Mortgage vs Invest in this market

[swanson719]

The age old question. Mortgage Pay-down vs. Investing. We owe $143K on our mortgage @ 5% fixed, with 29 yrs left. We're throwing $991 a month at it with no extra, that includes insurance, taxes, etc. We're investing $1,030 a month in order to max out our Roths after we finished the 6 month EF this year. I'm 23, DW is 26, no kids, combined net of $43,500, no debt aside from the mortgage. DW is on disability and should start working again this time next year, raising our net to near $58K.

The best I can figure, if we were to stop investing altogether right now and put all $1,030 at the mortgage and continue to do so until DW starts working again, then invest the added income and continue to pay down principle on the mortgage, we'd only be out a year on a bad market, but would end up putting $12,000 down on principle, saving ourselves right around $30,000 in interest over the course of the loan and cutting just under 5 years off the loan. If we continue to do that after DW is working and invest her pay, we would pay off the mortgage in April 2018.

I don't see the Roth making anywhere near $30,000 over the next year, but I don't know what the compound interest over the next 40 years on $12,000 would look like. I'm hesitant to stop investing, but at the same time I'm a bit risk averse given the market.

We take the standard deduction instead of itemizing because my pay is almost all non-taxable so we don't have enough deductions to get more than the standard deduction. I'm one of the lucky ones with a 20 yr and out employer pension plan, so no 401K to invest in.

[jpg7n16]

...but would end up putting $12,000 down on principle, saving ourselves right around $30,000 in interest over the course of the loan...

I don't see the Roth making anywhere near $30,000 over the next year

Why are you comparing the 30 year life of the mortgage with 1 year in a ROTH?


It's all about interest rate maximization. Your mortgage is at 5% guaranteed (and with tax deductions is actually less than that - so say 4%). The market will hopefully earn more than that, but it's not guaranteed. What you need to decide is - at what point are you comfortable taking on that extra risk?

I feel the market will likely make 7-11% over the next long period of time. So investing (for me) takes priority over any interest cost of 7% or less.

I am comfortable with risk. You may not be as much. So if mine is 7%, what is your number? Find that, and pay off anything over that interest rate before investing. And invest more before paying extra on anything lower than that number.

[swanson719]

I compare the 30 year life of the mortgage and 1 year in a Roth by the effect $12,000 would have on either - the common factor for both. $12,000 in a 30 year mortgage, saves $30,000 in interest and cuts $12,000 in principle, so it equals $42,000. Long term, that $12,000 (because over the next 12 calendar months, it's 2 different FY's for Roths) in a roth should average the 7% to 11%, but short term, we're looking at a much larger range of -50% in the risk of a double dip, to +90% if you look at real estate mutual funds current YTD returns. That's a range I'm not comfortable with.

[jpg7n16]

I compare the 30 year life of the mortgage and 1 year in a Roth by the effect $12,000 would have on either - the common factor for both. $12,000 in a 30 year mortgage, saves $30,000 in interest and cuts $12,000 in principle, so it equals $42,000. Long term, that $12,000 (because over the next 12 calendar months, it's 2 different FY's for Roths) in a roth should average the 7% to 11%, but short term, we're looking at a much larger range of -50% in the risk of a double dip, to +90% if you look at real estate mutual funds current YTD returns. That's a range I'm not comfortable with.

Okay, then... why are you comparing long term money with short term rates of return?


Ignoring taxes, 12,000 paying down a 5% debt would have the identical effect of investing 12,000 at 5% for the same period of time.

In order to save 30,000 - that means you have 301 payments left. Or 25 years. At 7%, that same one time 12k investment would turn into 69,222 (gain = $57,222) and at 11% it would turn into $187,568 (gain= $175,568)

So if the market returns are consistent with past long term rates of return (25 year periods, not 1 year) then the same investment in a ROTH would be better by $27,222 @7% and $145,568 @11% over the same period of time.

[MonkeyMama]

I don't agree with the thought process here.

You are comparing one year of ROTH performance to saving interest over a mortgage period of 25 years. This is not apples to apples by any means.

Statistically, your ROTH will earn far more in that 25-ish years than the $30k in mortgage interest you'd save.

Anyway, young, low mortgage interest rate, etc. (I am in the same boat), I'd max out the ROTHs. The low mortgage interest rate means that odds are you will do better in the market. Also, now is a GREAT time to invest - to plow money in while the market is "low."

As your income increases with age, add more principle to your mortgage (+$200/month? See how much it takes to shave 5 years off your mortgage, at that point). Add more with the second income if you want. (This is what we do - first income goes to retirement - second income - coes and goes - so goes to mortgage. This could be viewed as conservative, but I feel it's good middle ground. Investing/saving comes first, but with more income we can do both).

The point is that retirement contributions will not prevent you from achieving a goal of paying off your mortgage in 8 years, most likely. Why choose, when you can do both? If the market makes you uncomfortable, get more conservative. It will still be easy to beat 5% in the LONG run. The short run doesn't really matter.

[Hector]

How about not adding all the savings money to house mortgage? If you feel like, why not add 200 bucks or so more towards mortgage?
Or
You could refinance for 20-25 years or so and you will pay off mortgage faster and your mortgage interest rate might go down as well

[swanson719]

JPG, what I was looking for was the comparitive advantage that you gave of long term gain of $27K+ as long as the market maintains long-term averages. What I feel many people do not account for when they give this point of view is the money that would then be available for investment if the mortgage was paid off, which would be a valid argument if it were a traditional IRA as opposed to Roth's. The other thing you've mentioned is that because of deductions, it lowers the actual interest. We take the standard deduction either way, so it's a moot point.

MonkeyMama, my only fear with investing while the market is down is that the bottom might fall out again. I could only lose a few thousand, but stand to gain several thousand, so the possible gain is worth the comparitive risk.

Hector, it's a short term question because our income will increase around $20,000 net next year, so that income would be able to go towards the mortgage.

Thanks for the responses.

[jpg7n16]

...What I feel many people do not account for when they give this point of view is the money that would then be available for investment if the mortgage was paid off, which would be a valid argument if it were a traditional IRA as opposed to Roth's...

That's because that concept is based on a faulty argument. Here's why:

Say you had a 30 year mortgage @5% for exactly $186,281. That would give you a monthly payment of $1000. Now let's say you also had $186,281 in cash lying around that you were deciding what to do with. We'll assume you have $0 a month free to invest as this will maximize the effectiveness of that "extra" $1000/month.

You can either 1) take the cash and eliminate the mortgage today - freeing up $1000/month to be "available to invest." Or you can 2) keep paying the $1000 to the mortgage and invest the $186,281 long term.

Here's the results after 360 months:
-If the market averages 7%-
1) paid $186,281 in cash to eliminate mortgage of $186,281, and $1000/month ($360,000) turns into $1,219,966.95. Net gain = $859,966.95
2) paid $1000/month ($360,000) in cash to elimintate $186,281 mortgage, and $186,281 investment turns into $1,325,668.27. Net gain = $965,668.27

Gain by investing over paying extra = $105,701.31

-If the market averages 11%-
1) paid $186,281 in cash to eliminate mortgage of $186,281, and $1000/month ($360,000) turns into $2,804,510.45. Net gain = $2,444,510.45
2) paid $1000/month in cash to elimintate $186,281 mortgage, and $186,281 investment turns into $4,975,211.13. Net gain = $4,615,211.13

Gain by investing over paying extra = $2,170,700.68


The idea you mention about freeing up extra cash to invest doesn't work out. Because you use your $186,281 to eliminate a 5% debt, to free up 1000/month cash to then invest at 7-11%. Instead of using the $186,281 to invest at 7-11% and use the 1000/month to eliminate a 5% debt.


Like I said above - it's all about interest rate maximization. Put the most money you can at any given point to the largest interest rate, and mathematically you will always come out ahead.

[disneysteve]

Don't forget the fact that you can't make up for missed Roth contributions. If you don't make a 2010 contribution, you can't go back 2 or 3 or 4 years from now and put that money in. That opportunity is lost forever. You lose the benefit of 40+ years of tax-free growth on that money. No way will prepaying the mortgage ever beat that.

[Scanner]

I think it's also pertinent to weigh where you are at on the 30 year mortgage and consider the amortization schedule.

It makes more sense to pay extra payments at the beginning, first 10 years of the 30 mortgage. . .if the mortgage is starting to "flip" on the amortization schedule and be more a principal paydown vs. interest payment, then it makes sense to just make the minimum IMO.