Stock Market
- Thread starter Bobber
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IMO both emotion (which is reflected in a lot of the comments) and "it is what my parent's told me to do" have a lot to do with why people tend to go the route of thinking that paying down their mortgage faster is automatically the wisest financial decision to make.
Here are a couple articles I found. You'll see they do both leave room for both sides of the arguement...
http://www.businessweek.com/magazine/content/07_06/b4020112.htm
http://www.mymoneyblog.com/archives/2007/10/10-reasons-you-should-never-pay-off-your-mortgage.html
Here are a couple articles I found. You'll see they do both leave room for both sides of the arguement...
http://www.businessweek.com/magazine/content/07_06/b4020112.htm
http://www.mymoneyblog.com/archives/2007/10/10-reasons-you-should-never-pay-off-your-mortgage.html
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I would have to agree with Phaedrus. Completely freeing yourself from debt is a fantastic strategy for anyone - regardless of your income.
Main benefits of the debt-free, cash-only plan:
- Very easy to do it yourself
- Money is always available (you don't owe anyone!)
Main benefits of the debt-free, cash-only plan:
- Very easy to do it yourself
- Money is always available (you don't owe anyone!)
Contrary to popular belief, money stored in your house (equity, I mean, not under the mattress) is not always available. You can only take it out in the form of a loan so you are more at the mercy of the bank than you would be had you invested or saved the money.
Also contrary to popular belief is: the equity in your house is used to fund retirement. Most people "down-size" in terms of yard/house work, but not out of house value. Specifically looking at your house as a retirement asset is rarely a true analysis of your future ability to generate a paycheck in retirement. In all reality homes are normally an asset for heirs, not the owners.
I have had many people say that they are going to downsize, but only to find that they buy a more expensive townhome, so they don't free any equity up, but do free up their time.
Maybe it should be a funciton of how much money you have to invest. If funds are limited and you have to choose between funding your 401K or Roth or paying down extra debt on your home, you should probably go for funding the accounts, because the stock market has historically averaged 7 to 8% and your effective loan interest rate is going to be about 5% right now.
If you have money left over after funding your accounts, go ahead and pay down the debt on your home. That's what I've been doing in effect.
If you have money left over after funding your accounts, go ahead and pay down the debt on your home. That's what I've been doing in effect.
I should clarify - I was not referring to using equity. I meant that when you are debt-free, your paycheck is free to spend how you wish. You are not bound by debt payments.
The bottom line is that you need to do the math to determine whether it makes sense to take out a mortgage and invest or pay cash or pay off your home loan. For example, say you have a 15 year fixed mortgage at 5 1/2% with an initial balance of $150,000. Your payment is $1226/month or $14,708/year. $8,085 of that annual payment is interest.
You must first calculate your effective cost of money. The starting point is 5.5%. Then, you need to reduce that number by the mortgage deduction. If you are in the 25% federal marginal tax bracket, you reduce your effective cost of money by 25% to 4.125%. Additionally, the cost of money is reduced by the rate of inflation. Presently, it is running about 3%. This gets your effective cost of money down to about 1.125%. If you choose to invest the money, you will need to earn 1.125% to break even in the first year. However, the total interest paid annually is reduced each year and the tax reduction is reduced each year as well.
Another way to look at this is to consider the total tax benefit over the life of the loan. In this example, the total tax benefit is about $23,302 by maintaining the mortgage. However, if you choose to maintain the mortgage and invest, you must keep up with inflation. If inflation over the next 15 years is the same as the past 15 (2.65% annually,) you would need to make the $150,000 increase to $222,033 over the 15 years just keep up with inflation, a difference of $72,033. However, you will have the benefit of the tax reduction which will effectively reduce this amount to $48,731. In other words, you will need to turn your $150,000 into $198,731 in 15 years to break even on your decision to take out a mortgage rather than pay cash. In terms of rate of return, you would need to earn about 1.9% on your money to break even.
Keep in mind that you take on additional risk when you choose to invest. A mortgage payment provides a set rate of return, for lack of a better term. Investing involves market risk. Further, there are several factors which would impact this calculation. If inflation increases, you would need a higher rate of return on your investment than this calculation. If your mortgage interest rate is higher, the advantage to investing is reduced.
Note: This is a bit of an oversimplification. It took too long to post this as it is, let alone calculating the net present value of the tax deduction, for example. However, I hope it provides some food for thought.
You must first calculate your effective cost of money. The starting point is 5.5%. Then, you need to reduce that number by the mortgage deduction. If you are in the 25% federal marginal tax bracket, you reduce your effective cost of money by 25% to 4.125%. Additionally, the cost of money is reduced by the rate of inflation. Presently, it is running about 3%. This gets your effective cost of money down to about 1.125%. If you choose to invest the money, you will need to earn 1.125% to break even in the first year. However, the total interest paid annually is reduced each year and the tax reduction is reduced each year as well.
Another way to look at this is to consider the total tax benefit over the life of the loan. In this example, the total tax benefit is about $23,302 by maintaining the mortgage. However, if you choose to maintain the mortgage and invest, you must keep up with inflation. If inflation over the next 15 years is the same as the past 15 (2.65% annually,) you would need to make the $150,000 increase to $222,033 over the 15 years just keep up with inflation, a difference of $72,033. However, you will have the benefit of the tax reduction which will effectively reduce this amount to $48,731. In other words, you will need to turn your $150,000 into $198,731 in 15 years to break even on your decision to take out a mortgage rather than pay cash. In terms of rate of return, you would need to earn about 1.9% on your money to break even.
Keep in mind that you take on additional risk when you choose to invest. A mortgage payment provides a set rate of return, for lack of a better term. Investing involves market risk. Further, there are several factors which would impact this calculation. If inflation increases, you would need a higher rate of return on your investment than this calculation. If your mortgage interest rate is higher, the advantage to investing is reduced.
Note: This is a bit of an oversimplification. It took too long to post this as it is, let alone calculating the net present value of the tax deduction, for example. However, I hope it provides some food for thought.
It also can completely depend on what your goals are. I put 6% of my income (with a company match) into my 401k, and the rest goes to making extra debt payments. But my goal is to pay off my house and so my wife won't have to work or she might only have to work part time. That is my dream - not maximizing the value of every dollar I have.
Agreed. You also need to decide why you own your home. Is it a lifestyle choice or an investment? Further, as you point out, there are life goals and attitudes towards money that impact your decision. However, it is always good to determine the opportunity cost of the decisions you make. You don't need to choose the path that provides the greatest financial return, but you should know how much you will be leaving on the table to make that decision.
Assuming that you do not possess the financial sense of a bag of hammers, the lack of a house payment is a great start to not needing to be at the mercy of the bank.
Contrary to popular belief, the purpose of life is NOT to borrow more money to buy crap.
One particular factoid that isn't being inserted into the discussion, is the power of living modestly, within one's means.
I know, I know, it's unAmerican. I'll stop now....
The thing with the stock market that makes it so difficult is that I can do all the analysis I want, but all the news thats out there on a company is already factored into the sales price of the stock, including future earnings. Unless of course there is information out there not known to the general public, in which case you can go to jail for.....but nonetheless, historically its been a good investment for those willing to stay in for a long period of time.
As much as we are disagreeing on here, I don't think I am coming across clearly enough because I really do agree with a lot of the stuff said, I just don't agree on the means to get there.
I'm not saying take out a mortgage so you can spend more now, I'm saying that if you do things the most effective and efficient way possible right now, you'll have more to spend later, which I think is the goal of what a lot of us are doing.
Balken typed out a lot more than I was going to, but it provides a pretty good argument for not paying off a mortgage.
Believe it or not, for a lot of us, putting extra to your mortgage is not the fastest way to have it paid off.
If I had 200,000 set aside for a house, I wouldn't go out and pay cash for a house, I would take a mortgage on that house and use the interest generated from my side account of 200k to make the payments. In 30 years, (or 15, whatever) I have my house paid off and the value of that, plus the 200k.
All the while I have a hedge against inflation (fixed mortgage, not ARMs) and protection knowing that if something happens (disability, lose my job, etc, ) I still have the 200k to fall back on. If the same bad thing happens and I have my house paid off, I can't get at that money.
I'm not saying take out a mortgage so you can spend more now, I'm saying that if you do things the most effective and efficient way possible right now, you'll have more to spend later, which I think is the goal of what a lot of us are doing.
Balken typed out a lot more than I was going to, but it provides a pretty good argument for not paying off a mortgage.
Believe it or not, for a lot of us, putting extra to your mortgage is not the fastest way to have it paid off.
If I had 200,000 set aside for a house, I wouldn't go out and pay cash for a house, I would take a mortgage on that house and use the interest generated from my side account of 200k to make the payments. In 30 years, (or 15, whatever) I have my house paid off and the value of that, plus the 200k.
All the while I have a hedge against inflation (fixed mortgage, not ARMs) and protection knowing that if something happens (disability, lose my job, etc, ) I still have the 200k to fall back on. If the same bad thing happens and I have my house paid off, I can't get at that money.
But if you bought a $100,000 house, and banked the other $100,000, you wouldn't need to earn much to keep afloat. Especially if you had a good LTD policy. And it's less risky, to boot.
Even if you paid off the $200,000 house right away, you would have a darned big shovel to start building up equity, without being nickeled and dimed to death with payments.
Of course, there is risk to paying down house debt: Paying down house debt while you have car debt and credit card debt and student loan debt is stupid. So is paying down house debt without a 6 month emergency fund. If you try to pay down your house while you have other debts, if you ever have an emergency, all your money will be tied up in a house, and getting money from your house can be problemmatic, like has been said several times before on this thread.
Your equity will grow at the same rate regardless of you having a mortgage or not.
I would submit that paying off your house early is a very risky investment, you can only lose money by doing that. Your house will appreciate/depriciate no matter how much of a mortgage you do or don't have.
A (an?) LTD policy would be an added expense to that.
I would submit that paying off your house early is a very risky investment, you can only lose money by doing that. Your house will appreciate/depriciate no matter how much of a mortgage you do or don't have.
A (an?) LTD policy would be an added expense to that.
Other than your comment about the LTD policy (which you're an idiot if you don't have one anyway - "Derrr, my plan if I'm disabled long-term is to hose my family, Derrr!") costing money, I disagree completely with the above post.
Saying that "you can only lose money" by paying off your house early is doublespeak, and incorrect.
Paying off your house early gives you a guaranteed absolutely risk-free return, each and every time. (With the caveats I mentioned in my earlier post).
Question for you; do you have a car loan? The reason that I ask, is that it seems to me the folks who freak out about someone paying off their house because it "wastes valuable money" usually don't have a problem peeing away vast amounts of money on depreciating assets such as an automobile. I'm just curious if my estimate is accurate.
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