Boston Gal's Open Wallet

This is interesting. Usually you hear from personal finance people that its best to take on the longest fixed rate mortgage you can afford. This allows you to tie up as little cash in a non liquid asset as possible (slowly building equity). Also allows you to protect that pile of cash from the effects of inflation. The house is bought in todays dollars and paid off over 30 years in todays dollars.

Do the math in a spreadsheet. I have modelled my own situation and in every case I find that if I pay my mortgage as its ammortized by the bank over 30 years, and simply strategically invest the money I could afford to use as extra payments, that I will be far better off as a result.

For me... my numbers show that my investments earning a conservative 8% (nothing special) that my invested assets will exceed the mortgage principal balance within 11 years 3 months. So at that point I can decide to pay off in full if I wish.

This prevents me from tying up all my cash in a non liquid asset(The house), allows me to grow assets that can easily be liquidated (Sell stock shares or mutual funds) should I need access to the cash, and protects that amount of money from the effects of inflation over time.

To me, I would much rather have liquid assets building.

Even if you don't pay off the loan when assets grow to the point you can, and you carry it out the full 30 years, the assets growth and performance gains will still leave you with more cash at the end than what you end up paying in interest over the 30 yrs.

Model it out in a spreadsheet. Don't rush to a decision, don't let the interest costs blind you. There are much better decisions for people to make in most cases.

Of course everyone's mileage may vary. And this does not consider the warm fuzzy feeling one would have being debt free.

 

I hear ya on the tough decision part of it! I can see both sides of it just about equally. I think it boils down to, there is not just one right answer and you have to do what you are most comfortable with. It really does become a personal decision. Best of luck figuring out what you would like to do.

 

Few things:

(1) Suze was targeting her comments towards those that are nearing retirement. I'm assuming that is because she doesn't see near term rebounding of the market - she doesn't seem to think that even a 20 year (she mentioned 40 year olds in her plan) time-frame is sufficient to see investments rebound and grow at the rates you'd want to make up for lost opportunity costs of mortgage interest payments.

(2) I've been blogging alot about inflation, because I don't see how we can avoid it. Inflation will help homeowners (in the short-term) while hurting savers. All the news about property prices dropping? Inflation will counter that by pushing property prices back up. In comparison, every dollar saved not only earns you less in interest b/c of the low rates, but is less valuable in the future b/c of inflation.

Owning your home outright is also a hedge against unemployment, which, if we are not only in a recession but in a depression, might be on the horizon.

I have to say, the most worrying thing about this segment is that it is ultimately pretty pessimistic to suggest paying down mortgage as opposed to contributing to a retirement savings plan. I have never thought of Suze as a glass half empty kinda gal (as I am) so when she gets all doom and gloom, I take it as a bad sign.

 

Whether to pay off early is a tough decision. We ended up doing so for the very simple reason that it (being the mortgage balance & related interest) was one less thing to have to track and record.

Yes, perhaps too much of your net worth will be tied up in real estate. But in the next few years as all your new cash goes to non-RE investments things will quickly get in balance.

Love you, BG!

 

I think you are in a great position! You have a lot of options..and that's a good place to be.

 

Bostongal, you are on the right track with seriously considering paying off your home. You already max out your 401(k) and Roth IRA, both wise moves. And you have money in savings. If you can, make an effort to pay down the home, either through extra principal payments and/or future stock market earnings. Why? Because without a mortgage, you have much, much more freedom. How so? Maybe you want to take a less stressful job that pays less (like I did.) No mortgage makes the transition easy in that you don't sacrifice your standard of living. Want to move away from Boston and become Phoenix, AZ-gal and catch the warm winters? You have the freedom to do that without worrying about selling your home for a certain amount of money. (Just ask your neighbors who carry a fat mortgage and are trying to sell their homes in today's environment!)

I think the power of "imputed income" ranks just behind the power of "compound interest" as being as close to a financial law of gravity as you can get. By the way, imputed income are financial services you receive that are not in cash, hence, are not taxable, such as "shelter services" by living in a mortgage-free home. Not having to pay a mortgatge = not having to earn the money, either through your job or investments. Scott Burns, MIT grad and financial columnist, wrote this column about imputed income in 1999 causing me to re-think my investing strategy.

http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/columns/archives/1999/990525TU.htm

You are well diversified in stocks and bonds, I presume, in your 401(k) and your Roth, and you own rental property. Now its time to think outside of the box and use imputed income to your advantage.

Good luck!

 

Hi BG - I agree with Suze's mortgage advice to the extent that if you are planning on staying in your home, it is best to pay off the mortgage so that you don't have that expense when you retire. We are taking this approach - easier to pay off the mortgage now than to try to make sure we've saved enough to kick off enough income to cover the extra mortgage expense.

The other comment I agree with is the Fed interest rate cuts are penalizing savers. It will get to a point where there will not be an interest differentiator between online savings (ING, Emigrant, etc.) and brick and mortar banks. B&M banks have been paying less than a half point for years, and the online banks' interest rates are ridiculously low now, too. After taxes, I'm barely ahead.

 

Hi Boston Gal - Suze specifically said that you should plan to have your house paid off by the time you're 62. She was basically saying that she doesn't want to see retired people dealing with mortgages as a drain on their finances.

So, as long as you're on track to do that, I wouldn't worry about it too much. It sounds like overall, you're doing the right things.

-Erica

 

If Suze Orman wants you to pay off your mortgage then you know you are doing the right thing ;-). I'm joking, she just rubs me the wrong way, so she loses any benefit of the doubt.

 

We just paid off our house, and it feels great! No mortgage, no credit card debt, no auto loans, no student loans, no personal loans. Retirement savings could use some work. Honestly, I don't know if it was the best decision financially, but it feels like a hundred pounds off my back. Expenses relating to the house are about $325 a month (property taxes and insurance) so if either my husband or I lost our job, we could live very cheaply. And with four kids to put through college(the first already there) the "extra" cash will come in very useful ...

 

Chris in Boston:

Great comment on why paying down the mortgage might not be the best use of investment money. You had one assumption that might need reexamining: an 8% annualized return.

Warren Buffett surprised me when he recently stated that an 8% annual return may actually be "something special". In his 2007 Letter to Shareholders—starting on page 18 under the heading "Fanciful Figures – How Public Companies Juice Earnings"—Mr. Buffett explained why companies estimating an 8% return on their pension funds are actually over-estimating that return.

You can find Mr. Buffett's explanation at www.berkshirehathaway.com/letters/2007ltr.pdf, but here's a summary:

1. During the 20th Century the Dow Jones advanced at 5.3% compounded annually.

2. Dividends currently average about 2% annually.

3. If you add these together, it is less than an 8% annualized return.

4. Even estimating a return of 7.3% assumes all of the money is in stock, but most pension funds have a significant portion of their funds in lower paying bonds and cash, so that 7.3% would be too high an estimate.

As a result of Buffett's arguments, I've started assuming 7% as my new "safe" annualized return, with the knowledge that it might still be too generous. Unless another reputable source convinces me otherwise, I can longer plan on more.

 

Suze is personally extremely risk averse:

http://moominhouse.blogspot.com/2007/02/suze-orman-is-extremely-risk-averse.html

I'd see her advice in this light. US mortgage rates are low and part is usually tax deductible pushing the rate even lower. I wouldn't be in a hurry to pay it off. OTOH in Australia home mortgage rates are near 9% and not tax deductible to owner occupiers. There might be a good case then to paying it down.

I think that now is a great time to invest in other things. I've been doing it big time including with borrowed money. JMHO.

 

Buffett's comments are illogical (I'm a Berkshire shareholder but not everything he says makes sense). Dividends are lower now because the tax code favors companies buying back stock. This results in stock prices rising faster than the historic 5.3% he quotes which was an average that applied when dividends were on average higher. Rates of return might be lower in the future but his argument doesn't hold up IMO. In the end the rate of return on stocks depends on the premium investors demand above the rate of return on risk free assets like short term government bonds to own stocks. That's historically been 5-6%. Economists have always puzzled why it's so high and it could come down through a one off appreciation in stock prices and then lower gains after that. Bottom line is, we don't know what future returns in the stockmarket will be at all one way or the other...

 

Rookster,

Agreed that these times they are a changin.

I still think a solid stock portfolio, (not mutual funds) can achieve 8% or better over the long term. For me, I am not talking about retirement assets. I max out my 401K to the $15,500 limit, and anything else I save to invest I put all in non-qualified accounts and all in stocks.

However, if you follow Dave Ramsey's advice. When it comes time to draw down from your investments you should never draw down more than 4% annually, and if you achieve a 6+% return you should stand well to keep pace with inflation over the long term. If you achieve greater than 7+% which is probably realistic in most cases with a smart stock portfolio you should do well over the long haul.

For me... I am keeping my 30yr Fixed rate mortgage. paying it as slowly as the bank allows and every spare nickel I could use to pay down principal I am placing into non-qualified investment accounts. After first fully funding my 401K. The big thing for me is I want access to my cash without needing to go back to the bank for an HELOC to only pay back the Bank with more interest.

To the other poster that mentioned Scott Burns. He has several articles on the subject and also a web site www.assetbuilder.com. His view is quite similar in that a large 30yr mortgage protects you from inflation and investing the extra cash you have available is the best choice.

As I see it. I am on track now to have enough assets built up to pay off my 30yr mortgage in less than 12 years. 11yrs 3 months is my goal, and only 9 years left to reach that!

So when the time comes I will have a pile of cash to then make a decision...? pay the mortgage or continue letting the assets grow. Perhaps then I may draw down enough each month to pay the payments for me? We'll see when the time comes.

 

I liked this article in Business Week a while back. It compared paying off the mortgage early with investing the extra money, and basically concluded that paying off the mortgage early was a bad idea for most of us -- financially speaking. People would be better off investing the money instead.

Later, after your investments have compounded and made you a ton of cash, you could always pay off the mortgage in a lump sum:

http://www.businessweek.com/
magazine/content/07_06/
b4020112.htm?chan=
investing_sprb_retire

 

I agree with Chris with one adjustment. 8% is too high to be a conservative return. However, having the liquidity is key. What happens is you follow Sue's advice and start aggressively paying off your mortgage and 6 years before the end you get a long term illness, lose your job and cannot get rehired, etc. Had you stocked away the cash in reasonably diversified conservative investments you will have the cash to get you though or buy time to work things out. If you had simply paid down your mortgage, you still owe the monthly payment next month. Horde the cash and you can make the decision to make a big early principal towards the end of the mortgage while having the safety cushion. This is the same reason I advise everyone to take a 30 year mortgage rather than a 15. You can make payments on using a 15 amortization schedule and if something bad happens you can reduce your monthly payment down significantly using the contract's 30 year payment amount.

 

The simplest way is often the one most overlooked. Divide your mortgage into 12 equal parts. ($1,200 a month divided by 12 = $100) Add that to your monthly payment and marked as "toward the principal" and you can pay a thirty year mortgage off in about 22 years. Add another $100 to the mortgage payment, a total of $200 extra a month and you can dump that mortgage in 18 years or so.

Never opt for the bank offers of making two payments a month - too many fees. Save money by doing it yourself.

And as a financial author myself, sometimes Suze gets a little ahead of herself.

 

Suze is wrong (except just before or in retirement)! And, paying off both your home and investment property - if you are 10+ years to retirement - is going to limit your updside without much benefit to your downside.

Check out the 20% Rule and readjust:

http://7million7years.com/2008/02/04/how-much-to-spend-on-a-house/

... you'll thank me in 10 - 20 years! All the best, AJC.

 

"But with a paid off home I will have a LOT of my Net Worth locked up in mortgage free property"

I'm debating that also, It'd good to be debt free but at what price

 

I am actively working to pay my 15 year 5% fixed mortgage off early.

I am paying only $100/month more and will have it paid off in a total of 10 years- low housing costs in my market and a decent down payment made this possible.

I will be done two years before my eldest goes off to college. My $$ that otherwise would go into mortgage costs will likely be the college plan for all 4 kids. It won't be everything (I am also saving in the interim for each of them) but hopefully they won't have to take out too many loans (or they'll get enough scholarship to cover the rest!)

I will have 6 years from the year my youngest finishes college to what retirement will be w/ Social Security *if* its still around.

 

Hey everyone, we've had this discussion before and the split in comments is pretty 50/50 - pay the mortgage off with all possible speed vs invest all you can. Again my suggestion - do both- for every extra $100 available, apply $50 to mortgage,$50 to investments. That's mu approach and it is working so far.

 

As others have said, it's not a clear cut financial decision. I think it's as much a mental thing.

Personally, I'd feel worse knowing I had no exposure to the stock market. But enough people have told me the relief on paying their last mortgage payment was one of the high points of their life (really!) that I agree there must be a huge psychological 'dividend'.

 

Bad idea. Why? What happens if you get sick or ill before you finish paying off the mortgage?

That's the only problem I see, that if you pay off the mortgage instead of stashing away, if anything happens.

For me personally I would NEVER do it. It's way to risky. I would keep cash in hand and CONSIDER paying it off when the balances are equal. But otherwise NO way.