Pay Off Mortgage Early? Or Invest?

379 Responses to “Pay Off Mortgage Early? Or Invest?”

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1. 1
   Matt Says:
   May 15th, 2009 at 8:01 am

   Using mortgage proceeds to invest in the stock market could make sense for the reasons you give. But it doesn’t make sense to invest mortgage proceeds in bonds, CD’s, or other low-return investments because the marginal return (if any) isn’t worth the risk. In practice, this means your investment portfolio should be 100% stocks until you’re out of mortgage debt. Only after that does it make sense to hold the ‘diversified portfolio of stocks and bonds’ the experts talk about.

2. 2
   Nickel Says:
   May 15th, 2009 at 8:06 am

   Matt: The vehicle doesn’t technically matter as long as it outperforms the mortgage interest rate. Going “all in” on equities will raise your expected average rate of return, but will also create a very volatile (risky) portfolio.

   Look at it this way… Back in the early 1980s, CDs were paying 10-12%. I know this, because I was heading into middle school around that time and I bought some with the money I was saving for college. Now, I’m not suggesting that 10-12% CDs are just around the corner, but think of the (guaranteed) killing that you could make if they were.

3. 3
   Frank Curmudgeon Says:
   May 15th, 2009 at 8:29 am

   Depending on your tax situation, you might be able to buy municipal bonds with a higher after-tax return than the mortgage rate right now.

4. 4
   Corporate Barbarian Says:
   May 15th, 2009 at 8:46 am

   To us, mortgage = debt, and we wanted to rid ourselves of all debt. It’s a great feeling having one less monthly payment, and a big one at that. You can go through all of the analysis that you’re missing out on tax deductible interest, or the opportunity cost to your missed investments, but each extra principal payment brought us closer to financial freedom. I don’t regret the decision at all.

5. 5
   Baker @ ManVsDebt Says:
   May 15th, 2009 at 8:52 am

   This is a great overview of the issue. I don’t own a home, nor do I invest, however you asked my opinion (at the end of the post) so here it is.

   When I hear people talk about this issue, I always like backing into the question. By that I mean examining on whether or not you would borrow additional money on your house to invest in the stock market or bond markets.

   For most, the answer would be no. I understand you always are going to need more motivation to change than to not change. But for me, I can’t imagine myself doing that, so I would primarily focus on the mortgage debt first.

   Maybe my tune will change in 2-5 years once I’m faced with the issue head on! Hopefully, I’ll be lucky to be in your situation Nickel. A little for everyone!

6. 6
   Mike Says:
   May 15th, 2009 at 8:54 am

   I was laid off in 2002 and was looking at a prolonged unemployment. Salaries in my profession were plummeting. I ended up being unemployed for about 18 months with a salary about 50%.

   I had the cash available from a great contract the previous year. I looked at how many months of house payments that cash would make vs. paying it off. I considered the interest part of the payments as a waste of cash at the time and paid it off.

   Piece of mind has value…

   Now I am probably saving about 50% between various retirement & personal accounts. Savings can build fast if your not sending it to someone else, and you maintain your same lifestyle.

7. 7
   Stacey Says:
   May 15th, 2009 at 9:37 am

   I think it’s important to realize that these two goals aren’t mutually exclusive. What’s the point of paying off the mortgage if you’ll be 55 with no investments when it’s paid off?

   We ran the numbers and are working to pay off the mortgage and hit semi-retirement in the same year. It worked out to be a 60/40 split, with 60% of our extra money going towards investments and 40% towards the mortgage. Of course, paying off the mortgage also reduces the amount of cash flow needed – which made our investment goals just a bit more reachable! We’ll run the numbers again once a year to make sure we’re still on track.

8. 8
   adrock Says:
   May 15th, 2009 at 10:08 am

   We bought a house last month and decided to make a sizable extra principal payment each month (effectively making our 30 yr into a 15yr). Rationale behind the extra payment is that it forces us to remain frugal with our discretionary spending. If the money isn’t there to spend, it becomes a mentality. Whereas if we put the money in the market, its doesn’t have the same effect as being “gone”. We can alway close out positions. Our hope is that it reigns in our pattern of spending earlier in our careers, putting us on the path to financial independence down the road.

9. 9
   Christine Says:
   May 15th, 2009 at 10:14 am

   Another advantage of paying off/down your primary residence mortgage that many overlook is asset protection, meaning that, in some states, the equity in your home is protected in the event of a lawsuit (like in Florida). So, someone may sue you and may get your non-retirement bank accounts/investments, but the equity in your home cannot be touched. It is different in every state and there are certain limits, etc., but it is worth looking in to.

10. 10
    Nickel Says:
    May 15th, 2009 at 10:45 am

    Interesting point, Christine. I had never thought about that.

11. 11
    RD @ money blog Says:
    May 15th, 2009 at 11:27 am

    For me the tipping point is if one can earn more than the after tax rate of mortgage however I was unaware of asset protection bough up by Christine, so I have to give this another thought…

12. 12
    Stephen Says:
    May 15th, 2009 at 11:38 am

    We decided to do a bit of both as well. We’re on track to pay our 30-year mortgage off in 15 years or less, but we’re saving at the same time.

    Bi-weekly payments brought our 30-year to about 22.5 years, and we’re throwing in some extra each month towards the principal to bring it closer to 15 years.

13. 13
    Dave Says:
    May 15th, 2009 at 11:47 am

    Mike hit the nail on the head. Not having to pay a mortgage is called “imputed income” and it isn’t taxed. For example, how much money do you have to earn every month to pay your mortgage? Say your payment is $1,000. If you are in the 25% tax bracket, you have to earn $1,333 to see $1,000 after taxes. So NOT having to pay $1,000 a month is like earning $1,333 tax free. (The government hasn’t caught on to taxing this “imputed income…..yet! LOL!”) This “imputed income” combined with the increasing value of your home (and yes, homes will again start to increase, at least the rate of inflation) would bring in as good or better return than stocks. Here is a Scott Burns article that explains the concept:

    http://www.dallasnews.com/shar.....0525TU.htm

14. 14
    Ben Says:
    May 15th, 2009 at 12:12 pm

    We’re doing both just as Nickel outlines above. We max out our IRA, and then put the rest toward extra principle on our mortgage. Personally, in this economic climate, there is more of an emotional pull to enjoy a mortgage hanging over my head.

15. 15
    GM Says:
    May 15th, 2009 at 12:40 pm

    I like the idea of having the money in an safe(er)investment that offers a return equal to the interest rate or better. With the CD rates being low, an investment in a muni would offer a return close to the interest rate on the mortgage.

    That way the earnings on the investment are not taxed, you have the advantage of itemized deductions and in the event of a job loss or some other traumatic event, you can cash in your investment and pay off your mortgage.

    Additionally, you will need less of the amount invested to pay off your mortgage every month since the principal outstanding will reduce every month. So as you pay off your mortgage, this in essence becomes a nest egg.

    Of course one should have the amount needed to pay off the mortgage at hand in the first place and secondly have a disciplined approach never to touch this money for anything else.

16. 16
    Matt Jabs Says:
    May 15th, 2009 at 12:53 pm

    A few things:

    1. It is VERY attractive for me to pay off my mortgage early so I no longer have the payment. This would allow me to “semi-retire” and work at whatever job I wanted, however often I wanted.

    2. RANT **Inflation wouldn’t factor in nearly as much if our gov’t didn’t run the largest counterfeit operation in the history of the world – aka, they just print money whenever they want for all the wrong reasons** RANT OVER.

    3. Taking into account my point #1 above, I see myself being torn between choosing to completely pay it off early or do as Nickel suggests and do both. Pay off mortgage in around 7 years while maxing out retirement contributions.

    When it’s all said & done I’m going to say I would definitely lean toward having it paid off within 10 years, thus eliminating the huge interest amounts most home owners pay. In doing so, I would also prefer to max out my savings contributions along the way.

    I will let you know for sure once I pay off my $12,000 left in high interest consumer debt, which will take me another 6 – 12 months…Lord willing.

17. 17
    Lance Says:
    May 15th, 2009 at 1:26 pm

    Dave — I don’t think that’s an example of imputed income. Having fewer expenses per month doesn’t mean you’re earning more money, it means you don’t _have_ to earn as much money. That is, without a $1,000/mo loan payment you would be able to survive with a $1,333/mo lower salary.

    Or you could continue earning the $1,333, pay taxes, and invest the remaining $1,000. Which brings us to the question under debate.

18. 18
    Rosa Says:
    May 15th, 2009 at 2:01 pm

    We do both – we’re actually refinancing right now from a 30- to a 15-year mortgage, and if we continue to pay at our current rate we’ll be done in a total of about 15 years over both (the new mortgage is 2% lower than our current rate, so even with fees & taxes it’s going to save us quite a bit of money). That will put us completely out of debt before age 45.

    At the same time, we both contribute to 401ks and Roths. Plus a 529 for the kid – we treat the retirement and college accounts as monthly bills, along with monthly charitable donations & utilities.

    This lets us balance the insecurity of the stock market against the known cost of our mortgage. Plus, it means if one of the tactics turns out to be better than the other, we didnt’ miss out completely.

    I’m not sure about the psychological benefit of not having a mortgage – we will still have taxes & insurance to pay when the debt is gone, so we’ll either have to self-escrow or pay biannually anyway.

19. 19
    Undertrader Says:
    May 15th, 2009 at 2:27 pm

    I paid off both of my houses and here’s why:

    1) The stock market was tanking and there was no way I was going to be making a 10% return anytime soon without day trading, which I could do, but I’d rather play video games and go bike riding.

    2) I lowered my monthly expenses by $2000. That’s $2000 extra per month in my pocket while I have 2 paid for houses. That’s the most important thing to me. I could lose my job and have the market tank and go get a job at McDonalds and still be able to live in my 1900 sq ft house and pay all my bills with no problem at all. If I can make 10% on my investment cash, I can effectively retire.

    While everyone always says, “You could make more if you invest the cash!” Sure, you COULD make more, but you may not and then where are you? Without money and without your home potentially, which is what a good chunk of the country is looking at. My family is going through this recession and laughing. Our monthly bills including food come to less than $1000 a month with 2 incomes and 2 paid for homes, one of which is being rented by someone who lost their home that is bringing us $1500 a month. We could retire right now and have $500 cash extra a month and the stock market and recession wouldn’t affect us in any way at all.

    Now, with no bills, we can take that $2000 a month and do whatever we want with it, throw it in a Roth IRA, go on a cruise, buy a car with cash at the end of the year. It opens up so many opportunities and lowers your risk to the point where the current economic situation doesn’t matter. We can leave our investments and know we don’t need to sell our stock for the next 30 years, well after this recession is over.

    Pay off the mortgage if you can, the peace of mind is worth it.

    – Undertrader

20. 20
    haus Says:
    May 15th, 2009 at 3:31 pm

    I understand that the market has underperformed & there is no gaurantee of a higher return than your current mortgage rate. Let’s say you have a 30-year fixed rate loan for $200,000 at 6.0% and you have an extra $1,000 that you want to either a) apply to your principal or b) invest. If you happen to be sitting at year 5 of your mortgage when you have this $1,000 bonus, then you could pre-pay the mortgage and save over $3,400 in interest and immediately increase the equity in your home by $1,000. But if you invested that same $1,000 and happened to get an average of 8% growth over the next 25 years, then you’d have an investment account worth about $6,800.

    I’m investing the cash; isn’t having an investment portfolio that exceeds your mortgage the same as having it paid off? With the added bonus of higher returns.

21. 21
    Rosa Says:
    May 15th, 2009 at 3:34 pm

    Undertrader,the big issue is that the house is not easily convertible into cash, especially right now – if you lost your job and moved to get a new one, you’d be paying living expenses in the new place while trying to sell the old one. Being a landlord is like getting a second job, except if you get fed up or have a health crisis or something, you can’t just quit – it takes some untangling.

    Even if you don’t “make more money” on your investments (something that depends a lot on luck and market timing for both stocks & the house) for a lot of people the agility is important.

22. 22
    Jim Says:
    May 15th, 2009 at 5:01 pm

    We’re working on paying off our home early. The primary reason is the security we’ll have once we own our home debt free. But we made sure we had a good emergency fund first and that we also fully fund our Roth IRAs annually. IMO Paying down a mortgage should come after paying off other debts, building emergency fund and saving for retirement.

23. 23
    Matt Jabs Says:
    May 15th, 2009 at 5:05 pm

    @Jim:

    I totally agree, this is exactly what I have planned. Everything in balance & moderation.

24. 24
    Ashley Says:
    May 15th, 2009 at 5:16 pm

    Here’s why I’m working furiously on paying my house off:
    A year ago, my neighbor’s tree fell on my house. My home-owner’s insurance sent me a draw of $20K to start repairs, with the “carrot” of $12K when the repairs were complete. The check was made out to me and the bank that owns my mortgage. The bank’s policy is to release $10K and then when the repairs are 50% complete, they will send another check for $5K and at 90% completion, they will send the last $5K draw.
    I have tried explaining to the bank that I can’t possibly get the job 90% done with only $15K. Like they care. So every extra penny I have is going into getting my house to 90% completion so that I can get the rest of the repair money so that I can get it 100% completion so that insurance will send me the rest of the money.
    So, eventually, I will end up with my house repaired and an extra $12K check. But I vowed when this is over that I will never owe a dime to anyone again. If another tree falls on my house, the insurance checks will be made out to me and only me to do with as I feel best.

25. 25
    AG Says:
    May 15th, 2009 at 9:26 pm

    Quite popular concern, wonderfully and timely handled.

    It may have a little off-track experience here as I have a car loan at present. I had this same question in my mind for days and I decided to go with following strategy:

    1) accumulate enough for my emergency funds
    2) start paying double the monthly minimum towards car loan
    3) create a simple CD Ladder with what I am left with

    Definitely stocks might also be a great place to park some of your money but I am considering to think stocks a little later.

26. 26
    B7 Says:
    May 16th, 2009 at 9:55 am

    Like some other commenters, I would say both. And, the allocation of money and effort depends on your goals. If you just want to retire on Social Security (good luck!), then it is OK to invest mostly on paying off the mortgage.

    However, if you want to be rich, happy and wealthy, you need to become a successful investor. So most of the time and energy should be focussed on investing.

27. 27
    BuffetFan Says:
    May 16th, 2009 at 1:11 pm

    For my mother and for most people, who have better things to do then spend all their time on stock market timing. I recommend this:

    1. Build 3 months of emergency funds
    2. Pay off all high interest credit card debts
    3. Build 6 months of emergency funds
    4. Pay off all car loans
    5. Build 1 1/2 to 2 years of emergency funds
    6. Invest in the most solid returns with the lowest risk – payoff your mortgage or save for 20% down payment on a house.
    7. Invest money you can afford to loose 50% of in stocks.

    Do this and you’ll sleep better and retired better then the majority of the people.

28. 28
    JerryB Says:
    May 16th, 2009 at 10:39 pm

    I have less than $35k left on my mortgage. Once my car was paid off that money snowballed into my house payment. I now pay $1000 to the principal every month.
    With luck I’ll even have my Roth IRA fully funded by the end of June. Right now my intent is to have that money accrue in my mutual fund and use that to fully fund my 2010 Roth in early January. I know doing it this way doesn’t allow for dollar cost averaging, but my track record for years previous has left a serious dent in my retirement investments.

29. 29
    Mary Says:
    May 17th, 2009 at 4:13 pm

    Is anyone aware of an on-line calculator or software package that can help us weigh all of the variable in our particular situation? We are pretty balanced right now between very conservative investments and property, with our $100K mortage (5% fixed 15 year) being our only debt. My husband wants to pay off the mortgage as CDs mature.

30. 30
    Michael Harr @ Wealth...Uncomplicated Says:
    May 18th, 2009 at 1:08 am

    @Nickel – I wrote an extensive piece on this subject to finally disprove the myth that keeping a mortgage and investing the difference is smart. I’ll leave it here for your readers at the end, but your strategy is exactly where it needs to be. Max out tax-favored retirement accounts, payoff the mortgage, then enjoy your freedom. From a behavioral perspective, keeping a mortgage doesn’t work; from a mathematical perspective, keeping a mortgage doesn’t work; from an environmental (externalities) perspective, keeping a mortgage doesn’t work. Here’s the analysis:

    http://www.wealthuncomplicated.....vings.html

31. 31
    DDFD at DivorcedDadFrugalDad Says:
    May 18th, 2009 at 7:55 am

    Paying off the mortgage early removes one of the greatest tax deductions people have– mortgage interest.

    Invest the extra money and use it as a fall back to pay the mortgage in an emergency.

32. 32
    Michael @ The Life Insurance Insider Says:
    May 18th, 2009 at 12:46 pm

    We just paid ours off. The hard thing is placing a value on is the risk that you remove from your life. If I got laid off then I don’t have to worry about that mortgage payment and we can cut our discretionary expenses way back. Most banks don’t like it when you try to cut back on your mortgage payments.

    Sure historically, you can earn more than the low interest you usually pay on your mortgage, but investment returns that earn more than 5-6% per year usually have some sort of investment risk involved whereas your mortgage interest is locked in.

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    Michael Harr @ Wealth...Uncomplicated Says:
    May 18th, 2009 at 1:12 pm

    @ Michael – Quantifying risk is a function of standard deviation and can be accomplished through Monte Carlo Analysis. For those that are unfamiliar with these types of analyses, you essentially enter the expected rate of return along with the standard deviation. As an example, if you have a portfolio that is expected to return 8% annually over the long haul, and has a 14% standard deviation rate (meaning that in most years the return will be between -6% and +22%), you can determine the probability of your investments paying off. These programs will run through anywhere from 10,000 to 1,000,000 hypothetical series of returns to spit out a simple percentage probability of achieving success. In the case of paying off a mortgage versus keeping the mortgage and investing the savings, we find that paying a mortgage off makes sense based on the variability of investment returns each year–not to mention behavioral and environmental factors specific to the individual/family. If you want to grab some software, Money Tree Software is one of the better (and least expensive) providers.

    At any rate, you 100% did the right thing in paying off the mortgage.

    If you want to see the analysis, the link is somewhere in one of the comments I made above.

34. 34
    Michael Harr @ Wealth...Uncomplicated Says:
    May 18th, 2009 at 1:23 pm

    @DDFD – If someone is pursuing this strategy that you advocate, then placing money aside in an emergency fund would negate the premium returns that make this myth go. While you might put a portion of this aside, when the markets drop like a rock, your core investment fund will look like less of a safety net and more of a fire pit fueled by your hard earned cash. The risk/return metrics just don’t add up.

    The tax deduction is a pittance compared to the multitude of risks endured over the course of a 15 or 30 year mortgage.

35. 35
    Paul Says:
    May 18th, 2009 at 2:01 pm

    In some of the comments, there seems to be some confusion regarding taxes and comparing pre-paying a mortgaage to a taxable investment. If the investment is taxable compare your mortgage rate to the expected rate of return (obiviously everyone needs to do there own risk adjustment). But DON’T adjust your mortgage interest rate for taxes unless you also adjust the investment rate of return.

36. 36
    BuffetFan Says:
    May 18th, 2009 at 2:51 pm

    If you have to ask all these questions about taxes and details about where to better invest your money. Look at comment number 27 and do it. You’ll be much happier. This is from someone who timed the market well in 2000 and 2007.

    My mother’s home is paid off before retirement and her stock portfolio didn’t take the loss in the recent down turn. She’s got her son to manage her money instead of leaving it to a financial advisor. I was hired as a financial advisor for Ameriprise but couldn’t bring myself to sell junk to people. So I had to end that career quickly. Most financial advisors follow computer based allocation and don’t take market condition into account nor do they have the time to manage every account. Stock is very risky and you’re more likely to loose money if you don’t time the market right. Please take it from someone who’s very good with the stock market but won’t sell bad advice for money. See comment 27.

37. 37
    Brent Says:
    May 19th, 2009 at 11:40 am

    I’d pay my house off 110 times out of 100.

    Strange things happen when the house is paid off. You can deal with job layoffs, bad economy, emergencies, building wealth, giving and saving at a much higher rate than if you have a mortgage. Another thing that happens when you don’t have a mortgage is you don’t get foreclosed on.

    To many people forget to take risk into the equation when talking about paying off the home or not. You always hear why wouldn’t I invest my money to get 10% back instead of 5%? Once you take risk and inflation into account the difference is very small.

    You should be putting 15% into retirement and saving for kids college but after that anything left should go to paying the house off.

    I’m not this far yet as we’re still paying off debt, only a couple months left though.

38. 38
    Ken Says:
    May 19th, 2009 at 1:21 pm

    Leaving aside the psychological aspects of paying off a mortgage sooner (peace of mind, additional discipline), I think that you have to look at not paying off a mortgage and investing the cash NOT used for extra principal as similar to extra leverage in a portfolio. That is, the expected rate of return on your assets and risk will be magnified with borrowed money. As you pay down your mortgage, you deleverage and your expected rate of return and risk decrease. A lot people, including me, are more comfortable with lower risk, but should realize that this comes with a lower expected rate of return. The discipline in early payments, i.e. lower consumption, can eventually result in a re boost of return (not rate, but total return) once a mortgage is paid off and the mortgage payments redirected to a higher level of investment, at a lower leverage.

39. 39
    Spending It Says:
    May 20th, 2009 at 12:30 am

    This post presents a great question — one that has crossed my mind a few times. I just made a post on our blog about this topic, with a link to this article, to build on the discussion. Cheers!

40. 40
    Matt Jabs Says:
    May 20th, 2009 at 12:34 am

    @Brent – Amen, amen, amen!

    Since it’s publishing I have been kicking around this debate within my own mind (see comments #16 & #23 above).

    The more I debate it w/myself the more I conclude, “Self. You should pay off that mortgage and experience true freedom from debt.”

    My self finally agrees with me. Looks like it is settled.

    Thanks for bringing it up Nickel.

41. 41
    GR Says:
    May 22nd, 2009 at 1:28 pm

    My wife and I like a balanced approach and therefore put money into the following; mortgage prepayment, 401k, 529, money market. Why? We don’t know what the future holds.

    When we were paying down our mortgage, all the ‘professionals’ advised against this, saying ‘cash is king’. I think they meant ‘debt is king’, which we disagree with. What allowed us to afford extra mortgage payments was the fact that we bought a small house (could have gone big). With a lower monthly payment we paid off 100k of principal much easier than otherwise. After 3 years we were in a position to buy a much nicer home. If we bought the big house first it would have been much more difficult to pay down the principal, since the interest portion of the load would have been prohibitive. Imagine where we’d be if we bought a large home on an interest only mortgage? Not that my point here is revolutionary, but note that the real estate ‘professionals’ would never be heard iterating such advice. In fact, if you were to listen to a ‘professionals’ advice, then do the opposite, you’d probably be in a better financial position.

    From a diversification point of view, paying down the mortgage seemed quite clever, considering the direction the DOW has taken. But we didn’t know this would happen while cutting those checks, so deserve no credit for ‘predicting the future’.

    We also invested in our 401k, which took a beating, but since we also have liquid assets as a safety net, we don’t need to take this out and get hit with a loss/penalties.

    So on a high level, diversify. On a lower level, diversify (no individual stocks). It’s easy, it’s boring but it’s working very well for us.

    And yes, cash is king, if it’s going into your pocket and not the banks.

42. 42
    Joe Bleaux Says:
    May 23rd, 2009 at 10:47 am

    I agree with Ric Edelman, the CPA Journal, and the Journal of Financial Planning . In mine and I believe most cases, the opportunity costs, loss of flexibility, and loss of liquidity are overwhelming bad reasons to invest in your mortgage. Particularly so when rates are so low – mortgages are the cheapest financing around. With a 30-year fixed rate of 5%, my real interest rate is just above 3%.

    Debt is a tool like any other – it can be used effectively or abused to evil ends. So many of the comments here reflect a belief that debt is bad in and of itself. Generally debts are good if used to acquire generally appreciating assets, such as education (student loans) and real estate (mortgages).

43. 43
    JFP Says:
    May 24th, 2009 at 12:11 pm

    I don’t care what the Journal of Financial Planning says. For most people, my advice would be, Pay off your house. When people say, “When you run the numbers, etc.,” my response is, “You tell me the numbers you’re running, and I’ll tell you the numbers you’re ignoring.”

    Here are some of the numbers these people are ignoring:
    1. Probability that you will lose your job.
    2. Probability that you will have a major medical problem.
    3. Probability that you will invest in a ponzi scheme.
    4. Probability that you will have some hassle from your bank (see #24 above).

    For these factors, it is much better to have your house paid off when dealing with them, and over the course of a thirty-year mortgage, they become rather likely to happen. And so for most people the answer will be, Pay off your house.

    I admit that if you are unlikely to lose your job or can easily get another one, go right ahead and invest instead.

44. 44
    Chris Says:
    May 25th, 2009 at 12:42 am

    JFP hit it right on the head. There are many hidden risks involved that are difficult to mathematically factor in. In the end you have to learn as much as you can and go with a plan that allows you to sleep comfortably at night.

45. 45
    Super Saver Says:
    May 25th, 2009 at 11:19 pm

    Our plan was to pay off our mortgage by retirement. However, when I took early retirement in 2007, we were only 4 years into a thirty year mortgage, and making payments to pay it off in 15 years. Unfortunately, I convinced my spouse to keep the mortgage to stay invested in the stock market. In hindsight, a bad decision

    Last week, we decided to cash out most of our stock investments and pay off the mortgage. Our main reason was to reduce our monthly expenses and our retirement savings withdrawal rate. Even if the stock market goes up another 30% in the next two months, I believe that we have made the right decision for us

46. 46
    delete all debt Says:
    May 26th, 2009 at 5:33 pm

    Just a quick note. We are paying off our mortgage early. The interest deduction on Schedule A of your 1040 is a prime example of negative cash flow. Give your mortgage holder $1,000 then take a deduction on your Schedule A, Form 1040. If you are in the 25% tax bracket you get a credit for $250.00, heck of a return on the $1,000 you gave the mortgage holder. Any deduction that you put on Schedule A, 1040 works exactly this way. You may not be able to itemize your deductions if you don’t have that large Mortgage Interest deduction. You will lose the Mortgage Interest deduction over time, not all at once. You are still better off getting rid of that large Mortgage Interest payment. There is not any better rate of return anywhere. Most investment interest is taxable; some dividends are not, etc and you can flip, flop, hedge, nudge and calculate until the cows come home but it just plain simple math. Have a great day -

47. 47
    Joe Bleaux Says:
    May 27th, 2009 at 4:31 am

    @JFP – if you lose your job, you’ll want to have cash or liquid securities available. If you’ve put your cash into your house, you won’t be able to get it back out. The same is true if you have a major medical problem. Do you want to be forced into selling your house when the real estate market is low because you put all your cash into paying off your mortgage?

    The same is true in the bizarre case of the tree – don’t you want to have some money in a liquid account so you can cover this sort of contingency? Might it also make sense to pay for the repairs with a credit card (gasp!) so they can be completed and you can get your insurance payments and get on with your life?

48. 48
    Michael Harr @ Wealth...Uncomplicated Says:
    May 27th, 2009 at 10:23 am

    @Joe Bleaux – the plan to payoff a mortgage early is only suggested if you already have an adequate emergency fund, no other debt, and are maxing out tax-favored savings options. Also, if you consider many have mortgage payments that suck 25% of their gross income away, you need only live in a paid off home for three years to have a rock solid emergency fund that would be equivalent of a full year of take-home pay.

    If you have a good income, no debt, decent emergency fund, and are saving like mad, paying off a mortgage is the best option.

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    delete all debt Says:
    May 28th, 2009 at 5:24 pm

    Interesting conversations.

    Yes you should have a “rainy day” fund. You can still get Home Equity Lines of Credit (HELOCs) despite al the hoopla (harder to get sure, but still out there) and have that as an emergency fund.

    Build up a whole life insurance policy and be your own bank.

    There is always a way with good planning, good discipline and good thoughts. Be positive and the world will be positive with you.

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    AnnJo Says:
    May 30th, 2009 at 9:04 am

    Right now my HELOC rate is only 2.99% with a balance from recently paying off a small mortgage on a rental property, my home mortgage rate is 5.5% and the rates available for savings/CD investments are about 1.75%. Leaving my emergency fund aside, my extra cash right now is going to pay off my mortgage. But that’s because I’m hoping to retire in about three years, and want to reduce my after-retirement expenses; if I were a decade or two younger, I’d probably be putting that extra money into more stock investments. I guess.

    I do have some grave concerns about having a sizable amount of my net worth (40%) tied up in one asset, my home, and over 50% in real estate, but the current poltical climate is so hostile to business and growth, and likely to get worse before it gets better, that I’m just too nervous to put more money out there (in the market) to be seized. Of course, when hating business doesn’t work at turning things around, hating anybody with anything usually comes next, but if we truly are going down the Zimbabwe-style path, I’m not sure what can save us. There’s only so much you can worry about, though.

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    Michael Harr @ Wealth...Uncomplicated Says:
    May 30th, 2009 at 9:37 am

    @AnnJo – Definitely the smarter play to payoff the mortgages. As you get closer to retirement, there are a few things you’ll want to monitor. The first is the capitalization rate (net income divided by property value) on your rental property. If you find that the rate falls below that of investment grade bonds, it’s time to sell. This was one key indicator for folks holding rental properties in very expensive real estate markets prior to the bubble bursting. If a property was renting at a 3% cap rate, it was pretty clear that the rent charged wasn’t out of whack, it was the value of the property that had driven the cap rate down.

    With respect to stock investing, we’re in the midst of a long-term stagnant market meaning that returns in the early part of retirement are going to be far less dependable than when we’re in a long-term expansion market. This will add importance to clearly defining your asset allocation model (stocks, bonds, and cash) and then rebalancing over time and in response to market changes. A good rule of thumb is to set a reminder for every time the market moves up or down 10% and then rebalance your portfolio. By doing this, you get to buy/sell at relative lows/highs respectively. This can really make your nest egg last longer.

    Also, I wouldn’t worry too much about the Zimbabwe path because they have a far less stable political environment and keep in mind that they do have a trillion dollar bill. Our policymakers won’t let inflation get that far out of control (they’ll produce enough unemployment to kill inflation however painful it might be). There was a great discussion yesterday with Roubini, Soros, Krugman, and others about this topic. The real fear is not inflation, but going Japan and seeing an extended period of deflation. Unfortunately, we are using a similar model that they used in handling our banking crisis although fiscal stimulus has been far greater from us.

    The only way we go Zimbabwe is if we lose all credibility in the global financial markets. It’s possible, but only remotely so.

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    AnnJo Says:
    May 31st, 2009 at 1:45 pm

    Interesting comments, Michael. My two remaining rentals are in one of the few areas of the country where house prices were historically stunningly low in relation to rents for years ($1,200 rent on a house purchased in 1996 for $110,000, for example) and only in the last few years experienced stagnant rents with price increases (we sold that house for $145,000 a couple of years ago) which so far seem to be holding. Sometimes you just get lucky.

    I agree with the cap rate analysis, although I factor in expected price appreciation along with net income before deciding whether its time to sell, and the depreciation deduction also makes rental income attractive.

    I include rental real estate, commodities and secured private debts (real estate contracts) in my asset allocation model as well as stocks, bonds and cash. I believe this leaves me somewhat less exposed to the vagaries of the market

    I have no evidence to back this up with, but it wouldn’t surprise me a bit if George Soros was a major contributor to last year’s financial crisis – he’s always known how to make a buck out of wrecking a country’s economy – and Krugman is only a good economist when he isn’t being a partisan, so I take what they say with a grain of salt. I think it is highly improbable that Obama will allow himself to go into the next election with extraordinarily high unemployment figures, just to keep inflation down.

    In fact, if the CPI included the price of government services (legal system, law enforcement, public education, nagging, berating and meddling, etc.), inflation has always been much higher than is realized and is growing at a very rapid clip.

    There are only four ways a government can spend so wildly beyond its means as ours is doing and proposing to do: tax, borrow, inflate or dramatically increase productivity. HIgher taxes stifle growth and often reduce revenue rather than increase it; borrowing requires people who will trust you with their savings; increasing productivity is not something governments are very good at. If not inflation, which of those other three are you counting on?

    Zimbabwe did not always have a trillion dollar bill. During the 1970s, its inflation rate was almost identical to ours at the time. Since there’s a reasonable possibility that I’ll still be kicking (weakly) 35 years from now, the deterioration of this country along those lines has to be on my horizon. And it’s problem is not, as you suggest, political instability. They have had the same dictator for more than 20 years. Their problem is the dictator’s beliefs and their effects on the economy. Dictators per se are not bad for economies (not defending dictatorship, just pointing out a reality) – witness Pinochet in Chile, Batista in Cuba, what’s his name (Kew?) in Singapore, or at present, CCP in China.

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    Tom Says:
    May 31st, 2009 at 6:24 pm

    Ok so I read all these posts and many have made good arguments for both sides. My wife and I recently came into enough cash to pay off our mortgage 150,000 and still have 35,000 left over. I have a guaranteed government pension where I get 70% of my income (in 10years I can retire) plus I have another 150,000 in separate retirement vehicles and still adding, 100,000 in cash in the bank. I think I should pay off the mortgage and save the 850.00 bucks per month, I am good at saving. Not having to PAY THE MAN would be so cool. So what do you all think?

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    deletealldebt Says:
    May 31st, 2009 at 8:10 pm

    This is one of the most interesting “blogs” I have been on in quite awhile.

    Tom – your situation is a no-brainer. You should spend tomorrow morning making the moves to pay off your mortgage.

    With the kind of disposable income you have investigate and sign up for a divedend pay whole life insurance (I can do it for you, but selling is not the object of this discussion) and become your own bank.

    I obviously agree that you should pay off that mortgage sooner than later. All the complicated math based on speculative returns advocated by expertscan not match the ROI of paying off your mortgage early. It is pure simple math based on real numbers not projections or formulas.

    You need a system and you need to follow it to pay off your mortgage and ALL your debt. People without the pedigrees of some of the contributors to this blog need to get out of debt and plan for the future.

    I will be out of debt soon, my major investments ar ein some munis (doing ok) and whole life. I am my own bank. It is great.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 1st, 2009 at 10:41 pm

    @AnnJo – love your thinking. I’d just point out that Zimbabwe was never seriously considered as a reserve currency and while they’ve had a dictator installed for decades, it doesn’t mean that his power has achieved the kind of political stability that we enjoy here.

    As for your comments about the gov, I love it! I’d add emphasis on the trust in borrowing. The credibility factor of the dollar as a reserve currency is the ONE thing that could absolutely obliterate our economy.

    Great comment.

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    DCGuy Says:
    June 6th, 2009 at 9:25 am

    Whether to pay off one’s mortgage early depends on looking at the alternatives. I just refinanced at a low rate, but I would still like to pay the mortgage off early. However, by investing in Treasury bonds with a maturity at my target date for retiring the mortgage, I can earn a higher after tax return on the money and hold a liquid investment. It only makes sense to prepay the mortgage if that investment earns a higher return than a comparable alternative (comparable in terms of risk profile and maturity). Putting the money into Treasury bonds is better in my case, b/c the return is higher and the liquidity is much higher.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 6th, 2009 at 11:12 am

    @DCGuy – Just remember that your bonds carry a good deal of long-term risk with them. While the yield is guaranteed by Treasury, it still leaves you with significant long-term interest rate risk. Keep in mind that yields are in the basement and with any kind of inflation, you could be eating a double digit loss on bonds purchased today. Considering the incredibly loose monetary policy and a spend as much as humanly possible fiscal policy, inflation and higher interest rates won’t be too far off in the distance.

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    DCGuy Says:
    June 6th, 2009 at 12:19 pm

    @Michael Harr: I think that you are missing the point. When you prepay your mortgage, you are effectively buying a bond with a fixed rate equal to the interest rate on your mortgage. And you are forced to hold that bond until maturity. If it traded on the secondary market, its value would fluctuate as interest rates change, just like a T bond. But b/c that bond does not trade, you never see the fluctuation. You face the same effective interest rate risk whether you buy a T bond or prepay your mortgage, provided your strategy with the bonds is to hold them to maturity, which lines up with the date by which you want to pay off the mortgage. If the after tax rate of return on the bond is higher than your mortgage, you should put marginal dollars there. If the after tax rate of return on the bond is lower than your mortgage, you should put marginal dollars there.

    I’m not buying new 30 year T bonds; I’m buying T bonds in the secondary market that mature at the date by which I want to be mortgage-free. My intention is to hold them to maturity and then collect the face value, which will exactly equal the remaining principal balance on the mortgage. Because this strategy gives you the flexibility to buy bonds when interest rates are higher than my mortgage, and prepay the mortgage when interest rates are lower, it is a less expensive way to achieve the same goal. The additional liquidity of the T bonds is just a bonus.

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    Tony Pereira Says:
    June 6th, 2009 at 5:45 pm

    This is some good info, for what its worth, I think you should do as this, in this order:

    1) Max out any matched 401K
    2) Max out Roth contribution for each year
    3) Make sure you have enough reserves for 1 year
    4) Take any money left over and pay that amount off of the house each year until its paid off
    5) Once the house is paid off and #s 1 – 3 still apply, invest in whatever is most logical at the time, for me right now the safest thing I can see out there is CDs, thats just my opinion from what I have seen, maybe some other people that have done some further investigating/monitoring of returns (besides the stock market) could provide a better investment, maybe even gold is a safe investment nowadays.
    6) Play the lottery once in a while (hey, you never know)

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    cheryl rupp Says:
    June 7th, 2009 at 2:44 pm

    House has just been paid off —— Mentally Goal met.
    Next – Invest as possible.
    Security was the answer for me.

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    deletealldebt Says:
    June 7th, 2009 at 3:58 pm

    Pleae tell me of an investment that has a greter ROI than paying off your mortgage. I have seen some very interesting suggestions, opportunities, etc., on this blog. Paying off your mortgage early, as soon as possible gives the greatest rate of return. It is just simple math. A lot of you (but not all of you) seem to be more finacially savvy than I am, but then that is what I thought of my ex-broker also. And my ex-financial adviser, and the guy at the water cooler (do they still have those?)

    I wish all blogs were this civil. Take care have a great week and see you on the upside of life.

    Remember the distance between two people is a smile.

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    DCGuy Says:
    June 7th, 2009 at 9:22 pm

    @ deletealldebt:

    Here is an investment that has a higher ROI than paying off my mortgage: My mortgage rate is 4.75% (I just refinanced at the bottom). On Friday 30 year Treasuries were yielding about 4.65%, roughly the same maturity as my mortgage. But the after-tax yield on the Treasury bonds is higher for me, b/c I live in DC, where the state tax is pretty high (8.5%). Thus, b/c you do not pay state tax on interest earned on T-bonds, the after-tax return on buying Treasuries that mature at the same time as my mortgage is a bit higher than paying off the mortgage, and as I pointed out in my earlier post, it is a much more liquid investment. If interest rates go up, it will make less and less sense to prepay a mortgage, b/c better ROIs will be available on other financial instruments of comparable duration and risk.

    It is simple math to assess this issue, but it is important that all of the relevant factors are considered. In my case it really is the different tax treatment of mortgage interest vs. bond interest that makes the mortgage prepayment a worse investment.

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    Tom Says:
    June 8th, 2009 at 10:59 am

    DONE. Never have to write a check to the MAN again to pay for this house. Still it was a bit hard to pay the big chunck at one time. But it is over and now we can focus on the things we want to do. Save like crazy for the next seven years. Then full retirement at age 50, 44 for my beautiifual wife. And we did not even win the lotto. Just got lucky.

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    deletealldebt Says:
    June 8th, 2009 at 12:10 pm

    CONGRATULATIONS TOM!

    DCGuy – Thanks – I run many sceanarios for my clients – and just compare dollars saved as opposed to dollars spent on home mortgage (and other debt) interest. Clients can still invest as they are today by adjusting entries in the software. I am NOT a financial planner or investment person and neither are my clients (well a couple are) so just comparing $ to $ makes sense to get people out of debt.

    I really appreciate your reply and would love to run your numbers in this program, but that is not why I am on this blog. Maybe we could trade hypotheticals.

    Got get on my trusted steed and speed off to save one more soul by getting them out of debt.

    YOu all have a great day

    (typos due to haste)

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 9th, 2009 at 4:58 pm

    @DCGuy – I understand your strategy, and it makes sense as long as many assumptions hold true. Based on the information you’ve provided, you have a fixed rate mortgage at 4.75% and are buying Treasuries that coincide with the duration of your mortgage or are close approximations. The portfolio you are building is following the long end of the yield curve which is and will continue to increase as loose monetary policy and heavy fiscal spending push the probability of inflation and ensuing interest rates higher. Your strategy will feed off of this trend as you continue to purchase Treasuries at increasing yields, improving your spreads. All of this is well and good as long as you don’t encounter a major financial emergency.

    The point I am making is that unless you have sufficient cash reserves and the entire gamut of insurance coverages, a financial emergency could force you to sell Treasuries at a major discount in the secondary market. In keeping with the edge of the sword that will likely make you a good bit of money if trends hold true, the other edge has an equal potential to implode your strategy. While it is possible that your home could drop in value (as we’ve all seen in the last few years), in a hyperinflationary environment, real estate will hold up better than low-yield Treasuries purchased today. At this point, I think we can all agree that real estate has taken it’s bath and is now getting to more realistic prices. In addition, we can all agree that Treasuries are near the bottom of the yield range which is what sparked your strategy to begin with. Taking this into account, when inflation does accelerate (hyperinflation is a real risk assuming we get out of this recession and the Fed/Treasury don’t choke off a recovery), holding a paid off home will be a better bet than holding Treasuries at today’s yields.

    To illustrate the potential loss on a T-Bond, let’s go through an example. Say we buy $10,000 in T-Bonds today at 4.65% and five years from now, Treasury is auctioning bonds at 8%. Your $10,000 initial purchase would need to be discounted to match the 8% yield offered at auction five years from now. Your $10,000 invested would then be worth only $5,812 or a loss of $4,188. While losses on housing have been significant of late, they still fail to reach this level with the most limited of exceptions. When inflation does move up significantly, real estate will be unlikely to see the kind of losses that Treasuries purchased today will.

    Of course, you can argue that if you’re well positioned with your cash reserves and insurance that you can seriously diminish the probability of having to sell Treasuries at a bad time, but I would suggest there are very, very few people who have properly addressed all of these areas of their finances. It could be true in your case (and it sounds like you know your business), but for others out there, it’s a dangerous proposition and the risk of selling what many believe are safe assets at the wrong time must be accounted for.

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    DCGuy Says:
    June 9th, 2009 at 6:50 pm

    @ Michael Harr

    I probably have not been clear, which has sparked some confusion. When I refinanced my mortgage, I wanted to keep the time to amortize the note the same time as it was under the old mortgage, so I calculated the amount of extra principal I would need to pay every month to accomplish that. I could just send that cash mechanistically to the mortgage company every month, and I would then accomplish my goal But my point is that, in my case, given the tax rates that I face, I can accomplish the same goal at lower cost by buying T bonds that mature at the same date. If interest rates fall again that will no longer be true, and I will shift back to sending money to the mortgage company (and in that case I will have made a capital gain on the bonds). But, as you say, it is more likely that rates will rise, so it makes more sense to profit from the spread between T bonds and my mortgage. Essentially I am dollar cost averaging into bonds.

    You are correct, of course, that I could sustain a capital loss if I needed to sell some of the bonds in an emergency, but you neglect to point out that if I had sent the money to the mortgage company I couldn’t access it at all, unless I refinanced, which would be at a higher mortgage rate if your assumptions that we are in hyperinflation hold true!

    My situation is a little special b/c I plan to stay in my current house for at least 20 more years, and possibly permanently. That issue should generally affect people’s planning.

    My main point is that there may be alternative strategies that are better than simply cutting the same check to the mortgage company every month.

    Incidentally, if we had hyperinflation and rates were very high, would you really advise people to continue paying principal early on a 4.75% mortgage? Probably not.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 9th, 2009 at 9:22 pm

    @DCGuy – I wouldn’t advise LT Government Bonds during any near record low interest rate period. I would much prefer to pay down the mortgage quickly now, and when inflation returns, purchase TIPS/I Bonds. That’s a more conservative play as it allows participation in the upside while reducing risk from personal debt. As for neglecting the inherent illiquidity of a residence, it is one thing to pay a 10% second mortgage if you need cash later and entirely another to lose 40% on LT Gov’t Bonds. Given the choice, I’d always choose the more conservative path of paying the mortgage down and if a balance remains when hyperinflation kicks up, I’ll take my TIPS and I Bonds all the way to the bank.

    Either way, you have a legitimate strategy, but (without calculating the numbers) I’d say the risk/return relationship is better overall with the more conservative play. Also, I wouldn’t have any problem with LT Gov’t Bonds allocated at least to the level of the then current mortgage balance if we were already in a hyperinflation environment. At that point, it’d be hard to stop me from buying them–lots of them.

    I can’t tell you how many stories clients have shared with me about ‘oh I wish I would’ve bought more long-term bonds back then’.

    At any rate, great discussion.

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    DCGuy Says:
    June 9th, 2009 at 11:14 pm

    @ Michael Harr

    The only thing that confuses me about what you have written is that you don’t seem to view paying off mortgage principal early as buying a long term bond with a fixed interest rate. Anyone who pays off additional principal IS buying a LT bond in a near record low interest rate period! (Unless you didn’t refinance at the lower rates, but that is a whole separate discussion). It just seems to me that if a person is going to allocate part of his or her savings to buying LT bonds, he or she should at least purchase the bonds that yield the highest after tax return. Sometimes that involves prepaying the mortgage, sometimes not.

69. 69
    Michael Harr @ Wealth...Uncomplicated Says:
    June 10th, 2009 at 4:31 am

    @DCGuy – You’re right, I do distinguish between the two choices. It isn’t the same as buying a LT Bond. It’s similar, but not the same. The biggest difference is that a failure to pay the mortgage will result in fees, collections calls, and if delinquent long enough, foreclosure. While strictly from a return perspective they are in effect, the same, they are incredibly different from a risk perspective. If I buy LT Bonds and they later result in a capital loss, it’s not nearly as big a deal as facing foreclosure.

    In addition, paying down the mortgage now does not confine the total return and life decisions like LT Bonds. Though you have every intention of staying in the home for twenty years, there is always the possibility that you would move for a better opportunity, health reasons, etc. This further increases risk not only in the potential cap loss on the bonds, but also in your ability to move since the mortgage could be underwater at the time coupled with bonds that are carrying unrealized cap losses…a double dose of pain. If you eliminate the bonds from the equation, you have a reduced mortgage and can move about more freely.

    In exploring what to do with additional free cash flow after purchasing appropriate insurance coverages, fully funding an emergency fund, and maxing out tax-favored retirement opportunities, it is a ‘next dollar invested’ question. Paying down the mortgage (while having similar return characteristics) represents a mechanism of reducing risk in one’s overall financial condition. There is less risk in owning one’s home outright than in owning a large portfolio of LT Bonds AND carrying a matching mortgage balance. When interest rates move to high levels, the LT Bonds will still yield above the mortgage rate, but will be essentially illiquid unless a major capital loss is desired. On the other hand, interest rates will not have quite the negative impact on the home’s value plus you get to live there.

    Ultimately, I think our differences amount to the size of the financial landscape that we’re accounting for. With your analysis, it involves a somewhat more confined view that emphasizes investment return. I’m coming from a slightly more global view that emphasizes personal financial risk. In the end, I believe it a superior goal to be debt free whereas you would prefer to maximize net investment returns as long as it makes sense. The strategy you propose does make sense, but I perceive greater risk in the strategy than you.

    Okay, it’s 4:30 a.m. and I’m a bit delirious…hopefully this makes sense.

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    DCGuy Says:
    June 10th, 2009 at 9:48 am

    @Michael Harr

    Btw, one other risk that you did not mention that argues against putting all of the eggs in the mortgage prepay basket is the undiversified nature of a real estate investment in a particular city. I live in DC and, post-9/11, one risk that would be foolish to ignore is a major terrorist incident in the capital that could very negatively affect real estate prices. B/c one can always walk away from a secured loan like a mortgage, you can effectively force the mortgage company to face part of that risk. If you own the house free and clear, you face that risk all alone. That factor is probably most relevant for NY and DC. Of course, other assets would be affected by such an incident as well, but that is a factor that should be considered.

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    DCGuy Says:
    June 10th, 2009 at 11:07 am

    @ Michael Harr

    Just one last note to thank you for the productive discussion. I appreciate it. You make a lot of good points for people to consider. In my case the mortgage prepayment is a small part of my overall investment/saving strategy, so I have the luxury to focus primarily on maximizing return. But that might not be right for every person’s situation, as you highlighted.

    I hope you got some sleep!

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 10th, 2009 at 12:54 pm

    @DCGuy – Great discussion to be sure. I never view a primary residence as an investment. It is in fact a very poor investment over time unless you happen to buy right and downsize later (this usually doesn’t happen…once you get accustomed to your home most don’t want to take a step back). I had a number of clients in your area post 9/11 and even though there was an initial shock to prices, they recovered. Until the most recent downturn anyway. Central suburbs are still doing well relative to the outlying suburbs (think Leesburg…ouch!).

    I knew you were a high net worth investor by the ideas and arguments forwarded and you are correct; there are very few people in your financial position.

    Best of luck to you. If you have a strong balance sheet with sufficient liquid assets, I’d bet a good chunk of cash that you’ll find this strategy quite prosperous.

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    DCGuy Says:
    June 10th, 2009 at 1:03 pm

    @ Michael Harr

    I think that the people who think real estate is a great investment forget about the property taxes and maintenance expenses! It is more realistic to view it as consumption, and then be pleasantly surprised if you actually make money on it.

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    Charles Cory Says:
    June 13th, 2009 at 8:54 am

    The decision to pay off your mortgage early is simple math. Run your numbers under both scenarios (paying it off early or using whatever method you think would be better). If you have a consistent system for paying off all of your debt (including mortgage) and stick with it, market influences and guestimates, even highly sophisticated algorithms designed to reduce risk, paying off your debt early and investing in the right kind of whole life insurance will payoff better in the long run as you become your own bank.

    I could have made that sentence a bit longer, but I am trying to be brief.

    If you ever get a chance go to T. Harv Ecker’s MIllionaire Mind seminars. It will change the way you look at money.

    Take care and have a great weekend.

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    Ken Says:
    June 13th, 2009 at 3:40 pm

    Generally, whole life insurance is not a good investment vehicle. Buy cheap term life insurance and invest using vehicles with low cost.

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    Charles Cory Says:
    June 15th, 2009 at 9:36 am

    Ken,

    Yu brought up a good point, but not necessarily the one I intended. I momentarily forgot the subject of this blog, discussion or whatever you would like to call it. “Pay off your mortgage early or Invest?”. I am passionate about people getting out of debt, and went down a path to not only get people out of debt and keep them out of debt, but a way for them to be their own bank. R. Nelson Nash, Jeffrey Reeves and others illustrate the financial model that I promote far more eloquently than I can. If you can pay off all your debt in 10 – 12 years without changing your life style and save thousands, tens of thousands or even hundreds of thousands in interest while at the same time building your own bank so that you can borrow from yourself, you will have found a way that outshines any investment strategy available bar none. Interest free or low cost borrowings, dividends that are not taxed, and a whole host of positives outweigh investments that produce taxable income.

    I hope this fires up this discussion.

    By The Way, if you ever have the opportunity to attend a Millionaire Mind Intensive go for it. It is three long days, but well worth the time.

    Take care and have a good life.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 15th, 2009 at 4:29 pm

    @Charles – I have a WAY better idea than being your own bank and borrowing from yourself (via cash value life insurance). How about NEVER using another loan.

    I’m sorry that you’ve been swept up into the permanent life ‘be your own bank’ philosophy, as it has an incredible number of inherent problems. Chief among them is the extra layer of expense created by having the insurance company serve as middleman for the investment part of the equation. While the insurance company will guarantee a minimum rate on the cash value accumulation, there is no guarantee that the insurance company will pass on gains from their general account. After all, that IS a major profit center – excess returns on the general account.

    ‘Being your own bank’ is a great idea that is really easy to sell, but when scrutinized, it doesn’t hold up.

    Perhaps you could also explain why state insurance commissioners have repeatedly demanded that insurance agents stop selling cash value life insurance as a retirement vehicle. Here are the facts:

    1. Whole life insurance provides a low rate of return that is typically between cash equivalents and intermediate term bonds.
    2. Whole life insurance is a contract for insurance that requires payments be made until the contract is in effect, self funding.
    3. Because properly funded whole life insurance continues through age 100 (in most cases), the cost of insurance on the back end is considerably higher–i.e. you’re a helluvalot more likely to die at age 90 than age 65.
    4. The interest rate paid by the insurance company is dictated by the insurance company and NOT prevailing market conditions.
    5. Most young people cannot afford premiums for a whole life policy with a face amount equal to their needs. This leads to a whole life/term life combination solution that increases overall administrative costs to the detriment of the insured.
    6. Loans provisions in permanent life policies (WL, UL, VUL) vary from one insurer to the next, but most will have a significant interest rate early in the policy lifetime (when loans are more likely to be taken out by insureds) which negates a meaningful advantage over loans in the marketplace.
    7. Permanent policies often carry long surrender periods where a substantial portion of cash value accumulated can be forfeited if a withdrawal would need to be made or if premium payments don’t continue as scheduled.
    8. While being your own bank is attractive, it’s far more attractive outside of a life insurance vehicle. It is a better proposition to maintain sufficient cash reserves and take the money out when needed.

    …I could go on, but for those peddling this strategy, gimme a break.

    Now, if you are older, have a nasty estate tax burden, and really hate the idea of giving cash to the government, we can start talking about permanent life insurance.

    Bottom Line: Insurance is insurance. Loans are loans. Cash is cash. Investments are investments. Whenever you see products designed for one, but you’re trying to turn it into something else, you will lose in the end. If you want permanent insurance to insure a permanent need, buy it. Otherwise, buy term insurance to insure the temporary need, and invest as much as you can above the premiums.

    Also, please try to avoid making statements like ‘you will have found a way that outshines any investment strategy available bar none’. This is an incredible statement.

    Now, let’s have a lively discussion.

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    Charles Cory Says:
    June 15th, 2009 at 7:43 pm

    @Michael

    First, I may have not sequenced my comments correctly because I mixed paying off your debt with creating your own bank. If one can save tens of thousands of interest by paying off a mortgage early (and all other debt at the same time) the return will be greater than investing in anything. Dollar for dollar. This savings is not taxed.

    Getting rid of debt is the best way to go for all but the most sophisticated investor who spends his or her life making all the right decisions all of the time.

    I will send your reply to someone that has been doing what Nelson Nash and others advocate for a lot longer than they have. I will post his reply. He is more articulate than I am.

    Because he may take a few days and will be better at this, I am not going to refute each item in your list. I am too busy getting people out of debt, and keeping them from financial disaster, and showing them how to be financially fee. I am helping them keep it simple so they do not have to risk their savings on the stock market, and weird hybrid concotions that only benefit those that tend to confuse people.

    I do not mind be rebutted but your condescending attitude (“I am so sorry; give me a break”) reflects your attitude towards the rest of us mere mortals. I would rather be rich than right, happy than right. Therefore, if my seasoned vetern agrees with some of you points, I will gladly say that I am wrong.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 15th, 2009 at 7:53 pm

    @Charles – To be clear, that was not condescension, but disdain that you were picking up on. I have a heightened sensitivity to strategies relying on permanent life insurance because I have yet to see this sold properly and fairly to individuals and families. In every instance where I met someone who was sold this strategy, I wound up having to play cleanup crew to unwind a poorly conceived and even more poorly executed strategy.

    While you are correct that being completely out of debt will be highly rewarding and is certainly the right path, I would really enjoy a detailed treatise of the part that involves leveraging permanent life insurance to create wealth. This is the wrinkle that I have yet to see ironed out by proponents of the strategy.

    If you would like a larger platform, perhaps Nickel would be so kind as to host a guest post.

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    Tom Layne Says:
    June 19th, 2009 at 1:05 pm

    Im confused. If I have a 300k mtg @ 5.125 and 150k sitting in the bank above and beyond a 12 month living expense cushion, what should I do? It seems to me rates will rise in the near term and I can conceivably find something like a 5 year CD at 6.5%. If I believe that, shouldnt I invest in the CD and then revaluate after the 5 years (or consutrct a ladder as long as the rates are higher than 5.125)? Isnt it more liquid in the CD / more than offsetting what I would benefit if I paid down the mortgage?

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    Charles Cory Says:
    June 19th, 2009 at 1:14 pm

    I will be back over the weekend to reply – it is getting very hectic around here.

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    Michael Harr @ Wealth...Uncomplicated Says:
    June 19th, 2009 at 1:56 pm

    @ Tom Layne – As DCGuy and I discussed, it makes sense from an investment return perspective if you meet certain conditions. If you have $150k sitting outside of tax favored accounts and a 12 month emergency fund, this is an indicator that you would likely be able to sustain the interest rate arbitrage strategy because you already max out your tax favored savings opportunities and have sufficient liquid assets to cover an emergency (and assuming you have appropriate insurance coverage). This also indicates that your financial house is in the exceptional category rather than the norm.

    Keep in mind that the probabilities favor paying off the mortgage once in retirement even if the interest rate opportunity exists due to the loss of income and beginning of withdrawals. This is the result of statistical analysis that accounts for the investment risks over a long period of time. Please see one of my earlier comments for a link to the post with the analysis. While it appears to be a riskless transaction on the surface (guaranteed return on investment backed by the FDIC and financed through a fixed rate mortgage), upward movements in interest rates and inflation present significant long-term risks to the strategy–i.e. if you lock in at 6.5% on a CD, but yields push up to 10% during the term of the original CD, you would lose out on the higher interest rate.

    At present, the best rate on a CD is still short of 4% on a five year term. Overall, there are opportunities in investment grade corporate bonds to pull off the strategy based on your mortgage rate, but that would add credit risk to the cons of the strategy.

    Fundamentally, the home where you live is not an investment and shouldn’t be treated as such. It is an assets that shows no net appreciation over the long-term after factoring in maintenance, taxes, insurance, furnishings, etc. and very few are willing or able to downsize on a dollar basis if significant net appreciation is realized. It IS a place to live and a great purchase. In the bigger picture, all but a few are better served paying off the mortgage early (or at least by the time they reach retirement) rather than attempting to make a percentage point or two in an arbitrage strategy.

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    Tom Layne Says:
    June 19th, 2009 at 2:19 pm

    Thanks for the feedback Michael. My wife and I are 35 so retirement is a long ways off / we should have our house paid off by then regardless of what we do by then, assuming we stay in this house as we intend. We have an equal 150k in our retirment accounts, and at this point we are only maxing out to the company match – not sure if you have a view on that. I think its the inflation point Im somewhat thick about – I dont understand why that significantly increases my risk. If I can lock in a 6.5% 7 year CD & I have a fixed rate mtg of 5.125, do I really care if a year later I couldve gotten a 10% CD? Im only concerned with beating my mtg rate bogey – the rest would just be gravy (and gravy I wouldnt be served if I instead paid off the mtg with this $). I have no desire to increase risk by investing in bonds – Im only interested in a risk free return that beats my mtg rate and keeps the funds more liquid in the event of true emergency. Another reason I think we dont want to pay the house directly is if we DID have to move and the mkt is still terrible Id hate to have put 150k into the house only to get 50k of it back when selling. Frankly I find myself hoping inflation comes and interest rates skyrocket as a side effect – Id love to see a CD at 15% that I can drop this $ in. We live modestly and dont buy tons of stuff so I think any inflation to our cost of living would be more than offset by the CD interest that is now paying a huge chunk of our mtg. Is this plain stupid and Im hoping for my own funeral? Where do you see interest rates going in the intermediate term? I know some of this has been discussed above / its really largely circumstance dependant – Im just trying to get a view on my circumstance!

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    DCGuy Says:
    June 24th, 2009 at 6:37 am

    @ Michael Harr

    Following up on your advice to Tom Layne, if a person wants to implement the interest rate arbitrage investment (like we discussed), he or she needs to be open to making constant adjustments, which a lot of people won’t want to do. When we talked about it bonds were trading at a point where I could beat my after-tax mortgage rate, but T bonds have since fallen so I am back to prepaying the mortgage. I kind of enjoy messing around with it (OK, I’m weird) but a lot of people won’t like to spend time focusing on their allocation of capital. Automating mortgage prepayment is a good way to implement a strategy and then forget it.

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    Joseph M Says:
    June 27th, 2009 at 5:54 pm

    Just found this from a google search. I’ve been turning this issue over in my mind for months now. I just got a new job six months ago, and am contributing the maximum matched amount to my 401k (6%). I’m also maxing out my Roth IRA every year.

    I’m currently in a 15yr 6.375% mtg, and most of this year I’ve been paying triple monthly payments, except for a couple months between which I paid an entire extra year of payments on top of the triple payments. I’ve been in this house for almost two years, and at the rate I’m going, I can have it entirely paid off in two more years.

    I have no debt whatsoever, and have, between my IRA and 401k, savings equal to 1/3 of the remaining amount owed on the house. I have another 1/3 worth of money invested in individual stocks. I’ve been putting money in the market, getting some great returns in this little bull run we’ve had, and then pulling back out and paying off the mortgage with the investment returns.

    I’m just looking for some opinions on whether I should continue this plan, or move more towards investing longer term with all my extra money. My wife and I are expecting our first child early next year, so that’s another concern. To me it seems better to get the mortgage out of the way, and then just start piling into a variety of savings methods afterward. I look forward to everyone’s thoughts!

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    Paul Fernandez Says:
    July 3rd, 2009 at 4:46 pm

    I’ve reviewed most of these comments, including reading a post that strongly pushes for early mortgage payoff, with the argument via a monte carlo analysis that those with mortgages at retirement will run out of money faster than those without mortgages.

    There are so many variables to consider here that there is no one right solution-it depends on your circumstance. No financial planner would encourage a client to pour into his/her mortgage extra payments and not have a cash cushion for emergencies. Likewise, financial planners will certainly encourage early mortgage payoffs when there is a reasonable long term retirement cushion and emergency reserves.

    Not discussed, but critically important, any investments, be they to pay off the mortgage early or place money into 401k’s are passive uses of money, not active ones.

    Instead, think of the use of extra money to BUILD A BUSINESS. This use of money becomes active, not passive, and trumps any passive investment. Of course, actively invested money into your own business is the riskiest type of investment, but with the greatest rewards. So, if one is foregoing the risk of developing a business to come home and write a check to pay off his/her mortgage, that person may have lost out on the biggest potential source of financial freedom.

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    Chuck Says:
    July 3rd, 2009 at 10:58 pm

    I used to comment on this subject but I have become too busy helping people get out of debt. The amount of time I was spending took away from that effort.

    I wholeheartedly agree that each individual situation needs to be addressed, problems identified, implications of the problem outlined and then viable solutions to the problem implemented using goals and strategies that are tailored to the individual situation.

    Let me state that 401Ks and most tax deferred plans are approved by the Federal Government for the benefit of the Federal Government and implemented by financial planners for the good of financial planners. A smokescreen of complicated products and services have been created over decades that are to the detriment of the average consumer.

    That is not to say that financial planners etc are dishonest, it is just the way the system is built. ROI is the big come on when actual ROI after expenses and taxes is much lower. Lower ROI instruments that are not taxed or are favorabley taxed make a lot more sense in the long run.

    Sorry I am ranting. I am just tired of seeing people investing in high powered investments that invariably lose over time.

    As for using 401K money to start a business?? Well I know hundreds of unqualified people that have gone down that path and failed. The only ones that gained were those that got them into the business, or promoted the myth that “anyone can do it” or it is a “no-brainer” or everyone uses this product (not to mention that a ton of people are promoting the same product). NOT everyone is qualified or should be in business for themselves. Most small business people have traded on kind of JOB (Just Over Broke) for another JOB.

    If you decide to go that route go to your State Department that handles training, find out where to get tested to see if you are in fact the type of person that should be a small business owner, own a franchise or should actually work for someone else.

    Well let us see how many toes I stepped on this time. I am passionate about helping people and getting older and wiser by the day.

    Have a great 4th of July.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 4th, 2009 at 11:12 am

    @Chuck – So, based on your logic, I suppose that whole life insurance was created by the government for the government’s benefit and sold by insurance agents (like you) for the benefit of life insurance agents. A smokescreen of complicated products and services have been created over decades that are to the detriment of the average consumer.

    Or is it that you prefer to pay a higher amount of taxes, reduce total compensation paid to individuals by employers (by leaving the match on the table), and would prefer to completely ignore the tax-free withdrawal benefits offered by a Roth IRA. Tell me you’re kidding.

    @Tom Layne – The reason it matters if you lock in at a low rate today and inflation (and consequently interest rates) spikes later is the risk of a liquidity event–meaning if you had to move and sell your house. If you sell your house and hold these lower yielding bonds, then you could be forced to purchase your next home with a higher interest rate mortgage AND either have to continue to hold low yield bonds OR sell them at a significant loss.

    Also, there is something known as managing ROI for relative returns. What this means is that you want to be near appropriate benchmarks over time and not have significant +/- performance in any given year because you are assuming that the average historical rate of return will be achieved over the long-term. Passive investors like Bogle and his followers use this approach. They don’t care (at least not as much) that the market drops or interest rates are horrible in any given year. They diversify their assets so they can meet the benchmark index and over time they will achieve their expected rate of return.

    The other school of thought on ROI is absolute returns. This is more likely something that you would appreciate since you’ve indicated a preference for more conservative investments. In this school of thought, you try to achieve say an 8% or 7% rate of return every single year. Sometimes this means shifting into stocks, long bonds, short bonds, etc., but what you try to do is get to a stated rate of return consistently using the ‘best’ asset class each year. The problem with absolute return strategies is that if you set your target return too high, you’ll find it extremely difficult to manage to the number. If your target is say 5% instead of 10%, you’ll have better luck. Of course, the problem with this is inflation.

    If inflation is 5% and you receive 5% on your investments, you have a net return of zero. That’s why CDs have historically been a poor investment because they offer a near zero net rate of return. When a CD is paying 15%, it’s likely inflation is around 14%. When this happens, if you can buy long maturities at the top, CDs can potentially offer a significant premium over inflation. However, timing is hard to pull off and that’s why relative performance is used by so many.

    As for your specific situation, here’s what you should do:

    1. Construct a retirement plan that will tell you if you are on track or not. You can use something like MyPlan from Fidelity or something similar.
    2. If you’re on track, you have more options that we can get into offline. If you’re not on track, you’ll need to increase your contributions for retirement in this order:

    If you qualify for the Roth IRA:
    -Contribute to 401k to match level (you’re already there)
    -Max out Roth IRA contribution for you and your wife
    -Max out 401k or to the level you need to be on track for retirement
    -Consider a low-cost variable annuity for post 59 1/2 retirement money OR a taxable account with tax efficient investments for pre 59 1/2 retirement money

    If you don’t qualify for the Roth IRA:
    -Contribute to 401k to match level
    -Contribute to 401k to max
    -Contribute to a non-deductible traditional IRA
    -Consider a low-cost variable annuity for post 59 1/2 retirement money OR a taxable account with tax efficient investments for pre 59 1/2 retirement money

    Keep in mind that these accounts only designate how you are taxed currently, on the investment returns until withdrawal, and on the withdrawal. In other words, these accounts designate tax status, not investments held.

    For clients that were on track for an early retirement, we would typically max out tax advantaged contributions until they were on track for their post 59 1/2 portion of their retirement and then do a second retirement plan for their retirement age until age 59 1/2. This way, we made sure we had money that wouldn’t be subject to more limited 72t distributions and we could be sure they would have plenty of liquid assets for their pre 59 1/2 retirement days.

    I hope this helps, but if you have additional questions, feel free to hit my blog and drop me an email.

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    Heather Idoni Says:
    July 11th, 2009 at 3:49 pm

    My husband recently got laid off from General Motors (permanently), but he’ll be an RN in about 18 months and resume working at a hospital with benefits, IRA, etc.

    We are thinking about paying down our 15 year mortgage (was $215K originally, now $140K, so about 6 years to go) by absorbing the penalties on his current IRA and using the remaining $50K after taxes/penalties (he’s 48, not retirement age) to pay DOWN our mortgage. (We are doing fine making regular payments with my income.)

    Now — the penalties are about $30K, but will we save more in interest at this point in our mortgage by doing this?

    We are planning on aggressively starting over with an IRA when his nursing career begins.

    Is this nuts???

    H.

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    Jaromy Says:
    July 13th, 2009 at 7:08 pm

    There is one thing I think everyone has been overlooking when paying extra towards the principle of your mortgage. That is this, the extra money is going to you not the bank. Everyone knows that the interest charged is based on the remaining loan balance each month, so as you pay down the balance the bank gets less money from you and you are actually paying yourself more. Also the earlier you make the extra payments the better, as the loan is designed to get the most money for the bank early on. That is why banks are happy to refinance, as that just starts the cycle over again allowing the banks to rake in more cash from us. Try to limit the number of refinances you make. Investing the extra money in other ventures always carries risk, paying off your mortgage carries no risk, especially if you have already set up an emergency fund for yourself, and you continue funding for retirement. I agree with others in this post that the mortgage deduction is a crock, why do people think that paying $10,000 in interest to the bank and getting a $3,000 tax credit is good? That makes no sense to me at all I’d rather pay the taxes on the $10,000 and keep what’s left over.

    J.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 14th, 2009 at 2:54 am

    @Heather Idoni – I would postpone paying down the mortgage with a full distribution until your husband has his next job. The reason here is that while maintaining any debt adds risk, you face greater risks if you lose your job. In addition, you don’t have long until the magic age of 59 1/2 comes around when the 10% penalty would go away.

    IF you decide to go down the path of taking money out of the retirement account, consider a 72t distribution program that would allow you to take a small percentage of the account out annually before 59 1/2 without penalties. Sometimes 72t distributions are referred to as substantially equal periodic payments (SEPP) and what it amounts to is you are making a permanent election to take money out at least yearly from the retirement account. To break down the term SEPP, ’substantially equal’ means that you will have to take out similar amounts each year. This can be tabulated as a percentage or dollar figure that must come out each year. ‘Periodic’ means that you must take them out periodically and the IRS requires this to be at least annually. ‘Payments’ just means withdrawals. This will save you the 10% penalty, but it will also eliminate your ability to take a lump sum or the entire balance at once. If you deviate from the SEPP arrangement, all distributions are subject to a 10% penalty going back to day 1.

    What is attractive about the SEPP route is that you can have a little more freedom about what to do with the money. If you maintain your job and can continue to support your family, then you can use the withdrawals to pay down the mortgage. If you lose your job later, you can use the withdrawals to live off of. If you payoff the mortgage earlier than 59 1/2, you can simply increase your employer sponsored retirement plan contributions to offset the distribution. It just gives you more options while reducing your tax burden and still accelerating your mortgage burning party.

    Also, since your husband is back in school, you are likely eligible for the $2,500 tax credit meaning that you could withdraw in a lump sum the amount that corresponds to that tax credit and still be even up on your tax rate from last year. (if you’re in the 25% bracket, it would correspond to a $7,142 withdrawal inclusive of the 10% penalty).

    You should also check into your state’s returning student financial aid package. Some states require early filing of the FAFSA, but many states offer grants to adult students and I would not be surprised to see some kind of grant/tax credit/tax deduction from states hit hard by auto industry layoffs.

    In short, you’re not crazy to want to do this, but from a risk perspective, you will do better by delaying the distribution or setting up SEPPs. IF you do decide to do the lump sum anyway, sit with an accountant or use a tax prep software package to see if you would be better served taking the distribution this year, next year, or both. The way you figure it out is by computing your marginal tax bracket based on your income and deductions. I’m sure you can do a Google search to find a basic tax calculator and I believe the IRS has one on its site too.

    Hope that helps.

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    Heather I. Says:
    July 14th, 2009 at 12:30 pm

    Wow. Thanks SO much! I had never even heard of this option before. I will print this out and share it with my husband — we’ve been needing exactly this type of advice.

    Your blog looks great, by the way! I added it to my Google Reader RSS.

    Thanks again!
    Heather

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    Sandy Says:
    July 18th, 2009 at 10:26 pm

    Lot of great reads here! Now wondering what the input will be on my devastating financial situation? Just went thru a hell of a divorce. Someone had a midlife crisis and along with that committed financial suicide. So long story short after home is sold and I get my portion of TSP account I must purchase new home for myself. Rather than have a mortgage I basically have decided that it would be best to take the monies from both the house sale and the TSP account and pay for the house in cash. The TSP account has to be turned over to me (my portion) and cashed out which will cause a 20% early tax penalty any way…which is necessary in order for me to have the ability to pay my lawyers fees (which are incredible). Of course I could pay from the house sale but than their would be a delinquent amount for the house purchase that I need to make. Either way I need to cash out the TSP plan. My income is fixed as I am retired already. Who would have thought that divorce would happen when life was just suppose to get good? Thanks for anyones comments

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    SoConflicted Says:
    July 19th, 2009 at 5:11 am

    I am at a point where I can now see the light at the end of the mortgage tunnel. I owe approx 75k on my mortgage and am considering calling upon assets sitting in a variety of mutual funds to wipe the slate clean. If I take this action, I would sell the funds that would not trigger a capital gain(Thanks to the horrible market of the past couple years). I have been dancing on this fence for soooooooo long that I figured I would seek the opinions and recommendations from others.

    Here is a bit more info. I have a fully funded 401k with a balance of approx 400k, I just opened an IRA within the past couple of years and have a balance of nearly 5k. I have non-tax advantaged accounts of about 90k. If I use the non-tax advantages assets to payoff the mortgage, I will have about 16k left as emergency funds.

    Intrest rate on the loan is 4.625%

    I have no other debts and am 39 yrs old.

    Please help me get past my paralysis.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 19th, 2009 at 10:18 am

    @SoConflicted – This is an easy call with your age, assets, and tax situation. Pay it off as soon as possible. Based on the information you’ve provided, it is clear that you are a terrific saver and have made a lot of good decisions to get you to this point. To be 39 and have a net worth that puts you in the top 20% of ALL Americans is OUT-standing.

    In all seriousness, the hesitation that you are feeling probably relates to the market losses and the really low interest rate that you have on your mortgage. The odds are that the market will not move past 1999 highs until 2015 or later and we’ll trade up and down without solidly moving higher for a number of years. In addition, the interest rate is nice, but with only $75k on a mortgage, much of your interest is probably being eaten up by the standard deduction anyway. If you believe the market isn’t going to move significantly higher AND you take a hard look at your taxes with and without a mortgage, you will find that paying off the mortgage is in your best interests.

    If you’re concerned about losing out on the market move upward, keep in mind that at your young age, you will have more than enough time to dollar cost average into the market and put you back ahead of where you would be without paying off the mortgage. In stagnant markets with many ups and downs, dollar cost averaging is the most effective way to stabilize your portfolio returns when compared to a lump sum (like the $75k you’d have to sell).

    In my opinion, you are a perfect candidate for an early payoff of the mortgage.

    The only thing that might be a bad deal is if you have massive capital losses that would be set to carryforward. If this is the case, you should try to get the loss recapture within the next three years or so.

    In the grand scheme, paying off the mortgage will significantly reduce the amount of capital required to retire, act as a stabilizing asset to your overall financial condition, and allow you greater freedom in your career choices.

    If this comment isn’t enough to get you off the fence, go to a CFP in your area that charges by the hour and let them know that you will not be moving assets to him/her and you only want help with this single decision. This will eliminate biases since an advisor that charges based on assets will not have the cloud of “If I recommend not paying it off, I can make money on the other $75k”. That’s why hourly is much better than asset fees. For $200 to $500, you can get all the information you need to make a good decision. What you get for that money should be a tax projection with and without the mortgage and monte carlo retirement probabilities with and without the mortgage (where without the mortgage you dollar cost average the amount you’re paying on the mortgage today and with the mortgage, you keep the $75k invested). Having those analyses completed should give you the confidence you need to put this decision to bed.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 19th, 2009 at 11:04 am

    @Sandy – I am sorry to hear about your divorce, but it is becoming more and more common in retirement.

    The short answer is: Slow down.

    Divorce is always a bitter pill and adding financial suicide by a spouse to the list is never helpful. I would hesitate making any decisions until you get settled into being divorced and the emotional side of things has dissipated. There will be plenty of houses available six, twelve, or eighteen months from now, so take your time and figure out what your new life is going to look like.

    The only things you MUST do is pay the attorneys and complete all of the paperwork to move the assets into your name. Aside from this, you may even want to park your money in cash until you have a very clear plan as to how you want to proceed.

    Also, I am guessing hubbie went out and racked up some pretty nice sized debts. If that is the case, make sure the divorce decree forces him to put those debts solely in his name. I’d also sign up for LifeLock or something similar to lock down your credit for a period of time until everything is under his name. Even if the decree requires him to pay debts that also have your name, it will still impact your credit report until he pays them off or moves the debt under his name. Beyond the credit report, LifeLock or similar services can help you prevent future identity theft. The likelihood of this is much greater from people that know you and your not-so-secret information (like an ex-spouse). These services are usually anywhere from $10 to $30/month and they’re definitely worth paying for until things settle down.

    From here, take a few months to:

    1. Create a retirement plan
    2. Create a housing plan
    3. Develop an investing plan for long-term money
    4. Sit down with a CPA to figure out how best to buy your home (a lump sum all at once will likely be a terrible tax outcome that could do irreparable harm to your retirement plan)
    5. Figure out what you want to do with the rest of your life

    I can’t tell you how many divorcees I’ve met that made a series of bad decisions immediately following the divorce (like cashing out a retirement plan). Take your time and explore all of the options. You have experienced a major change, treat it as such.

    Good luck, and if you need help, don’t hesitate to reach out to an hourly fee advisor in your area.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 19th, 2009 at 11:07 am

    @Sandy – Also, there are advisors that specialize in divorces and if you’re in a metro area, you will likely find one nearby. They are familiar with all of the issues that divorcees endure and are comfortable working with divorce attorneys, estate attorneys, accountants, forensic accountants, etc.

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    SoConflicted Says:
    July 19th, 2009 at 9:08 pm

    Michael – Thank you very much for your insights. It helped quite a bit for someone else to validate that my mortgage pay-off plan was not flawed in some profound way. I think my paralysis was due to my concern that I was overlooking something and didn’t want to end up kicking myself. I will definitely structure the assets I sell to take advantage of the carryover write-off within as few years as possible (Is there a max number of years during which the loss must be absorbed?). I know there is a cap on the annual write-off, I just don’t recall what it is (But for some reason, the figure 3k is stuck in my head). I’ll need to do some search during next couple of weeks to determine which investments will be sold.

    By the way, thanks for the compliment on my savings habits. I wish I could take full credit for them but have had some pretty good influences in my life that helped to get me focused. As a result of those influences, I now enjoy researching investments, reading 10-k reports, and can’t walk by a newspaper without reading the business/financial sections.

    I am officially off the fence and racing towards the finish line. I hope to cross it before my 40th B-day in a couple months.

    Thanks again. I just bookmarked your wealth uncomplicated blog (It’s awesome). keep sharing.

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    Michael Harr @ Wealth...Uncomplicated Says:
    July 20th, 2009 at 12:14 pm

    @SoConflicted – You are correct, the cap on capital losses is still $3k and there is no limit. In fact, you can die with a huge capital loss carryforward, never to actually benefit from them. This is one of the serious problems with the tax code that puts capital loss treatment squarely in favor of the government. I worked with a client that had some massive losses and will have to live until age 266 to recoup them (before we met he was an active trader in options contracts).

    The main reason you want to be able to absorb the losses or at least match them with gains as soon as possible is because of the time value of money. While waiting to use your capital loss carryforward, your money and the deduction will be worth less every year out from today. You might want to drop a line to your Congressman to see if they can at least index the $3k to inflation, but I doubt we’ll ever see any significant changes.

    As for your habits, always remember that you are the exception and not the rule. There are very, very few who can save at the rate you have, and even fewer who will take the time to research their investments. In my decade plus of experience as an advisor, I met exactly one person that had this combination of qualities. After I met him for the initial appointment, I told him, “you don’t need my help; you’re doing just fine on your own.”

    Don’t forget to throw a proper mortgage burning party when you pay it off. You can get as creative as you want, but invite all of your friends. This is a tradition that used to be widely known, but has seemed to dwindle over the last couple of decades. It is a great lesson for friends and family to know that living without a mortgage is possible and they know someone who is doing it. Sometimes your financial footprint needs to be seen by others before they can follow you.

    Thanks for the kind words on my blog, and best of luck in securing your financial future. You also might want to start figuring out what you’d like to do with that early retirement you’re tracking;-)~

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     Erik Says:
     July 21st, 2009 at 12:47 pm

     I loved reading everyone’s responses here–it totally made me remain firmly planted on the fence about paying off my mortgage or not! I’m a teacher with two young children (18 mos and 1 month). I could pay off our mortgage in 6 years if I stop all contributions to retirement. One friend is advising me to actually refinance to a 30 year mortgage so I have very low payments ($130,000 principal balance on a 5.6% mortgage) which would then allow me to make high contributions to my 403(b) plan. His argument is that I immediately gain a 30% return on that money since it’s pre-tax dollars. The lower payments also give me some extra monthly cash flow for the kids’ activities (music classes, trips to amusement parks, etc.). Any thoughts?

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