. In the event I use the bonds to pay off the house I am exploring whether I might be ahead to take out a home equity loan just prior to quitting work pay off the house and get the interest deduction and gradually paying off the home equity loan with the bonds over a 3 to 5 year period when Im in a lower tax bracket.

Given this information, my first advice would be pay down the mortgage. If you wanted the money liquid, my suggestion would be to save $400/month in a money market account, then whenever balance in money market exceeds $2000, send $1000 to mortgage and keep $1000 in MM. By doing this, you have money liquid, but are getting a better return (money markets are better return than I-bonds right now).

If the above is not what you want (even adjusting threshold to $2000, $4000 or something else), my next suggestion would be to find a balanced fund which returns around 7%, probably a 50-50 fund or 40-60 fund. Then invest $400/month in this, in the end pay off the mortgage with the balance.

Both of above cases, IMO, have better tax advantages and returns than original I-bond idea. IMO the goal is highest after tax return with minimal risk. I think 40-60 is conservative enough to maintain purchasing power of investment, possibly exceeding inflation over 10 years.

More ideas:

Put $400/month into dividend paying stocks in a taxable account. Use the dividends to pay down the mortgage, and keep the principal invested. If mortgage is not paid off in 10 years, cash out the stocks (as needed) to pay it off, and use the rest of the dividend paying stocks to supplement your retirement income.

$4800/year 1= 3% yield=$144 to pay down
$9600/year 2=3% yield=$288 to pay down
$14400/year 3=3% yield=$432 to pay down
$19200/year 4=3% yield=$576 to pay down
$24000 year 5=3% yield=$720 to pay down
$28800 year 6=3% yield=$864 to pay down
$33600 year 7=3% yield=$1008 to pay down
$38400 year 8=3% yield=$1152 to pay down
$43200 year 9=3% yield=$1296 to pay down
$48000 year 10=3% yield=$1440 to pay down

total amount paid down (from dividends): $7920

The $36000 you will own in 10 years has been cut by 20%, plus you have around $48000 in principal basis. Some of which you get to keep and some of which you can sell to pay down. I would expect around a 6% gain on principal, so the 48000 could be worth something close to 90k after 10 years.

To modify this some, sell the losers each year, and use the losers sold amount to pay down the mortgage and write off the capital loss on your income taxes.

The third idea creates more taxes (dividends) but also might increase deductions (capital losses). If you invest well without losses, you will approach having 90k in the taxable account which would be taxed at 15% (capital gains). I think the I-bonds are taxed at marginal rates (as ordinary income). Something to think about.

**flatrock** · 06-09-2007, 04:46 PM

thanks

Thanks for all that responded. Certainly, have some new ideals to explore.
Jim_Ohio. I like the balanced mutual fund approach and I have considered it. I already have some money in a IRA in the Vanguard Wellington balanced mutual fund and have been impressed with the results . Theyve been around since the depression and I like their investing philosophy. The account minimuns for them have recently been raised to 10K. Im trying to decide whether the balanced mutual fund would be better off in a tax deferred account like a roth and pay the penalty & taxes pre-59-1/2 for house pay-off or start out in a taxable account . The other thing is pscyhological, I know the I bonds will be there unless the United States ceases to exist. Worst case scenario a major terrorist event how long will the stock market be down? I have a fixed goal of paying my house off at a specific time . I have to sort all that out and will probably do some sort of blended approach with a balanced mutal fund and I bonds or MM funds. Again thanks everyone for all the feedback.

**kv968** · 06-10-2007, 08:37 AM

Originally posted by jIM_Ohio View Post

The third idea creates more taxes (dividends) but also might increase deductions (capital losses). If you invest well without losses, you will approach having 90k in the taxable account which would be taxed at 15% (capital gains). I think the I-bonds are taxed at marginal rates (as ordinary income). Something to think about.

Besides capital gains held for a year, qualified dividends are also taxed at 15% for most people. The I-bonds will be taxed as ordinary income.

**kv968** · 06-10-2007, 08:42 AM

Originally posted by flatrock View Post

Thanks for all that responded. Certainly, have some new ideals to explore.
Jim_Ohio. I like the balanced mutual fund approach and I have considered it. I already have some money in a IRA in the Vanguard Wellington balanced mutual fund and have been impressed with the results . Theyve been around since the depression and I like their investing philosophy. The account minimuns for them have recently been raised to 10K. Im trying to decide whether the balanced mutual fund would be better off in a tax deferred account like a roth and pay the penalty & taxes pre-59-1/2 for house pay-off or start out in a taxable account .

If you're planning on only holding the balanced fund in a Roth to later pull it out prior to becoming 59 1/2, paying the penality and taxes, I'd say you'd be better off just keeping it in a taxable account from the beginning. You're going to pay the taxes either way but in a taxable, you won't get hit with the 10% early penalty withdrawl. That is of course if you're certain you're going to pull that money out early. If you think you might not touch it and want it for retirement instead, then go with the Roth.

**jIM_Ohio** · 06-11-2007, 04:18 AM

I'd second avoiding the 10% penalty. IMO you would be better off putting dividends into paying down the debt than reinvesting them. It will also make taxes easier year over year.

Prepay all monthly Principal or invest in I bonds