Paying down a home mortage vs alternate investments. Looking for advice

[DCG]

Figured you smart folks might be able to give some advice about this.

 

 

We have a mortgage on our house, and had a townhouse we were renting out that we recently sold.

 

 

We're trying to decide whether it makes sense to put the cash we had tied up in that property into paying a good chunk of the mortgage on our house left. We'd be able to pay off approximately 50-60% of our mortgage, and could theoretically pay off our house in the next 5-6 or so years if we did that. Our mortgage is currently about 5%. We don't think our current house will be our permanent house, and will likely try to sell it in probably about 3-6 years from now, but we're not sure about that.

 

 

Does paying down that much of the mortgage make sense, or should we consider putting the $ into stocks or other investments? So I guess the question to ask ourselves is whether we can invest the cash at a rate higher than 5% (our mortgage amount), but we also don't want to risk losing much of it.

[ERICOPOLY]

We don't think our current house will be our permanent house, and will likely try to sell it in probably about 3-6 years from now, but we're not sure about that.

 

How would you afford the next house if all of your money were sunk in the current house?  Get a cash-out refinance?  A HELOC?

 

Sell the one you own before buying the next one?  Does this put you in a hurry to buy the next house after selling the first?

 

Does it mean you need to get a bridge loan to buy the next house -- sellers don't like that so you might lose out bidding on the house you want.

 

Seems like a pain in the butt.

 

[DCG]

We don't think our current house will be our permanent house, and will likely try to sell it in probably about 3-6 years from now, but we're not sure about that.

 

How would you afford the next house if all of your money were sunk in the current house?  Get a cash-out refinance?  A HELOC?

 

Sell the one you own before buying the next one?  Does this put you in a hurry to buy the next house after selling the first?

 

Does it mean you need to get a bridge loan to buy the next house -- sellers don't like that so you might lose out bidding on the house you want.

 

Seems like a pain in the butt.

 

 

We'd have to sell our current house. So a purchase of a new house would have to be contingent of selling our current house, which is very common.

[ERICOPOLY]

I was in a similar position in 2006.  I had about $200k to invest in my taxable account -- this money had come from selling a rental property.  I had a home mortgage at the time (only about 10% equity in my primary home).  The $200k was enough to pay off 50% of my home mortgage debt.

 

Instead, I sunk the entire $200k into Fairfax calls.  Well, good look with whatever you decide to do.

 

[DCG]

Instead, I sunk the entire $200k into Fairfax calls.  Well, good look with whatever you decide to do.

 

 

The issue is I'm having a hard time finding stocks with a large discount to fair value right now without a lot of risk (I'm not really looking to put all our cash into companies like SHLD and JCP that have the potential to be insolvent within a few years). If I was in the same position in 2007 this putting the money into stocks vs paying off a mortgage wouldn't be a question.

[Uccmal]

DCG,

 

This is a very interesting question.  I get asked by friends and my wife's family to invest money for them.  These days I am telling everyone to take the excess cash and pay down their mortgage. 

 

In your case the question is more ambiguous.  I know in the Us that some of your mortgage interest is tax deductible.  On the other hand you are paying the mortgage in after tax dollars, so we need to set a bogey of say 7-8 %.  Can you beat 7-8% going forward WITHOUT risk to your principle.  At some point you will need to renegotiate the mortgage rate, perhaps at even higher rates.  Can you beat 12% under the same conditions. 

 

Put another way.  My 9 year returns are somewhere over 25%, after tax.  I am preparing to take

200 k off the table as soon as Bac, AIG approach book value and pay down my mortgage completely.  My mortgage is 3.7%.  I cant think of anything more satisfying or safer than owning my own house outright.  Barring war, civil, or otherwise, in Canada, owning my own home outright is safer than US or Canadian treasuries. 

 

This is obviously circumstantial.  In 2009, stocks were at multi-generation lows so the risk reward profile was different.  These days I am going to have to go way down the quality, and yield curve, to do as well with stocks.  That is something I am unwilling to do anymore. 

 

I Dont know if that kind of mental model helps clarify your thinking.

[matjone]

It is a tough call.  I asked the same thing a while back and got a lot of different answers so you could revisit that thread if you wanted some different perspectives.  It depends on the rate you are paying vs. what you think you can get, but it also depends on how much cash flow you get from your job/business and how secure that is, how much wealth you have, how old you are, your personality, all kinds of things.

 

Here's a crazy idea...  take the cash and invest it in tax liens at rates of 18% or more.  That way if the economy stays good they likely redeem and you are way above your hurdle, but if we go into a depression and the investment goes bad and you lose your job and you can't pay your note,  you get another house.

[bargainman]

after thinking about it for quite some time, I really have no idea why anybody especially anybody in United States, would ever want to fully pay off their mortgage, especially at the current rates that we have today. If you have a mortgage rate at 4 percent or less for 30 years, (remember that that is tax deductible as well) so you are in an insanely low borrowed rate! You have money that is liquid, generally a non-recourse load.. You can invest in other things like the stock market. Even if you don't find anything that is insanely cheap in the stock market, time and again it's been shown that over a 20 to 30 year periods, the stock market returns will be 6-7 percent after inflation is taken into account.  Real estate will not.  Plus over time the real value of the loan goes down with inflation..  Why would anyone ever want to pay off their mortgage?  It makes no logical/rational sense as far as I can tell..  As long as you're not over leveraged...

[ERICOPOLY]

Instead, I sunk the entire $200k into Fairfax calls.  Well, good look with whatever you decide to do.

 

 

The issue is I'm having a hard time finding stocks with a large discount to fair value right now without a lot of risk (I'm not really looking to put all our cash into companies like SHLD and JCP that have the potential to be insolvent within a few years). If I was in the same position in 2007 this putting the money into stocks vs paying off a mortgage wouldn't be a question.

 

What's your tax bracket?

 

I'm assuming you have a 30 yr mortgage...

 

So invest in tax-exempt muni bonds -- maybe 7 yr duration.  Here in California your after-tax mortgage cost would be lower than your tax-exempt muni income (our tax rates go all the way to 50%).

 

Then in 7 years, you can reinvest at (likely) higher interest rates.  Maybe even Treasuries will yield more than your mortgage 7 years from now.  Then you'll effectively have a mortgage with negative interest rate!

[bookie71]

Before you can figure your tax benefit from the interest you need to factor in the standard deduction which you get anyway whether you itemize or not.  Then IF your gross income is over a certain amount your itemized deductions are reduced to the standard deduction.

Te easiest way is to input your info into one of the tax programs and see what your tax is with and without.

[original mungerville]

DCG,

 

This is a very interesting question.  I get asked by friends and my wife's family to invest money for them.  These days I am telling everyone to take the excess cash and pay down their mortgage. 

 

In your case the question is more ambiguous.  I know in the Us that some of your mortgage interest is tax deductible.  On the other hand you are paying the mortgage in after tax dollars, so we need to set a bogey of say 7-8 %.  Can you beat 7-8% going forward WITHOUT risk to your principle.  At some point you will need to renegotiate the mortgage rate, perhaps at even higher rates.  Can you beat 12% under the same conditions. 

 

Put another way.  My 9 year returns are somewhere over 25%, after tax.  I am preparing to take

200 k off the table as soon as Bac, AIG approach book value and pay down my mortgage completely.  My mortgage is 3.7%.  I cant think of anything more satisfying or safer than owning my own house outright.  Barring war, civil, or otherwise, in Canada, owning my own home outright is safer than US or Canadian treasuries. 

 

This is obviously circumstantial.  In 2009, stocks were at multi-generation lows so the risk reward profile was different.  These days I am going to have to go way down the quality, and yield curve, to do as well with stocks.  That is something I am unwilling to do anymore. 

 

I Dont know if that kind of mental model helps clarify your thinking.

 

I agree completely with Uccmal - at this point in time, the market is very high so for the average person, definitely pay down the mortgage... but those on this board are a little more involved in investing so the answer is more difficult.

 

You aren't buying the market, so there should always be something to do in small caps, etc. But if you are not finding anything, there will be another time to borrow a lot (secured against your house) to invest and it probably is not today. Further, the pressure of not having to invest in something now (because you paid down the mortgage and don't have the cash) and the barrier to accessing that cash (ie going to the bank to set up a HELOC) will help ensure that when you do decide to go through the trouble of getting that HELOC and borrowing against your residence, the investment will have a very large margin of safety.

 

If you are in the US with 30 year mortgages that are tax deductible, however, the question becomes even more difficult. You could make a little spread on something marginal like the muni suggestion by Ericopoly and not lose money but that does expose you to some risk. Psychologically, paying the thing off but being prepared to draw down on it if something really mouth watering comes around (like Fairfax calls in the mid 2000s!), is much more powerful in my view. I remember reading one of the Money Masters books and the writer talked about some farmer that never invested, saved up cash, and every time there was blood in the streets in terms of the stock market, he would call up his broker and buy up all sorts of stocks, then go back to saving - sounded like he did that every 5-6 years.

 

If you aren't finding anything now, you can do a lot worse than to be like that farmer. 

 

 

 

[Uccmal]

after thinking about it for quite some time, I really have no idea why anybody especially anybody in United States, would ever want to fully pay off their mortgage, especially at the current rates that we have today. If you have a mortgage rate at 4 percent or less for 30 years, (remember that that is tax deductible as well) so you are in an insanely low borrowed rate! You have money that is liquid, generally a non-recourse load.. You can invest in other things like the stock market. Even if you don't find anything that is insanely cheap in the stock market, time and again it's been shown that over a 20 to 30 year periods, the stock market returns will be 6-7 percent after inflation is taken into account.  Real estate will not.  Plus over time the real value of the loan goes down with inflation..  Why would anyone ever want to pay off their mortgage?  It makes no logical/rational sense as far as I can tell..  As long as you're not over leveraged...

 

I agree with your logic but not where it is taking you.  There are several assumptions in your statement:

1) That the investment someone chooses will equal the stock returns.  They often dont.

2) That the person doesn't get spooked out of their investment at the wrong time.  They often do.

3) That they have a mortgage that cheap for 30 years.  Most don't and will face a readjustment at an inopportune time when interest rates are double digit.

4) That the person buys stocks throughout the cycle, not just at the top of the market. 

5) That the person buys a properly run ETF via dollar cost averaging and never gets spooked. 

The majority of people cannot adequately describe what a stock is, or what a stock market is, but they do understand their mortgage payments.

 

I am with Peter Lynch and others on this one.  Pay the mortgage first.  Unless you have the kind of investing ability of some of the board members here.  We just went through a period of huge numbers of people using their homes as cash machines and look where it ended up. 

 

I don't know where DCg stands in terms of tax rates, age, mortgage ability, or investing ability; the above likely does not apply to him. 

[ERICOPOLY]

You could make a little spread on something marginal like the muni suggestion by Ericopoly and not lose money but that does expose you to some risk.

 

Paying off the house has some risk as well, although very small.

 

House burns down and your insurance company is insolvent?

or

You don't carry earthquake insurance?  Maybe you thought it wasn't necessary in Seattle?  I think for example most in Seattle do not carry it, although there is a risk of a large quake there.  I don't know where he lives, but I'm familiar with Seattle.  Even here in California many don't carry it.

 

I presume the mortgage is non-recourse... that can be very handy!!!!  Although not very likely.  Kind of like a basket of munis being worthless is not very likely.

 

[fareastwarriors]

Eric, do you own your home? I forgot. Do you carry earthquake insurance? Which carrier?

 

I haven't really checked it out but just heard it was really cost prohibitive.  I live in the SF Bay Area and I think nearly all of my family/friends don't carry quake insurance.

[ERICOPOLY]

Eric, do you own your home? I forgot. Do you carry earthquake insurance? Which carrier?

 

I haven't really checked it out but just heard it was really cost prohibitive.  I live in the SF Bay Area and I think nearly all of my family/friends don't carry quake insurance.

 

I'm renting.  I signed a purchase option in July 2013 -- expires in July 2016.

 

I view the non-recourse language in the mortgage to be a nice way of protecting yourself if you can finance as much as possible of the property (preferably 100%).

 

There's nothing risky about zero-down mortgages.  They are in some ways less risky as you have nothing at risk (no risk of house price declines, no risk of uninsured losses, etc...).  Unfortunately, they became hard/impossible to obtain after the crisis.

 

It's like having a put, sort of (you suffer only credit ratings hit if you walk).

 

EDIT:  I forgot to mention, I made my landlord purchase earthquake insurance as a condition for the option agreement.  I was worried that he might not be able to rebuild a damaged home, making my option worthless in the event of a serious earthquake.

 

[CorpRaider]

You could make a little spread on something marginal like the muni suggestion by Ericopoly and not lose money but that does expose you to some risk.

 

Paying off the house has some risk as well, although very small.

 

House burns down and your insurance company is insolvent?

or

You don't carry earthquake insurance?  Maybe you thought it wasn't necessary in Seattle?  I think for example most in Seattle do not carry it, although there is a risk of a large quake there.  I don't know where he lives, but I'm familiar with Seattle.  Even here in California many don't carry it.

 

I presume the mortgage is non-recourse... that can be very handy!!!!  Although not very likely.  Kind of like a basket of munis being worthless is not very likely.

 

Exactly.  Or what if property values tank again WHEN rates rise, or if you live in the burbs and everyone continues to decide that they should live in the city, or if a crack house opens up down the street because your mayor decides to throw a party, or your house burns down and insurance company tells you to go eff yourself.  Also, the home is probably less liquid than most other investments, even munis; you've just said you're going to need the liquidity within a few years when you hope to sell.  I would try and keep it in something liquid that earns more than your after tax rate on your mortgage, assuming you have a 30 year fixed.  I think some of our canadian friends don't realize that most people in the US have 30 year fixed mortgage rates.  I don't think any of us should be rushing to pay back ~4%, 30 year fixed-term, tax deductible debt.

[original mungerville]

You could make a little spread on something marginal like the muni suggestion by Ericopoly and not lose money but that does expose you to some risk.

 

Paying off the house has some risk as well, although very small.

 

House burns down and your insurance company is insolvent?

or

You don't carry earthquake insurance?  Maybe you thought it wasn't necessary in Seattle?  I think for example most in Seattle do not carry it, although there is a risk of a large quake there.  I don't know where he lives, but I'm familiar with Seattle.  Even here in California many don't carry it.

 

I presume the mortgage is non-recourse... that can be very handy!!!!  Although not very likely.  Kind of like a basket of munis being worthless is not very likely.

 

Eric,

 

Those insurance and earthquake risks remain present when you layer on the muni risk. But if your point is that a paid off house is not some sacred risk-free thing, then I certainly agree. My point was not that munis are too risky, but that that is kinda marginal, and that it is nice to be removed from the need to invest and to only draw down on the house when there is a huge opportunity.

 

 

[original mungerville]

Now if its going to be hard to draw down on the house in future outside a mortgage (eg, if you are retiring early soon, etc), or if you think interest rates are going to spike, etc, and the 30-year tax deductible option is there, the answer is probably different.

 

I would just try to earn a minor positive or negative spread over a tax deductible 3% with as little risk as possible. I would take a  small negative spread rather than to expose myself to minor risk in order to earn a small positive spread. I would reserve risk exposure for when the opportunity is large relative to the price paid.

 

[Cardboard]

"I think some of our canadian friends don't realize that most people in the US have 30 year fixed mortgage rates.  I don't think any of us should be rushing to pay back ~4%, 30 year fixed-term, tax deductible debt."

 

That is 2 phenomenal advantages that you guys have.

 

If it wasn't for the 30 year at such low fixed rate (here it is normally locked for only 5 years), I would still recommend Original mungerville suggestion of paying off the mortgage and then to go for a Heloc once the cash is needed to invest. At least up here when you go for that Heloc and demonstrate that you use the proceeds to invest, the interest becomes fully tax deductible and there is no deduction limit.

 

Cardboard

[DCG]

I don't know where DCg stands in terms of tax rates, age, mortgage ability, or investing ability; the above likely does not apply to him.

 

 

I'm 37 years old, have a 30-year-fixed mortage, & I think we're (my wife & I) taxed at either 25% or 28%. As far as investing ability, I've done well over the last 6 or so years (although I started with a relatively small amount of investable cash), but it's been a great run for the market. I'm not naive enough to think that I can guarantee I can continue to produce great returns every year going forward.

[Ham Hockers]

Most of us will never ever get better leverage than 30 year fixed around current rates. FWIW my mortgage is defeased with uninvested cash on hand, so I'm basically paying for the option that this is someday massively in the money (which I think it will be ... i mean there's still 28 years left on this thing).

[ERICOPOLY]

Those insurance and earthquake risks remain present when you layer on the muni risk.

 

Only to the extent that you have equity in the home is it your liability (it's somebody else's liability now if you have no equity in the home).  I'm not sure there are many people anymore with 0% equity in their homes -- my point (I think) is valid as long as there is somebody with little of their personal wealth in the home, who is contemplating tying up the bulk of their wealth in the home (paying down a huge chunk of mortgage). 

 

My point was that if you have no equity in the home, then you have none of your own money at risk in the event of uninsured damage to the property.

 

I'm assuming a non-recourse mortgage here -- you just turn in the keys to the bank and walk away.  You lose only damage to furniture and belongings (and hopefully no injuries).

 

[CorpRaider]

Yeah, HELOCs generally float or are locked in only for a term and the cap on the deductible portion is much lower than a term mortage in the U.S.  That would almost always be a poor decision here.

 

Yeah, I mean wait till the 10 year is yielding 3% and you're probably coming out ahead on the 4% fixed tax deductible mortgage given the shorter duration of your investment.

 

Exactly, mail them the keys and then head down to the carribean with your AIG-WT money.

[randomep]

You could make a little spread on something marginal like the muni suggestion by Ericopoly and not lose money but that does expose you to some risk.

 

Paying off the house has some risk as well, although very small.

 

House burns down and your insurance company is insolvent?

or

You don't carry earthquake insurance?  Maybe you thought it wasn't necessary in Seattle?  I think for example most in Seattle do not carry it, although there is a risk of a large quake there.  I don't know where he lives, but I'm familiar with Seattle.  Even here in California many don't carry it.

 

I presume the mortgage is non-recourse... that can be very handy!!!!  Although not very likely.  Kind of like a basket of munis being worthless is not very likely.

 

Eric,

 

Those insurance and earthquake risks remain present when you layer on the muni risk. But if your point is that a paid off house is not some sacred risk-free thing, then I certainly agree. My point was not that munis are too risky, but that that is kinda marginal, and that it is nice to be removed from the need to invest and to only draw down on the house when there is a huge opportunity.

 

Insurance companies are backed by the state no? So if they can't pay the state will.

 

In the event of an earthquakes, if you don't have earthquake insurance and your house is totalled there is a big chance IMO that FEMA will help pay for restoring your house.

 

But I think the mortgage vs. investment issue depends on your equity in the house. I think 100% is too much but 30% sounds just right and after that you can use money to invest.

 

 

[Ham Hockers]

In the event of an earthquakes, if you don't have earthquake insurance and your house is totalled there is a big chance IMO that FEMA will help pay for restoring your house.

 

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