When is money "free enough"?

[TexasHusker]

I sold my WRX last year for almost the exact amount i paid for originally in 2012 ($21K with trade-in). In some way I broke even driving it for free for 3 years (excluding gas & maintenance cost). I hated the fact that my car $$ losing value. So i bought me a used $3K SUV with 170K miles on it that I still drive. Best decision ever! Hope to drive it for 2-3 more years and sell it for $2K grand once I'm ready to upgrade.

You can buy an old suv - Toyota landcruiser, Land Rover etc., - and not lose much money. You need to find one 25-35 yes old that's been restored.

[MakeAStash]

It's a no brainer to not early pay any loan at or less than the prevailing inflation rate. Since in the US the Fed's inflation target is 2%, by prepaying anything under 2% you are expected to lose money.

Next up is tax deductibility. Mortgage interest is deductible by those who itemize. Depending on income, that might provide another 2% of room, for a total of 4%. So it's not economically sensible to prepay a mortgage of a 4% or less rate.

The final big factor is how much you can earn by investing the money that would have gone toward a prepayment. Over the long term 7% to 8% is the historic investment return, but that comes with risk and is taxable, so let's say reduce that to a low-risk, after tax 2%.

Add that up and the math says that by prepaying any loan with a less than a 4% to 6% interest rate many people are coming out behind financially.

[Nutria]

Next up is tax deductibility. Mortgage interest is deductible by those who itemize.

What about for those of us where the Married Filing Jointly standard deduction of $12,600 covers things?

[corn18]

What about for those of us where the Married Filing Jointly standard deduction of $12,600 covers things?

In addition to this, even if you can itemize, the first 12,600 of interest is a wash because you would have gotten that from the standardized deduction. Now, the mortgage interest could push you into the itemized world and then allow you to deduct things that were not deductible without the interest.

The math usually favors a rate that is less than inflation. The psychological usually favors the payoff. Both answers are correct.

Tom

[greenskeeper]

Next up is tax deductibility. Mortgage interest is deductible by those who itemize. Depending on income, that might provide another 2% of room, for a total of 4%. So it's not economically sensible to prepay a mortgage of a 4% or less rate.

I never fail to get a chuckle when someone brings up the "advantage" of having a mortgage to get a tax deduction....I'd rather own the property free and clear and let uncle sam keep his two bits of silver.

[Jovanny]

It depends on different situations to clear off debts.

[sv2007]

It's a no brainer to not early pay any loan at or less than the prevailing inflation rate. Since in the US the Fed's inflation target is 2%, by prepaying anything under 2% you are expected to lose money.

This isn't exactly correct. By not paying early, the lender is for sure to lose money. You, on the other hand, may or may not lose money wrt loan interest.

We weren't sure if we wanted to pay off our mortgage for the longest time (like > 15 years). During that time, it's rates fluctuated between (if I remember right) 6.x-3.x%; there is a drawback to repaying that is more than just interest. Finally, we just paid it off one day, not even sure of the reason (I think as one has more money, the small costs aren't scrutinized/optimized as much; maybe that's the reason).

[GoodSteward]

I can see the math and possible benefit to this. However, it seems very hard to make it actually work out since you are assuming the interest you need to beat this, and I personally think it is silly to consider a debt an asset, even if it is on rare occasions. If you are trying to justify the loan, then just do it. All juggling of this money aside, debts mean a loss of cash flow. That is always a bad thing from a stability standpoint. This sounds like the same rationale I use to justify buying something I shouldn't lol!

I also don't think you should use investment as a reason to not pay off a debt. If you are out of cash by paying off the car, you couldn't really afford the car anyway, if you are talking about being financially wise. This is the reason I think a lot of people use this whole thought process to justify financing a car. If you were really worried about investments, you would buy a cheaper car, and invest the rest anyway. There are fee's to finances on top of buying the item, and then the interest. You are paying more money for the item than it was worth. You can try to make that up on the side by investing, but who really goes through with that? I bet few people actually ever do invest the difference. I hear the same sob stories with people who buy term but never invest the difference. Then they get stuck without insurance, or savings, or retirement. All the sudden it's the insurance companies fault. Something tells me this is just a ploy to trick yourself into buying a car you really shouldn't be getting. Just my opinion! haha.

[niniwoj]

Nice discussion... I have learnt a lot

[Gailete]

I try to pay extra on any outstanding loan we have that isn't attached to our mortgage or rental property. Because of wildly fluctuating income month to month and year to year, we have to pull out the cc at times. Whether we have the money or not we still need minimal groceries and medication. My business expenses also go on a cc as well. But rather than trying to tackle those bills once a month, I take advantage of the power of the internet to make payments on cc bills weekly or however often we want. I used to read about pay your cards every two weeks which would have involved an extra check and a stamp every two weeks. Now there is no need for stamps or checks, you can just go online and make payments. Every payment made before the due date is less interest you have to pay if you can't pay the bill in full. Once I get those bills taken care of, if there is time left on the other loans, then I will tackle the car loan and the rental property loan. They should be paid off anyhow in about 16 months. Our mortgage is the last thing I would pay off since it has a low rate of around 6% (low when you think of the 14%+ rates during the Carter era that I lived through as a new bride). But the mortgage is just for the building of the house currently at around $70K on 3 acres with a house that the insurance company insists we have to insure for $350K and taxes are as if the house is worth $250+. My husband built the house, bought new when he had to including $10K worth of supplies the day after Katrina since we knew the price of drywall etc. would go up and we had a $1K off coupon and got free shipping and several rebates. He also recycled all sorts of things. All told we spent about $100K building. We have a totally unique house and might actually have a hard time selling it, BUT the land is worth about what we owe at this point.

I try to set aside savings when I do my end of the month paperwork for our businesses, etc. and put money into a retirement plan. Currently we have enough tucked away to pay off all cc bills which would free us up to double our house payments, but real cash money is so hard for us to come by, that I prefer to keep it tucked away and make payments according to our earning each month. It is exciting though to see a couple of long term bills coming to the end and the rental property when paid off should allow about $400 'free' each month - in other words some breathing room. When the car is paid off I want to continue tucking that into a car account for the next time we need to trade our old one in.

I'm sure some would say just pay off those cc bills with your savings, but that would leave us with no ready cash if needed. Our savings and investments are our EF and I don't want to touch them. My stock account at times I could only put in $20-35 a month so to see it where it is at now makes me proud.