Pay off mortgage? Invest? Hoard? Help!

[km27865]

I need some advice on what to do with my savings. I purchased my house in the mid-2000s for $190,000 with a 30y fixed 5.6% interest rate and 20% down. My principal balance is currently $130,000. My house is now only worth about $120,000.

I'm 32 years old and I currently put some money into my 401K at work and also put some into other investments (shame.. I don't know the details of this very well) and I suspect I should be investing more than I am. I have about $100,000 in my savings account with the bank and pretty sure I should be doing something better with it than letting it sit in the bank.

Should I put it all towards my principal and nearly pay off my mortgage? That seems like a good idea (to me... but what do I know?) so I save on all the interest due but I hear the term "house rich and cash poor" so not sure if I should do that... I have a slight desire to upgrade to a nicer house but realistically probably won't get around to it for another couple of years.

Or would it be better to invest elsewhere? Or do a little of both?

On a different topic, my 401K is now offering the vanguard 20xx funds. My 401K investments are currently scattered across a bunch of different things and I was wondering if it's a good idea to route everything towards a Vanguard fund instead?

Any advice is appreciated. Thanks!

[jIM_Ohio]

You are correct that paying on mortgage will save you interest. You need to balance that against two things...

1) what interest would you earn in 401k? (if you "knew" the interest in the 401k would be higher, you could look at mortgage interest vs investment interest).
2) You need to weigh the risks of not knowing things... you do not know the interest your 401k will give you (the return of a 401k is not guaranteed) and also put a premium on the fixed return of paying off the mortgage.

If you don't think you can sustain 5.6% returns inside the 401k (for example), you need to rethink how you invest that money.

Even if you do get better than a 5.6% return inside 401k, you need to then weigh- is it better to get a 5.6% fixed return on mortgage or 6% inside the 401k for taking on X risk? Is it better to get a 5.6% return on mortgage or 7% inside 401k taking on more risk.

And so on... if you could get 8% in 401k (this is an aggressive portfolio) that is where I would draw the line myself (my mortgage is 5.75% and if my investments did not get 8%, I would be paying down the debt).

[coach2wealth]

My 2 cents...

Pay off the mortgage. The peace of mind is ever bit worth it. But by the numbers:

Set aside 3-6 months expense. Keep it in savings or a money market account. This is not an investment its a financial safety net. Let's say that is 12K.

88K earning 8% (not risk free, but relatively low risk) = 7,040 - taxes = 5,280.

130K paying 5.6 = 7,280 - tax deduction = 5,460.

It's about a wash financially, but if you pay off your home and apply the same habits that got you to 100K in savings to building wealth you will be a debt free multi-millionaire in no time. Note, you will need to invest for market like returns to get there, but with no debt and a solid financial safety net you don't have the stress and can more comfortably ride the markets ups and downs.

[creditcardfree]

Personally, both seem important to me. Paying the mortgage and saving for retirement.

How much do you save for retirement as a percentage of gross income? You should saving at least 15%. I would make sure you are doing this before paying down any mortgage debt. If you need to pull some of the $100K each month to meet this goal, then do it!

You could also, used a portion of the $100K to pay extra on the mortgage each month rather than one large one time payment. You can find amortization calculators online that will show how much you save by paying extra. Figure out when you want this paid off (before your 40?) and then know how much extra to send in each month as a principal payment.

You will need to provide more information about your current investments before we can suggest that you route your retirement money differently.

[creditcardfree]

Set aside 3-6 months expense. Keep it in savings or a money market account. This is not an investment its a financial safety net. Let's say that is 12K.

This is very important to have an emergency fund in place! If part of the $100K is your emergency fund, don't use all of it to pay off your mortgage.

[jpg7n16]

How much are your living expenses for a month?
What is your income?
What is your 401k invested in?
What are those "other investments"? (bonds, stocks, cds, etc.)
Do you have other money in accounts at banks? (checking, money market, etc.)
Edited to add: Do you have any other debts?

"House rich and cash poor" is solved by having a proper emergency fund. In your case, you have too much cash. That statement usually describes people who have a well paid down mortgage, but only $5-10k (or less) in cash liquid. Once you establish a 3-6 month emergency fund, don't worry about being "cash poor."


If that $100k was my only cash in the world, I'd probably put $75k on my mortgage, and leave the other $25k in the bank. I personally like the guaranteed 5.6%. Stocks over time will probably do better than that, but I like risk free returns. If your mortgage was only at 4% or so, I'd probably only pay down enough so that my home was worth more than I owe (say put $20k towards mortgage) and invest the rest.

Before we tell you what you should invest in, you'd need to figure out what risk tolerance level you have, and what asset allocation you currently have. A target date fund may be okay, but if all your 401k is invested in bonds, an equity fund would be more appropriate.

[willywonka]

paydown mortgage

I was in the same boat you are describing a couple of years ago. In my case I had 90k cash and owed 70k on the house. I kept 30k as my reserve fund and paid down the loan...a year later the house was mine free and clear. Once the house was paid for, I took an equity line out if something really bad happened and needed extra cash.

I can say without hesitation (for me) the decision was sound. All my market investments returned a rate lower than the cost of my mortgage. Now, I’m saving what used to be my house payment in addition to the 17% I was saving prior to the pay down.

My overall advice is this: You are guaranteed with earning/saving money by paying off your mortgage but are not guaranteed anything with the market. Therefore, grab all the “for sure” items and then invest (take risk) from there.

[MonkeyMama]

I am in the "everything is important" category.

An idea not mentioned, is to pay $20k-$40k down on the mortgage, in order to decrease the life of the loan and the interest paid on the loan, significantly. That is what I would do if I had $100k cash. Kind of the easy way to make a big impact. Adding to the mortgage monthly is just less "simple," and the benefits aren't so immediate.

Don't know anything about your income, assets, spending, etc., etc., so hard to give relative advice. I would work on diverting as much as possible to the 401k ($16,500 is generally the max, per year) and would also work on maxing out IRAs. This could be wise for you, as far as your taxes. I'd keep a fair amount in cash for an emergency. I don't think a years' net take-home is a bad idea. But for all of the above, depends on the details of your situation.

[jpg7n16]

Or on another line of thinking, if you're going to be in the house for a long time, you could consider refinancing the note, esp if you can get into the 4% range. Then investing is a better option.

[cschin4]

You dont need "all or nothing" thinking. It is not an "either/or" and most good financial management isnt. Instead, there are many ways to approach it. I took a couple of years of aggressively paying down my principal and over a couple of years paid off my home in full. I would not recommend that you plunk down your entire savings. However, if you want to put a chunk down on the principal, then I would do that and the spend the next several years adding additional principle, even if it is only making one extra payment a year and you will shave years off of your mortgage.

[zetta]

I personally like the guaranteed 5.6%. Stocks over time will probably do better than that, but I like risk free returns.

Just wanted to note that paying off the mortgage is not risk-free. You are tying up the majority of your portfolio in one asset (the house). If the local real estate market or your immediate neighborhood goes down significantly and permanently (like Detroit) you are out the money. If the country has a period of high inflation, you would be better off by investing in mutual funds.

[jIM_Ohio]

Just wanted to note that paying off the mortgage is not risk-free. You are tying up the majority of your portfolio in one asset (the house). If the local real estate market or your immediate neighborhood goes down significantly and permanently (like Detroit) you are out the money. If the country has a period of high inflation, you would be better off by investing in mutual funds.

well said

[jpg7n16]

Just wanted to note that paying off the mortgage is not risk-free. You are tying up the majority of your portfolio in one asset (the house). If the local real estate market or your immediate neighborhood goes down significantly and permanently (like Detroit) you are out the money. If the country has a period of high inflation, you would be better off by investing in mutual funds.

The value of the home is independent of the value of the debt outstanding on the home.

For better or for worse, you already own the house and will gain/lose money whatever the market does whether you have a mortgage or whether you don't.

Say you buy a home by taking out a mortgage of $100,000. Whether your home value goes up to $1mil or drops to $0, either way you still owe the bank $100,000. On which you are being charged interest. The sooner the debt is gone, the less interest you will pay - therefore your "return" is guaranteed. Because the rate on a fixed mortgage is guaranteed and the rate on the stock market isn't.

Each additional dollar paid onto the mortgage reduces the total interest owed by exactly the interest rate - making it a "risk free" return over the present course of action.

Plug it in any financial calculator and tell me I'm wrong.

And since inflation is an unknown, it is not risk free. Hence "inflation risk."

Example: $100,000 mortgage @ 5%
1) If has 100,000 in savings account earning 0.15%, and leaves mortgage balance alone.
Mortgage - charges $5,000 in interest (roughly)
Bank account - earns $150 (roughly)
Net income from this position: Loss ($4,850)

2) If instead, that money is paid down on the mortgage:
Mortgage - debt is gone, so no interest is charged $0
Bank account - $0 balance, so earns $0 interest
Net income from this position: $0

The paying down of the mortgage has saved exactly the interest rate differential. It has increased net income by $4,850.

3) Keeps mortgage, invests $100,000 in stock market
Mortgage - charges $5,000 in interest
Stock investments - ??? (could be gain or loss)
Net income from this position: ???


At no point in any scenario does the value of the home affect how much interest will be charged, so the home value is an irrelevant variable.

[Edwin]

You should first save some money in an emergency fund. 3-6 months is the guideline and it really depends on your career security and living expenses among other things. Use the rest of the money to first max out your yearly retirement contributions and then place the remainder towards your house.

Given that the argument for house vs. investment has already been made I wont reiterate it.

[jIM_Ohio]

The value of the home is independent of the value of the debt outstanding on the home.

For better or for worse, you already own the house and will gain/lose money whatever the market does whether you have a mortgage or whether you don't.

Say you buy a home by taking out a mortgage of $100,000. Whether your home value goes up to $1mil or drops to $0, either way you still owe the bank $100,000. On which you are being charged interest. The sooner the debt is gone, the less interest you will pay - therefore your "return" is guaranteed. Because the rate on a fixed mortgage is guaranteed and the rate on the stock market isn't.

Each additional dollar paid onto the mortgage reduces the total interest owed by exactly the interest rate - making it a "risk free" return over the present course of action.

Plug it in any financial calculator and tell me I'm wrong.

And since inflation is an unknown, it is not risk free. Hence "inflation risk."

Example: $100,000 mortgage @ 5%
1) If has 100,000 in savings account earning 0.15%, and leaves mortgage balance alone.
Mortgage - charges $5,000 in interest (roughly)
Bank account - earns $150 (roughly)
Net income from this position: Loss ($4,850)

2) If instead, that money is paid down on the mortgage:
Mortgage - debt is gone, so no interest is charged $0
Bank account - $0 balance, so earns $0 interest
Net income from this position: $0

The paying down of the mortgage has saved exactly the interest rate differential. It has increased net income by $4,850.

3) Keeps mortgage, invests $100,000 in stock market
Mortgage - charges $5,000 in interest
Stock investments - ??? (could be gain or loss)
Net income from this position: ???


At no point in any scenario does the value of the home affect how much interest will be charged, so the home value is an irrelevant variable.

you are putting words in zetta's mouth
I did not see her use the word guaranteed in her post...

and you missed the main point, which is the "guaranteed" return you are guaranteeing is in an asset which is not liquid. So the person has "no access" to the money.

Hence zetta stating the mortgage payoff is not risk free
the return is fixed (based on interest rate of mortgage)
but it is far from being risk free when paying down mortgage (the money is tied up until a person can sell the house for what the person thinks its worth).

Every investment has risks, stating something is risk free means you are neglecting other aspects of the investment (like liquidity in this case).

Other risks to consider are inflation risk (in which case its better to have a loan than to have house paid off), return risks (can you invest money for same amount of risk and get a higher return somewhere else), and interest rate risks (with a fixed rate loan this risk only exists if mortgage rates go down).