IRA verses Principle on Mortgage

[myrdale]

Hello all! I discovered this website earlier today and it is great! Alot of great advice and experience on these boards. I wish I knew about it 5 years ago.

*Before hand, all my numbers were done with an Excel amortization table. They are not exact, but they seem close to me.

Some background. I am a single college grad. I have been out of school for about two and a half years working as an engineer. Work is great, pay is OK, but we do not have a 401K program.

Shifting gears, last year I purchased my first house. This was an experience, since I had no credit, NONE. Building credit is currently one of my top priorities now. Back in June I had made it up to the 650-710 range for a credit score.

I had to jump though several hoops for the bank, but I was able to get an FHA loan. 30 year, fixed. The house was $108k and I was able to pay $8k down, so I am still stuck with PMI for a bit. With escro, my payments are about $800/month.

For the past year I have been making $1500 payments instead of $800 every month trying to knock the principle on down. $2000 payments a couple of times when I had a few extra pennys (pennies?). Those hurt bad though. Anyway I figure I have moved it from a 30 year loan down to a 23 year loan already in my first year. If I continue at this rate it will "hopefully" be an 8 year loan, assuming no wife and kids appear out of mid-air.

My cousin was telling me how my #1 priority should be maxing out an IRA right now and forgetting about the extra house payments. He is a very smart and savvy guy.

I can see ALOT of advantages of the IRA, both savings and tax wise. If I do it, I would try for $2-3k a year if I can afford it. I trust the bank, and yes I believe investing in the market always pays off long term, but it is still a gamble to some extent. However if my math is right, the approximate $9k extra I have payed on the mortgage this year has saved me $68k of payments by making my 30 year loan a 23 year loan. Granted, there are diminishing returns in making the same house payment, $9k extra next year will only save me about $45k off the life of the loan.

So, with just these few details, which option would be most benificial for me? Investing in an IRA or instead continue applying those extra funds towards the mortgage, or some where in the the middle.

Thankyou all for your advice!

[disneysteve]

My cousin was telling me how my #1 priority should be maxing out an IRA right now and forgetting about the extra house payments. He is a very smart and savvy guy.

What is the interest rate on your mortgage? Assuming it is relatively normal, I would agree with your cousin. You can never recapture the value of time and compounding for your retirement money. And odds are you will earn more in the IRA than you will save with your prepayments.

[myrdale]

6.5% interest rate for the mortgage.

[disneysteve]

Then your cousin is absolutely correct. After the tax deduction, the mortgage is costing you about 4.9% in interest. So prepaying the mortgage is like earning 4.9% on your investment. If, instead, you put the money into a Roth, you could be earning 7% or 8% or more. Starting your retirement savings in your mid-20s is the best thing you could be doing with your money at this point.

[FrugalFish]

Do both

Work your way up to funding your IRA completely and then skim off some other money to prepay your mortgage.

One thing to keep in consideration is that you may lose your great tax deduction sooner than later at which point your mortgage will become a 6.5% debt and nothing more. This year was probably the last year that we will pay enough in interest to itemize deductions (we have low property taxes and not much else in the way of deductions) so now our mortgage is just a debt without any benefits whatsoever.

Suze Orman is one of the few financial advisers who advocates prepaying a mortgage. If you google those terms, you should be able to find an article written by her on the subject- to see if her thinking gels with yours.

[lgslgs]

Use this calculator to see in cold hard $$$ just how correct your cousin is: Invest vs. Payoff

Lynda

[Tree0164]

Fund your retirement first and then any extra pay towards the mortgage. You don't want to be house rich in retirement but not have any cash.

[MonkeyMama]

I wouldn't prepay a dime of mortgage until IRAs were maxes. Agreed Agreed. At that point then you can attack the mortgage.

This particularly makes more sense when you are young.

[Ingtar17]

Definitely put all your extra cash into the IRA! You will make more on average investing than you will save through prepayments!

[Scanner]

One thing though - I think the forum is forgetting that yourmortgage interest rate may effectively be around 8 or 9% with PMI.

Does that change the forum's recommendation?

I may actually consider making extra principal payments until you reach 20% equity.

[FinWhiz]

If you didn't have house payments, how much more could you invest for retirement?

[disneysteve]

If you didn't have house payments, how much more could you invest for retirement?

That doesn't make sense, though. If the house payments is costing you 5% in interest but the investment account is earning 10%, why would you want to pay off the house? You'd lose years of valuable, irreplaceable compounding, meaning you'd end up with a much smaller retirement nest egg.

[TBH]

First I want to say that you sound like you're doing great. This is a great problem to have--the question of what you should do with an extra $700/month.

And you prepaid on your mortgage at the right time, at the beginning of the loan when prepayments will save you the most in interest.

I agree, though, that you should start saving in an IRA. You should get in the habit of saving at least 10-15% of your gross income for retirement.

If you max your Roth IRA, you can still use the extra $$ to prepay your mortgage. You're almost low enough to avoid PMI now. Even if you start maxing an IRA you'll still have 80% equity before too much longer.

I also want to ask if you have any other savings. If you don't, I would suggest the following plan for your $700/month of surplus

1. Open a Roth IRA and start an autodeposit of, $416/month. That way you'll be all set to max it out for 2008, and you won't have to think about it except to figure out what to invest the money in.

2. Start saving $200/month in a liquid savings account for emergencies.

3. With the little bit that's left over, continue to prepay your mortgage.

4. When you've got 3 months' worth of living expenses in your emergency fund, go back to throwing all available $$ at your mortgage.


I think it's a fine thing to pay off your mortgage early, but only if you are not neglecting retirement savings and also making sure you're prepared for medical emergencies, job losses, etc.

[Like2Plan]

Even thought I am a believer in paying off your mortgage early, you have a finite amount of money that you can contribute to an IRA and you can not make up for past years in which you did not elect to make a contribution. I think it is a smart idea to fully fund your IRA every year you are eligible to do so.

[Ima saver]

I would also agree, fully fund the IRA then put any extra towards the mortgage. I paid my mortgage off early, in 10 years, but we did not have ITA's or roths back in my day.