Pros and Cons of paying off house early

[NorthernCalGal]

I am curious as to why no one has mentioned the advantage of the mortgage interest tax deduction -- this is saving you money on taxes so that effectively brings down the cost of that loan. And it is already at such a low interest rate. I would think you would be better off investing in 529K plans for college for your kids that would most likely make much better rates of return than what you are paying for your mortgage. Just a thought.

[sblatner]

I am curious as to why no one has mentioned the advantage of the mortgage interest tax deduction -- this is saving you money on taxes so that effectively brings down the cost of that loan. And it is already at such a low interest rate. I would think you would be better off investing in 529K plans for college for your kids that would most likely make much better rates of return than what you are paying for your mortgage. Just a thought.

The further you get into a mortgage, the less of a tax deduction you receive. I would think at 12.5 years left on a mortgage, skimon is not paying much in mortgage interest anymore. When we paid off our mortgage, our interest was less than a $100 a month.

[photo]

Every student should fill out the FAFSA each year.

It simply isn't worth the time for some. The deadlines are ridiculously early, and people often have to file amended returns, especially with K-1s. However, it is true that some families who do not file out a FAFSA will not realize they qualify for aid. The last time we filled out FAFSA our EC was over $60,000 which covers nearly any university. Therefore, it isn't worth the effort for us. However, a salary of just over $100,000 may qualify. For those who apply, it's strongly recommended to apply early because aid is distributed on a first-come, first-served basis.


Merit-based scholarships are obviously very much worth the effort for those with strong academic records.

First, don't believe that just because you are a high income family that you won't qualify for scholarships, grants, loans and other financial aid. Many families lose out on plenty of opportunities because they just assume they make too much money.

It isn't how much you make but it's how many assets you have. If you are a saver, then FAFSA punishes you because you have to divulge all amounts in IRAs, savings, and other investments. It's a bad deal for students whose families have assets but who decide they will not finance their children's educations.

[skimom]

We paid off our house last fall and have a son going to college in 2013. We used most of our savings and are now saving for college and anything else that comes up. We own our own company and have good cash flow so I'm not worried about saving. It is a great feeling to not have a house payment.

We refinanced our house a couple years ago to a five year fixed. Interest rate was 3.75% or around there. Our payment went down, we continued to pay the old amount and the amount due went down really fast. You might want to look into a no cost refinance for a short time. You could then continue paying the $800 (or even more) for a year and then use your bonuses to pay it off before 2015. I would not refinance if I couldn't get a true no-cost loan. You would never make up paying for the fees.

This has been an excellent thread to read.

Do you know where you would go about looking for a true no-cost refi? I called our local bank that our current loan is through and they have a 3.25% rate now with no points, but we would still have to get an appraisal and they said to estimate about $1500 cost associated with refinancing.

[KTP]

Do you know where you would go about looking for a true no-cost refi? I called our local bank that our current loan is through and they have a 3.25% rate now with no points, but we would still have to get an appraisal and they said to estimate about $1500 cost associated with refinancing.

When we refinanced, we first tried to get a 15 year no cost refi through Wells Fargo, but they wanted to charge for the appraisal and a few other fees...around $1200 to $1500 like you mention. We then went to BECU (a credit union) and they happily gave us a 12 year absolute zero cost loan for an even lower rate that Wells Fargo. You usually have to have pretty good credit for a credit union loan, but if you do, it might be worth checking out.

[Like2Plan]

This is another question I have. I'm not sure how I feel about our retirement savings. DH and I both have a defined benefit plan at our company. We will receive about 60% of the average of our last 5 years of earnings when we retire. Most online calcuators that I've found show what you need to have as a lump sum when you retire, but we don't have the option of a lump sum, just the monthly payments. Is there anywhere that I can put in an estimate of the monthly payment that we will receive and see what we will need to have saved in addition to this? I'd love to find somethink like that!

Try this Vanguard calculator, it lets you put in values for a pension based on a percentage of your income: Vanguard Retirement calculator


Vanguard Retirement nest egg calculator

[skimom]

Try this Vanguard calculator, it lets you put in values for a pension based on a percentage of your income: Vanguard Retirement calculator

Vanguard Retirement nest egg calculator

Wow, this is just what I was looking for!

One other question - do you usually do two calculations - one for you spouse and one for yourself? DH is 6 years older than me and will probably retire before I do, so do I put his information in and calculate and then do one for me?

[Like2Plan]

Wow, this is just what I was looking for!

One other question - do you usually do two calculations - one for you spouse and one for yourself? DH is 6 years older than me and will probably retire before I do, so do I put his information in and calculate and then do one for me?

Yes, I would probably do two calculations. (Are you going to let your DH retire before you ? LOL)

[thekid]

I was in a similar position to you (money to prepay mortgage and defined benefit plan). I prepaid the mortgage, but there were considerations that would not apply to you (I'm canadian and tax consequences were different).

For me, it's simply a question of expected return on investment. In Canada, mortgage payments aren't tax deductible and my marginal taxation rate is 45% (Canada, eh). My mortgage was at 4%. My differed income tax plans where near maxed. So, it was either get a 4% after tax return by prepaying mortgage or invest in out of tax sheltered retirement vehicles...where I would need (at my marginal taxation rate) returns of about 7.5% to match my 4% after tax mortgage prepayment return. With upside only available on attaining returns above 7.5%, it was clear to me that the wise bet was to pay the mortgage.

I think you have to do a similar analysis, but as applicable to your situation. I believe your mortgage payments are income tax deductable and you have room in differed tax retirement vehicles. If that's the case, that changes the game. Since your 4.5% interest rate is tax deductable, your real rate is 4.5% - [marginal tax rate * 4.5%]. Lets say (for arguments sake, you will have to plug your real numbers) your marginal rate is 35%, then your effective mortgage rate is 2.9%. If you have space in differed tax vehicles, you would only need to "beat" returns of 2.9% to be better off by contributing and investing in those retirement vehicles.

On your question regarding how much retirement savings you will need considering you have a DB plan, you need to work it backwards sort of speak. What will your annuity be? Compare that to expected expenses. Will it be enough? If not, how much more will you need per year to "top off" your annuity? Once you get that annual amount, the safe rule is to multiply that by 25 (especially if you are retiring at a youngish age) to ensure an annual drawdown of not more than 4% of initial retirement nest egg amount. For example, if you figure you need an additional $1000/month on top of your annuity to live, then your retirement nest egg should be (at year 1 of retirement) $12 000*25 = $300 000.

[bennkar]

It isn't how much you make but it's how many assets you have. If you are a saver, then FAFSA punishes you because you have to divulge all amounts in IRAs, savings, and other investments. It's a bad deal for students whose families have assets but who decide they will not finance their children's educations.

I could be wrong (and I'm not researching this!) but I thought I heard many schools that give out their own financial aid don't look at home and retirement accounts when determining family contributions. If your kids have any preferences at this point, you might want to contact these universities and find out what is considered when aid is determined. If the home (or 401k) is not counted, then you might consider paying off the home early (or maxing out the 401k) to make you look poorer. Hard to say if it will work, but at least do research and determine your best plan of attack.

[dawnwes]

If we were in your situation we would pay off the mortgage.

We are paying more towards our mortgage now and I really wish we had a smaller mortgage.....hindsight and all that.

[jpg7n16]

Pros:

-Save 4.5%/year interest
-Reduces monthly expenses
-No more lien against the home
-May qualify for the standard deduction which MAY be more than other itemized deductions (and therefore increase tax efficiency)
-Feels good to have a paid off home and no mortgage payment

Cons:

-Significantly reduces cash on hand
-Hinders retirement savings
-Forgoes potential investment income of expected 7-11%/year (could cost your net worth several $1000's over time)
-Loss of tax deduction on interest
-Ties up majority of net worth in a less liquid asset
-Unable to access the bulk of your net worth in an emergency, short of selling your home
-If lose your job, may be unable to borrow against the equity in your home (as no income to support the loan)
-Doesn't feel good to have $100k less investments

Personally, if you gave me the choice between having A) a mortgage free $300k home, or B) a $300k, 3% mortgage and a $300k investment portfolio, I would choose option B every time.

Cons:

None.

I strongly disagree.

[thekid]

Pros:

-Save 4.5%/year interest
-Reduces monthly expenses
-No more lien against the home
-May qualify for the standard deduction which MAY be more than other itemized deductions (and therefore increase tax efficiency)
-Feels good to have a paid off home and no mortgage payment

Cons:

-Significantly reduces cash on hand
-Hinders retirement savings
-Forgoes potential investment income of expected 7-11%/year (could cost your net worth several $1000's over time)
-Loss of tax deduction on interest
-Ties up majority of net worth in a less liquid asset
-Unable to access the bulk of your net worth in an emergency, short of selling your home
-If lose your job, may be unable to borrow against the equity in your home (as no income to support the loan)
-Doesn't feel good to have $100k less investments

Personally, if you gave me the choice between having A) a mortgage free $300k home, or B) a $300k, 3% mortgage and a $300k investment portfolio, I would choose option B every time.

I lurk from time to time. Your posts are always great jp[letters and numbers]. I appreciate your input and would like to pick your brain if you don't mind.

You still have confidence in long term average 7-11% returns (on broad indexed stock funds)?

Regarding liquidity, when I paid off the mortgage (very recently) I figured I'd open up a HELOC and pull if need be (I still have an EM).

Basically, I see keeping a mortgage while having the money invested as borrowing to invest. Didn't want to do that (wasn't overly optimistic on market returns over the next 7-10 years -time remaining on my mortgage- and decided to bank the interest savings).

[disneysteve]

Basically, I see keeping a mortgage while having the money invested as borrowing to invest.

I can understand thinking that when you are talking about credit card debt at 17% or maybe a car loan at 8%. I have trouble agreeing on a 4% mortgage which, after the tax deduction, is an effective rate of 3% or even less. If you can't outperform 3% with your investments, you're doing it wrong.

Even Dave Ramsey, a strict anti-debt proponent, puts investing for retirement and investing for college ahead of prepaying the mortgage in his baby steps.

[thekid]

I can understand thinking that when you are talking about credit card debt at 17% or maybe a car loan at 8%. I have trouble agreeing on a 4% mortgage which, after the tax deduction, is an effective rate of 3% or even less. If you can't outperform 3% with your investments, you're doing it wrong.

Even Dave Ramsey, a strict anti-debt proponent, puts investing for retirement and investing for college ahead of prepaying the mortgage in his baby steps.

Sure. That's what I posted in reply to the OP.

Guess I forgot again that the situation is different between Canada and the US when I asked the question a few posts later, sorry.

In Canada, mortgage interest is not tax deductable and my marginal rate is at 45%, so the 4% mortgage interest meant that a non tax sheltered investment would need to return over 7.3% to be advantageous. Made sense for me as the interest is not tax deductable and I had very little tax sheltered investment space.

We all agree that mortgage prepayment vs savings is simply a question of estimating which offers higher expected returns or am I still missing something? With rates around 4% (plus tax deductability in the US) and tax sheltered space, it's a near no brainer to go with the investment. With higher rates or no tax sheltered space, you'd have to revisit.