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!
You are sooooooo right.
Because we have done the same thing, I was able to take another job that I love because I know I soon don't need the job I hated to pay a house payment.
No one on FR could convince me to go back to the other way.
Congrats on your new and better lifestyle.
I used to think just like you. I cringed when we paid cash for our car instead of financiing it. I thought I wanted the cash in the bank.
Funning thing, now that I don't have that payment, I have the car and cash in the bank. Get off that thinking you have.
That answer is good enough.
Sounds like you have a plan and good for you.
What a sweet scam that is for the money industry.
I’ve done both, although I haven’t had a car payment in many years. Certainly you don’t want to have a paid off car and no cash on hand because you have it tied up in a car you can’t borrow against. But if you have adequate cash reserves beyond the cost of the car, it’s probably prudent to pay cash for the car, or just buy less car. You just have to realize that when you finance something you can pay cash for, you are paying for the flexibility of having cash readily available. That is different in my mind than paying for it with money you haven’t made yet.
I tend to invest rather than save, so I don’t keep large bags of cash around. When an unexpected expense comes around, I am sometimes willing to pay a finance charge to maintain my investment strategy. Not always, but sometimes.
Liquidity is worth something in finance. I’m glad it worked out for you, but if you had made yourself cash poor to avoid the loan, you may have put yourself at risk unnecessarily (not saying you did... I don’t know your situation). Cash flow problems can get you in trouble. Liquidity at some level (not on everything, but the proper amount of liquidity) is insurance against cash on hand going negative, which is a bad time to try to borrow your way out of it.
But that doesn’t mean it is the right solution in every case. As a general rule, I agree that if people can’t evaluate the cash versus credit decision intelligently, they should default to using cash.
I have the car and cash in the bank. Get off that thinking you have.
Maybe the smart approach for those tempted to pay off is to get a fat line of credit that you can tap in an emergency.
One other factor I didn’t see discussed: a paid-off house is a juicy temptation to greedy trial lawyers. If you are paid-off, you’d better consult a specialist lawyer about responsible ways to protect your assets.
Your plan puts you at great risk when hard times hit than does my plan, not the other way around. You have to maintain cash to maintain your lifestyle of debt. I don’t!
Hard times come and my lifestyle stays the same and actually far better than yours. While you are watching your cash reserves dwindle and scambling against the clock to reinvigerate your cash stream, I am going about my daily routine, not having to cut back on bit.
I have a beautiful house, nice cars, big TV. Shucks, we even got one of them fancy dishwashers. And without debt and interest, our savings rate is greatly accelerated.
At
http://www.vertex42.com/Calculators/loan-calculators.html
there is a free excel template that can answer the question of tax implications, interest amortization and the benefits of prepaying a mortgage.
This is not intended as spam but was a great tool in my wife and I deciding how to allocated unexpected income.
Yes, it does me as well. It’s not even a hard word to spell. I have no clue why so many people get lose vs loose wrong.
“Should we strive for a balence?”
Yes, but my personal opinion is to approach it a little differently. First, I think people need to start with a basic question: are you in financial trouble or likely to be? E.g. having debts such as credit cards that can’t be paid off, spending large amounts of current income paying off debt, living well above one’s means, etc. In that case, my opinion is to listen very closely to Dave Ramsey and what he has to say. His “tough love” approach to getting rid of all debt is called for. Debt can be addictive.
If that’s not the situation, then I think a combination of approaches makes sense.
1. Have an emergency fund in a credit union account or “safe” investments equal to 6 months expenditure.
2, Make sure 15% of income going to retirement (Roth IRA’s, 401K)
3. Pay off high interest rate, non tax advantaged debt. E.g car loans.
4. Pay off low interest rate or tax advantaged debt. E.g. mortgage.
(Disclaimer: I’m not an investment adviser, accountant, lawyer, or anything else. I’m just some schmoe on the internet who has an interest in the subject. Listen at your own peril.)
It doesn't!? I can show you a whole neighborhood that lost half its value in the last couple of years. On the line of credit, why would you need to do that or need that? Your really have jumped on the debt propoganda bandwagon. Guess we just will disagree. Debt-free is the best plan for me.
Best wishes. You sound like you’re set also. If you want to do some reading, I recommend Last Chance Millionaire.
If I put 6,000 annually in a tax deferred account and it makes 7.5%, I'll have about 1 mill after 35 years. If I buy three 3 300,000 homes and they each double twice in 35 years, I've made 2.7 mill net(still owing 900,000). Also, I can redirect equity at any time, as I recommended earlier and make tax free money. Equity loans are also not taxable, so there is no tax anywhere in the system.
If you take out 75,000 per year from your retirement (using the same 7.5%), you'll pay about 25,000 per year in taxes, especially since you paid off your tax deduction.
I always recommend a cash reserve from 6-12 months worth of expenses.
If you pay off your home, you are risking not being able to take money out. Loans can be difficult after you retire. You may be able to do a reverse mortgage for say $1,200 a month in income to you.
Equity has no rate of return. So I shudder when I hear people sitting around year after year telling me how much equity they have in the house, making nothing. And where is it? Nowhere, unless you can reach it or make money from it.
People have made money flipping houses, but we like real estate for the long term. People say "Are you losing money?" I say how. I took out equity and invested it in a secure retirement program, tax free payouts AND I am not going to sell. We're buy and hold people.
Real estate is the best investment for leverage I know. You have to buy low and sell high just like everything else.
We did the same thing. We’ll be finishing paying off the house a couple years ahead of time.
While we are on this subject I would like to bring up a related question. How would the FAIR Tax affect the value of real estate? It would eliminate the mortgage deduction ... would that affect what people are willing to pay for your home, especially if you live in a high tax state like CA or NY?
A few reviews of the book at Amazon suggest the book has some questionable tax avoidance schemes that might not sit well with the IRS...
Chocolate; put it all in chocolate.
Calm down. Inflated houses can lose value, but a house retains its intrinsic value over the decades, while a car doesn’t.
My point remains.
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