Bought an older house in a neighborhood I like 1 year ago. 3.75% rate w/ about 79% left to go. Weighing my assets against my debt (student loan and mortgage), I'm worth 50k (however 2/3 assets tied up in 401k/roth/home equity). Does it make more sense to:
1)aggressively pay down the mortgage, or
2)invest all the money that I am able to save?
If "1" is the way to go, I figure I could do it in about 3 years, including an immediate pay-down transfer from a liquid fund. Or, 4.5 years if the available funds are applied else where...
If "2" is best, should I stop maxing out the 401k and Roth IRA in order to allocate monies elsewhere?
thanks for any and all input
pay down mortgage or invest?
If you have a reasonable chance of earning more than 3.75% through investments, I vote for #2. Once you save up and have enough $ invested, you will have the choice of paying off the mortgage.
The second part of your question (if "2" is best...) is hard to answer without knowing your goals. For instance, how long do you have until retirement? If you are 55 and want to retire at 60, it might make sense to put your money into a 401(k) or Roth IRA. However, if you're 25 and want to retire in five years, that's probably not the most strategic approach.
The second part of your question (if "2" is best...) is hard to answer without knowing your goals. For instance, how long do you have until retirement? If you are 55 and want to retire at 60, it might make sense to put your money into a 401(k) or Roth IRA. However, if you're 25 and want to retire in five years, that's probably not the most strategic approach.
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CelticTiger
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http://www.mrmoneymustache.com/2012/02/ ... -question/
I guess a lot depends on your age or attitude to risk.
I ran a spreadsheet on investment performance at different rates ie. 3,5,8 and 10% vs the guaranteed 3.99% on my mortgage. I decided to overpay a bit (30%) and invest a bit more (70%) of my allocated investment/savings money.
I spent a long time pondering if one in the hand was worth more than two in the bush (an old phrase my granmother use to say).
Either way it is a win win situation. I'm just happy I have woken up and made that choice. There are sheeple out their who wouldn't even consider it and i'm proud not to be one of them
I guess a lot depends on your age or attitude to risk.
I ran a spreadsheet on investment performance at different rates ie. 3,5,8 and 10% vs the guaranteed 3.99% on my mortgage. I decided to overpay a bit (30%) and invest a bit more (70%) of my allocated investment/savings money.
I spent a long time pondering if one in the hand was worth more than two in the bush (an old phrase my granmother use to say).
Either way it is a win win situation. I'm just happy I have woken up and made that choice. There are sheeple out their who wouldn't even consider it and i'm proud not to be one of them
It's a false choice -- you should probably do some of both (unless you can predict the future with certainty). Diversification of savings is similar to diversification of investments, and is predicated on the idea that the future is uncertain. In the real world, you won't know which one was best until you have the benefit of hindsight.
But I agree that paying down the student loan makes more sense than paying down the mortgage, unless the interest rate is lower or you are on some kind of forgiveness program.
For 2, I think I would continue maxing out the tax-advantaged options before doing other things, but the ideal strategy for you would depend on many other factors mostly having to do with when you expect to access the money.
But I agree that paying down the student loan makes more sense than paying down the mortgage, unless the interest rate is lower or you are on some kind of forgiveness program.
For 2, I think I would continue maxing out the tax-advantaged options before doing other things, but the ideal strategy for you would depend on many other factors mostly having to do with when you expect to access the money.
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squashroll
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@llorona
I'm 35 with/ government job. Unhappy(miserable?)at work. However, it pays too much to quit and eligible for a good retirement in 15 years (age 50). sorta like the "golden handcuffs" that Jacob describes. Can't access my 401k without penalty till age 59.5.
@CelticTiger
Thanks for the great link! I don't sleep well when taking "risks". I kinda like that 30/70 split line of thought. I'm 35.
@DutchGirl
Student loan 23k, fixed 1.65%. I was planning on letting that one ride for the full 11 years that remain.
I'm 35 with/ government job. Unhappy(miserable?)at work. However, it pays too much to quit and eligible for a good retirement in 15 years (age 50). sorta like the "golden handcuffs" that Jacob describes. Can't access my 401k without penalty till age 59.5.
@CelticTiger
Thanks for the great link! I don't sleep well when taking "risks". I kinda like that 30/70 split line of thought. I'm 35.
@DutchGirl
Student loan 23k, fixed 1.65%. I was planning on letting that one ride for the full 11 years that remain.
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squashroll
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Dragline and Celtic Tiger both make valid points about taking a more moderate "split" approach. CT is also right in that you can't lose with any of the paths you're considering. However, my thinking is:
1) Why tie up your cash in a house if you don't have to? If you invest in a relatively low-risk investment, like a tax-free municipal bond fund, you have a good chance of earning 4-5% interest each year. Also, the feds allow you to write off mortgage interest which represents savings. For these reasons, I would still go with saving and investing, then paying off the mortgage in one lump sum.
2) You mention that your net worth is about $50K, with the majority tied up in retirement and home equity. Do you feel that you would have enough of a cash buffer in the event of an emergency, like if your car and roof simultaneously needed to be replaced?
3) It seems like you'll need to adjust your investing strategy to account for the 9.5-year gap between age 50 and 59.5, when you can start drawing from your retirement accounts. Maybe you could split the money you save each month between retirement accounts and non-retirement accounts?
1) Why tie up your cash in a house if you don't have to? If you invest in a relatively low-risk investment, like a tax-free municipal bond fund, you have a good chance of earning 4-5% interest each year. Also, the feds allow you to write off mortgage interest which represents savings. For these reasons, I would still go with saving and investing, then paying off the mortgage in one lump sum.
2) You mention that your net worth is about $50K, with the majority tied up in retirement and home equity. Do you feel that you would have enough of a cash buffer in the event of an emergency, like if your car and roof simultaneously needed to be replaced?
3) It seems like you'll need to adjust your investing strategy to account for the 9.5-year gap between age 50 and 59.5, when you can start drawing from your retirement accounts. Maybe you could split the money you save each month between retirement accounts and non-retirement accounts?
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George the original one
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Everybody's giving you sound advice. It's not an either/or choice. Whatever you do, don't be cash poor -- definitely save some in a taxable account or a Roth IRA.
If you're seriously planning on sticking it out for 15 years, then I'd strongly urge stashing money in a Roth IRA. 15 yrs * $5500/yr = $8600/yr that you can withdraw penalty-free & tax-free during your 9.5 year gap from age 50 to age 59.5. It's also very likely that if you've been contributing to a Roth IRA 15 years that it will be capable of throwing off that much cash without drawing it down.
If you're seriously planning on sticking it out for 15 years, then I'd strongly urge stashing money in a Roth IRA. 15 yrs * $5500/yr = $8600/yr that you can withdraw penalty-free & tax-free during your 9.5 year gap from age 50 to age 59.5. It's also very likely that if you've been contributing to a Roth IRA 15 years that it will be capable of throwing off that much cash without drawing it down.
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Spartan_Warrior
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I faced a similar decision. Last year I did roughly 45%/55% mortgage pre-payment/savings. This year I'll be foregoing mortgage pre-payment almost entirely in favor of savings. I agree with Ilorana's reasoning. Federal taxpayers are subsidizing your interest payments anyway and assuming you can make more from investment (which I was able to do last year), you will come out slightly ahead that way. By pre-paying I was on track to pay my mortgage off in about nine years. This way I'll simply pay it off at the end of nine years in one lump-sum payment (if I so choose; I may just sell depending on the market).
As far as the 401k (TSP?), it probably goes without saying but whatever you do, don't miss out on the matching payment which for federal workers, at least, is 5%. That's all I'm contributing at the moment but then I'm planning to retire around 35.
As far as the 401k (TSP?), it probably goes without saying but whatever you do, don't miss out on the matching payment which for federal workers, at least, is 5%. That's all I'm contributing at the moment but then I'm planning to retire around 35.
People debate this issue a lot, and I think it's a good debate because it exposes a lot of issues relevant to investing an planning.
The common response is if you can earn more than your mortgage interest rate then you should invest. I've never liked this response. First, it seems that most people who ask the question don't know how much they can make investing-- perhaps that's the hidden real question. Additionally if you consider taxes, things becomes more accurate, but even harder to predict-- for instance you don't have to beat your mortgage rate so much as you have to beat the effective rate of your mortgage factoring in the mortgage interest tax deduction. Additionally, you have to beat that with after-tax gains from your investments.
Also, I think it's important to be realistic about how much you'll benefit financially from leveraging yourself. This depends a lot on the size of your mortgage and the difference between your after tax investment returns and after tax mortgage rate. Making 1% on $100k is still only about 80 bucks per month-- you haven't exactly changed your lifestyle with that amount. Perhaps owning your home would allow you to decrease your disability insurance. If you don't have disability insurance, perhaps it's more important to own a dwelling.
The approach that others have suggested about splitting the money up may be wise-- get some experience investing, but also hold some back. In theory earning a 5% after tax return is easy, in real life it isn't always so-- it can be complicated, messy, and you're probably going to screw some things up as you go. I certainly did and still do. Still, if you want to reach the promised land, it seems to be the path one must walk.
The common response is if you can earn more than your mortgage interest rate then you should invest. I've never liked this response. First, it seems that most people who ask the question don't know how much they can make investing-- perhaps that's the hidden real question. Additionally if you consider taxes, things becomes more accurate, but even harder to predict-- for instance you don't have to beat your mortgage rate so much as you have to beat the effective rate of your mortgage factoring in the mortgage interest tax deduction. Additionally, you have to beat that with after-tax gains from your investments.
Also, I think it's important to be realistic about how much you'll benefit financially from leveraging yourself. This depends a lot on the size of your mortgage and the difference between your after tax investment returns and after tax mortgage rate. Making 1% on $100k is still only about 80 bucks per month-- you haven't exactly changed your lifestyle with that amount. Perhaps owning your home would allow you to decrease your disability insurance. If you don't have disability insurance, perhaps it's more important to own a dwelling.
The approach that others have suggested about splitting the money up may be wise-- get some experience investing, but also hold some back. In theory earning a 5% after tax return is easy, in real life it isn't always so-- it can be complicated, messy, and you're probably going to screw some things up as you go. I certainly did and still do. Still, if you want to reach the promised land, it seems to be the path one must walk.
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squashroll
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@llorona
Tax free municipal bond funds. I had not heard of those, interesting... Yes I have an adequate windfall and wouldn't exhaust that. this moderate approach sounds sensible.
@George
Yep, contributing some to Roth IRA as well. Probably it would help as a buffer for that age gap.
@Spartan
wow, you are retiring at 35? how old are you, how long have you been at this? Maybe I should search the blog more before asking those questions. Would you really want to buy the house outright after 9 years when you have all that money working for you?
@Mo
Good points!
Thanks for the thoughtful replies, all!
Tax free municipal bond funds. I had not heard of those, interesting... Yes I have an adequate windfall and wouldn't exhaust that. this moderate approach sounds sensible.
@George
Yep, contributing some to Roth IRA as well. Probably it would help as a buffer for that age gap.
@Spartan
wow, you are retiring at 35? how old are you, how long have you been at this? Maybe I should search the blog more before asking those questions. Would you really want to buy the house outright after 9 years when you have all that money working for you?
@Mo
Good points!
Thanks for the thoughtful replies, all!
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Spartan_Warrior
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@squashroll: I'm 26 now, been considering early retirement since 23 when I entered the work force, got serious (aka found ERE forums) at 25.
I honestly don't know if I would buy the house outright or not--it seemed like a dream house when I got it, but of course it's come with annoyances (see my most recent post regarding neighbors and chicken coops
--but I do know I don't want to feel over-leveraged by still making the mortgage payment once I retire. My options would seem to be pay it off in full, sell it (if market conditions don't make this a loss), or convert it to a rental property. Now that I think about it, I suppose I could just keep making the mortgage payment and draw down my wealth more slowly, but at that point I believe I'll be in a lower tax bracket and won't see as much benefit from paying the interest. I guess I won't know for sure what I want to do until I get there.
I do have a blog you can check out if you're interested. I'm also a gooberment employee.
I honestly don't know if I would buy the house outright or not--it seemed like a dream house when I got it, but of course it's come with annoyances (see my most recent post regarding neighbors and chicken coops
--but I do know I don't want to feel over-leveraged by still making the mortgage payment once I retire. My options would seem to be pay it off in full, sell it (if market conditions don't make this a loss), or convert it to a rental property. Now that I think about it, I suppose I could just keep making the mortgage payment and draw down my wealth more slowly, but at that point I believe I'll be in a lower tax bracket and won't see as much benefit from paying the interest. I guess I won't know for sure what I want to do until I get there.I do have a blog you can check out if you're interested. I'm also a gooberment employee.
I am not an huge advocate of paying the mortgage early.
*Mortgages are politically more attractive that other debts; tax deductible, bailouts possible.
*Mortgages are demonstrably easy to weasel out of... Many people will flat walk away and not be punished. Leads to bubble pricing.
A big one being, the mortgage contract itself. You can make triple payments for 10 years, but you will still lose the house in months if you start missing the standard payment... I personally know someone who prided themselves on paying 2-3x monthly payments. They ended up in foreclosure after they lost their jobs.
Mortgage is not a savings account. Investment accounts don't drop to zero if you miss a deposit. If they hadn't made all those extra payments they most likely could have weathered the storm for a few years and kept their house and equity.
Hmmm... Callable debts are the only ones I'm really comfortable with.
*Mortgages are politically more attractive that other debts; tax deductible, bailouts possible.
*Mortgages are demonstrably easy to weasel out of... Many people will flat walk away and not be punished. Leads to bubble pricing.
A big one being, the mortgage contract itself. You can make triple payments for 10 years, but you will still lose the house in months if you start missing the standard payment... I personally know someone who prided themselves on paying 2-3x monthly payments. They ended up in foreclosure after they lost their jobs.
Mortgage is not a savings account. Investment accounts don't drop to zero if you miss a deposit. If they hadn't made all those extra payments they most likely could have weathered the storm for a few years and kept their house and equity.
Hmmm... Callable debts are the only ones I'm really comfortable with.
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George the original one
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@ JohnnyH: I doubt anyone is making triple payments and still have a mortgage after 10 years (unless they have a 50 year mortgage). With a 15 year mortgage, making double payments, you'd be mortgage free in 6 years. With a 30 year, around 9 years. The example you give is a good point but its just one example. You can never predict when financial hardship will hit you. It could be now while you are making mortgage payments or later when you are debt and mortgage free. All I know is they can't foreclose on a paid for home (as long as of course you don't have other debt).
@OP: I've had similar debates back and forth myself and running the numbers, I really didn't find a difference between what I did first. This is of course only if you want to be FI AND debt free (some are comfortable having debt and being FI). You can run your own numbers with excel, if you know how to calculate FV. I found that paying down debt first, delayed FI only by a little bit (specifically only months). The faster you aim to reach FI/debt free, the less it matters what you do first (because compounding becomes less important). This was one of the points in Jacob's book. FI in 5 years doesn't depend on your rate of return, but on your saving rate.
@OP: I've had similar debates back and forth myself and running the numbers, I really didn't find a difference between what I did first. This is of course only if you want to be FI AND debt free (some are comfortable having debt and being FI). You can run your own numbers with excel, if you know how to calculate FV. I found that paying down debt first, delayed FI only by a little bit (specifically only months). The faster you aim to reach FI/debt free, the less it matters what you do first (because compounding becomes less important). This was one of the points in Jacob's book. FI in 5 years doesn't depend on your rate of return, but on your saving rate.
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George the original one
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@squashroll - so far I've danced around specifics because people have different comfort zones.
For myself, I'm comfortable investing instead of paying down the mortgage because I'm confident that I can get a higher return than a mortgage that's under 3% or 4% (or even 5%, but no one should be carrying a mortgage with that high of a rate these days).
I also like knowing that if I lost my job today, it would be 5+ years before I need to find one to make the next mortgage payment... if I had done nothing but aggressively pay off the mortgage, I would not have that peace of mind because the mortgage still would not be paid off.
However, I'm not comfortable carrying a mortgage on my residence in retirement. Even if I can increase my returns by doing so because retirement, for me, means gaining control of my time, reducing the complexity & risk in my life and a mortgage is an unnecessary complexity.
If I were holding rental properties, then I'd probably be comfortable with a mortgage on some of them in retirement. Just not my own residence.
For myself, I'm comfortable investing instead of paying down the mortgage because I'm confident that I can get a higher return than a mortgage that's under 3% or 4% (or even 5%, but no one should be carrying a mortgage with that high of a rate these days).
I also like knowing that if I lost my job today, it would be 5+ years before I need to find one to make the next mortgage payment... if I had done nothing but aggressively pay off the mortgage, I would not have that peace of mind because the mortgage still would not be paid off.
However, I'm not comfortable carrying a mortgage on my residence in retirement. Even if I can increase my returns by doing so because retirement, for me, means gaining control of my time, reducing the complexity & risk in my life and a mortgage is an unnecessary complexity.
If I were holding rental properties, then I'd probably be comfortable with a mortgage on some of them in retirement. Just not my own residence.
I paid off my 30 year mortgage on my home in 5 years at the age of 28. There was no better feeling in the world than sending that last electronic payment and receiving the final statement with a zero balance. For me, this was the right course of action. I love having the security and knowing that my home is MINE.