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!
When computing retirement funds, do not count the house nor any of the luxuries therein, such as the wide-screen TV, the whirlpool tub, the simulated stone countertops in the kitchen or anything else such as what is parked in the driveway.
The author says that it's good unless the IRS or the congress changes the deduction. His first book Missed Fortune 101 lays out the issues.
my man!
Tax advantage?
Well, because I can afford to make less, I pay less.
Impact to my quality of life?
Zero.
My folks were “Deprssion babies” some of that must of rubbed off as I grew up.
Zero debt, a fat IRA and a good pension = not a lot to worry about.
Unless the dollar gets de-valued 15000 to 1, as hapened to the Ruble. In that case, everyone is pretty much screwed....
I'm out of all debt, have a large amount of equity in the house, and as we come up on the 'socialist uncertainty' of the Dem Administration, I'm worried about losing my job and being cash poor and equity flush.
If I roll out a 'low interest' home equity loan now while I have a job, and keep that cash on hand in some lower risk instrument I can get to, then I can payoff the loan if I lose my job and live off the 'winnings.'
If you lose your job, then you CAN'T get an equity loan after the fact because you're a good credit risk only when you don't need it.
And if the dollar does continue to fall, then I can pay back my loan with cheaper dollars form my paycheck.
We are pre-paying our mortgage. We have it timed so that it will be paid in full by retirement.
“Stop thinking that the most important thing is having equity in your house (which earns a zero rate of return, by the way), and learn why you can save more money by having a mortgage than by trying to pay it all off. “
http://www.realwealthvision.com/Reviews.htm
I personally know this person, and did exactly what she suggested last year.
One of the biggest advantages of taking out the equity is in case of loss of job. The bank will treat you as an untouchable. They would rather foreclose a property with a lot of equity and are more likely to deal with you if you have a high loan to value.
If you take money out there are several ways you may make more than the cost of the loan.
You need not feel pity for my lifestyle. I do just fine. Thanks for the advice, but I'm pretty sure you don't know my financial situation.
Credit is a tool to be used or misused. Borrowing against money is always better (and cheaper) than borrowing against a non-liquid asset. I understand the debt cycle, etc. You don't need to preach to me. My point in this whole discussion is that one size does not fit all. I'm glad you found what fits you. I found what fits me.
What's the old saying to that end?
"Owe the bank $100k and the bank owns you. Owe the bank a million, and you own the bank."
If you have cash your cash is buying less every day that inflation increases. Your hard assets much more likely retain their value.
Rarely does pay from a job keep up with inflation. So yes, on the up side you are paying back that debt with dollars that are worth less but on the down side you likely don’t have more dollars to make up for the loss in value of those dollars. In addition if you have a variable rate mortgage you really take it in the shorts during periods of high inflation.
Now I do agree it makes sense to carry some debt from time to time for a whole host of reasons. My only point is debt costs.
It’s kind of funny, banks make money when you borrow and banks make money when you invest - and - all of it is your money... That isn’t to say that what they offer isn’t worth the cost, but it does cost.
“Credit is a tool to be used or misused.”
That is absolutely true.
And the more tools (choices) in the toolbox the better.
I like Dave Ramsey, but my one negative (sort of) observation about him is that his financial advice is really aimed at people in financial distress and/or people who do not have the self-discipline needed to make rational decisions regarding their money.
A mortgage should be viewed as a financial tool -- nothing more, nothing less. I wouldn't even necessarily call it "debt" in the true sense of that word, as long as it is taken on and paid off in a prudent manner.
There are several aspects of a mortgage that make it a very attractive financial instrument for many Americans -- in addition to the leverage it gives them to buy and own a home they otherwise wouldn't be able to afford. For one thing, most mortgage interest is tax-deductible, which means the borrower pays off the loan at a lower effective rate than the actual interest rate. Secondly, a fixed-rate mortgage really only carries a fixed rate for as long as the consumer wants to carry it (in other words, the consumer has the right to pay it off and/or refinance it at a lower rate whenever he wants, but the bank does not have this flexibility).
My advice is to live well within your means, don't take on a larger mortgage than you can REALLY afford (under your terms, not according to what the bank thinks you can afford -- which is usually more than you can afford), and take advantage of whatever provisions the tax code offers to you.
That's a very good point. I'd play "devil's advocate" and provide two scenarios that might weigh against his advice:
1. If you live in an area where property taxes are high and/or insurance premiums are substantial, there's a good chance you won't be able to keep the home anyway in the event of a job loss or illness.
2. If you carry a mortgage, the bank shares the risk associated with potential problems outside your control that would adversely affect the value of your home (for example, the neighborhood goes bad, a major local employer closes shop or relocates, etc.). If you own your home outright, you are likely to have a very large portion of your personal wealth tied up in one asset whose value may increase or decline over time.
This is an excellent point. I'll use a similar example from my own experience with a car loan.
When I bought my first new car I decided that I could afford to pay $450/month for it, but I didn't use the monthly payment as a measure of how much I could actually pay for the vehicle. Also -- I had $10,000 I could have put down on it, but that didn't mean I wanted to use the entire $10,000 as a down payment.
I ended up financing the vehicle for five years with no money down, and my monthly payment was somewhere around $400 (I think the rate was around 5%). I took the $10,000 that I didn't use as a down payment and invested it in several low- to moderate-risk mutual funds, then added $50 to those investments every month (this $50 was based on the $450 I was capable of paying for the vehicle and the $400 I was actually paying for the vehicle). This went on for several (3+) years. At that point the value of my investments exceeded the remaining balance on the loan, and I ended up cashing out some of those mutual funds (bonds and money market, because their rate of return had declined considerably as interest rates declined) and paying off the loan.
When I look back on it I probably didn't come out very far ahead in the long run. But the key was that I had a good rate on the loan, I was getting a decent return on my investments, and (most important of all) it was not a hardship for me to absorb the $450 against my monthly cash flow. This gave me the flexibility to do other things with that money -- or even to just put it aside in the event something else came up unexpectedly.
There were stories about this circulating at the time, but I don't think what you've described here was the case at all.
I believe the so-called "rent avoidance" aspect of the 1993 Clinton budget only applied to the taxability of Social Security benefits for senior citizens. If a senior citizen owned a home outright, the plan was to have their "rent equivalent" added to their taxable income to determine if their Social Security benefits would be subject to Federal income taxes (I believe any Social Security benefits paid to retirees with incomes over something like $85,000 are taxed as income).
Hope you are tying to be funny. I didn’t say anything about great benefit. It’s just how I did it. First my payment was low because of a large down payment, second, I had refinanced for 15 years at the 13 year point because interest rates came down in the early nineties compared to the initial interest of 9.75, and third, back then I wasn’t exactly rolling in dough, although it sure would have been a great benefit to reduce the large interest payments by just making a small principle payment. The larger benefit I believe is at the front end of the loan, and I wasn’t.
I was trying to be funny with a little truth thrown in...
And seriously, good for you for getting your house nearly paid off. Even with the tax consequences not paying on a mortgage month after month is a major relief that you will enjoy every day.
Of course, Jersey has some real scary property taxes too.
You may be right. It’s been a long time.
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