Posted on 02/15/2008 10:48:40 PM PST by RKBA Democrat
Have you ever wondered if you should prepay your mortgage? In today's show I give you the information to make an informed decision based upon your personal situation. We take into account the analytical side of the decision as well as the emotional relief that can come from being DEBT FREE….
The analytical side of the discussion comes from a great article in this month's Consumer Reports titled «Your Mortgage It Rarely Pays to Prepay»
as you can probably see from the title of the article that most people should not prepay and instead use the money to invest. I think that Consumer Reports did a great analysis, but remember paying off your house versus investing in the stock market has many different factors beyond a simple math calculation. Depending on your personal risk threshold there are people that would prefer to be debt-free for the psychological satisfaction rather than maximize the earning potential of their investment portfolio. In today's show I give you my insight to help you determine where you fall in this decision.
A few key facts from the Consumer Reports article…
When comparing paying $100 extra each month towards your mortgage balance or investing in a S&P 500 Index Fund Consumer Reports provided the following results: After 10 years the S&P 500 investment on average produced a gain of $10,058 vs. $4,051 from the added mortgage payment In about a 1/3 of the 10 year periods analyzed, paying down the mortgage produced a better return. However, the difference was pretty meager ranging from $1 to $2,799 of an advantage for prepaying your mortgage. When the S&P 500 investment beat the prepayment, it did so by $70 to $16,763 It should be noted that when you extended the analysis out to a 15 and 20 year period of home ownership, the S&P 500 investment had the advantage 100% of the time. The average dollar gains from the stock investment grew from $10,058 in the 10 year analysis to $19,613 in the 15 year and $41,931 in the 20 year analysis. Please note that this was primarily a mathematical calculation and there is much more that should go into your decision of prepaying your mortgage. You should also take into account:
Your risk profile
Your tax situation (if you make enough money that the Mortgage Interest Deduction is reduced or eliminated by AMT tax then you have more to consider)
How close you are to retirement
Upcoming cash needs (investments are much more liquid then real estate)
Peace of Mind factor…
**Fund Managers are using this time of volatility to welcome new investors**
I also wanted to let you know that with all of the volatility in the financial markets there are some very well know Mutual Funds that have been closed to new investors for a number of years that have reopened to new investors. Below I have provided links, so that you can research each of these options:
Dodge and Cox Stock (DODGX) and Balanced Fund (DODBX) - Large Cap Value Fund First Eagle Global (SGIIX) and Overseas (SGOIX) - Global and International Equities Royce Low-Priced Stock Fund (RYLPX) and Royce Opportunity Fund (RYPNX) - Small Cap Investments Thanks and see you next week!
I take a philosophical approach closer to that of Dave Ramsey when it comes to debt. It's less stressful to be debt free.
Mr. Preston's weekly podcast is pretty good, and you can get it on i-tunes for free.
“If you were to take that $100 per month and put it into an investment that had a more comparable level of risk and volatility such as a a CD, the interest earned on that CD would likely be much less than you would pay in mortgage interest.”
completely agree, and that is BEFORE taxes on said interest.. only possible area of interest to me would be inflation so great that it inflated one’s wages far beyond whatever future earnings value you expected compared to mtg payments, but even given a gross devaluation of the dollar, hard to see wages inflating that fast.
“only possible area of interest to me would be inflation so great that it inflated one’s wages far beyond whatever future earnings value you expected compared to mtg payments, but even given a gross devaluation of the dollar, hard to see wages inflating that fast.”
I sorta doubt that the late 70’s will repeat. Our grandparents and great-grandparents were correct in their skepticism towards debt.
I agree with you. I mean, home debt is the best debt to have, but still, you don’t throw a party when you GET the mortgage, you throw it when you pay it off!
ping
You should borrow on your house if you need to fund a Roth IRA. Frankly, if you can borrow at 7%, at the 30% tax bracket, you only need 4.9% return to break even on an after tax basis. Frankly, you can even lose money pretax and make money after tax.
Did I mention that the IRS and US tax code is idiotic and stupid ?
Even better would be if someone started a Roth bank which would only have one line of business. You could get a loan at 10% if you maintained a roth ira cd at the same bank for the same amount which also paid 10%. The bank has zero risk, zero profit, but all the “depositors” make 3% after tax and risk free.
Did I mention that the IRS and US tax code stinks ?
If you have prepaid, the bank / mortgage holder may be more likely to work with you.
I got my house paid off the same month as I was laid off (after 10 years and no notice) - made a big difference the ‘after’ part.
I look at it as the house is now paying me $1K a month in rent avoidance.....in other words I can afford to take a job that pays less (and offers more satisfaction) without the monthly rent payment hanging overhead.
If you don't have the discipline to stay on schedule, then I would go with the 15 year plan. So many people take the 30 year plan so they can get more toys. Spending the extra money on a bigger truck or a boat or something just means you could have paid your house off sooner, but you felt it was more important to have a $30k boat, or a $50k truck. That would be about the interest difference you would pay for the extra 15 years.
The previous house my wife and I owned we bought in the late 80’s. We paid it off in about 15 years. We sold it last July after the housing market had already taken a dive and in spite of that, all said and done, we lived in the house for free for nearly 20 years including all payments, taxes, and maintenance. Everything we put into it we got back and then some.
You get more than just savings on interest which is considerable. You get the appreciation of the asset while you live in it. And last by not least, there’s a big weight lifted off your mind when you are debt free and are not constantly under the gun.
Unfortunately I'm in debt again... A new home that we built the way we wanted... So now I'm working on paying it off all over again only this time about 2/3rds is already paid off...
You mention Ramsey. One of his reasons for advocating home payoff is if something happens like eternal job loss or extreme illness, they can’t take your home because it’s paid for. Once paid for your only expense is taxes and upkeep and if wise insurance. For most, a significantly lower cost than if you add in principal and interest. It also encourages you to use the KISS method in your life. The simpler, the easier to stay out of trouble.
That way, they would have insurance next summer, if drought, disease, hail storm or insects decimated their garden harvest.
Very important if a couple had 2-4 or more kids they were raising.
While there have been times when my "financial modeling" indicated that taking out a mortgage made for a higher overall return..., I prefer to have one less major concern in my life!
My Daughters have commented several times that we are the only people they know without a mortgage BUT..., both are proceeding to "join the club" as soon as they can!
Debt is a "necessary evil" at times but, other than in terms of income generating pursuits..., it should be avoided!
A wizened old man who had lived through the Great Depression told me, "Don't underestimate the importance of owning your home. In tough times, you want to own a roof."
They missed another point - what if you loose your job?
THAT is one big point that always seems to be missed. IMO- mortgages are not beneficial to the person who has to pay, it is only beneficial to the lender. People tell me about the "tax write-off" or some other silly benefit they get from having a mortgage, and I laugh. What they mean to say is: I never did the math required to determine how much I would have to pay over the life of the mortgage that has a minimum down payment.
It's always better to pay it off as soon as possile.
no debt is good debt
we paid off years ago -
WTF is “prepaying your mortgage”?
Is that the same as BUYING?
I got a better idea. Sell the house, get a much smaller one with a lesser mortgage and pay that off in double time. Better still, get a house with no mortgage and stay away from debt thereafter.
It beats a Posturepedic!
Actually its not always better.
Suppose I got a $100 raise. Among the options I considered was putting the $75 I received after taxes into a house payment or putting the $100 pretax into a 401k in a bond fund paying an interest rate identical to my mortgage or putting the $75 after tax into a Roth 401k. You have to make assumptions about future taxes, but in most situations, the value to your portfolio is about the same. You will still owe on your house a few more years but you have the cash on hand to pay it off early.
The advantage to investing is liquidity. The Roth and the 401k can be pulled out and used for any purpose. To realize the equity in your house, you have to sell it or borrow against it. Added to that is the fact that I keep my small tax deduction for a few more years, so in the end, a safe investment in a tax-smart fund versus putting it into equity really gives a financial advantage toward investing as long as the loan is in place, certainly while the interest payments are deductable.
So given the chance to invest in paying off a 5% mortgage with after tax dollars or investing at 5% with pre-tax dollars (while deducting the mortgage interest), the answer isn't always obvious. In my case, investing works somewhat better, and I can pay the house off today if I need to. Plus I can create cash to use for something else if I need to without going into debt.
Not saying your approach is wrong, because it probably isn't for you. But this approach is better for me. When you have cash on hand to cover it, debt isn't always bad.
There are people paying that much or more in real estate taxes. We were paying that much in the 1980's! We moved to a rural area in another state and started paying peanuts. Currently about $30 a month goes to taxes, on a house larger than 3000 sf.
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