Pay off mortgage?

[Joe689]

Good points, you are right.    But I guess in some sense, what can you do?  We need a home to live.  With or without the mortgage we are on the hook?  Not like if values go down, I can runaway from the loan?    The answer would be to only rent or live in a dump?   

[Lance]

Do whatever your most comfortable doing.

 

I would be most comfortable buying the $500,000 home, making a $100,000 down payment thus avoiding having to pay pmi and then buy:

 

Municipal money market - $25k

Long term treasuries and short term investment grade debt split evenly - $75k

 

Large cap dividend payers that I expect to raise their dividends - $250k (e.g. Dividend aristocrats, utilities, healthcare, staples, telecoms, tech, a few industrials, discretionary and financials)

 

Leveraged, high yielding closed end funds trading at a discount to net asset value - $50k (e.g. option funds, municipals, commodity, convertibles, high yield, energy, infrastructure, etc.)

 

I would take the dividends as cash and selectively reinvest in existing holdings, make additional investments or perhaps use to pay down the mortgage.  The mortgage deduction is taken advantage of, I have cash coming in to invest or use for expenses and I'd sleep well at night.  Also, I'd scale into most of these.

 

Thanks

Lance

 

 

 

[Viking]

Joe, as has been stated, you need to go with an option that lets you sleep at night.

 

Having said that, what mortgage rate would you be able to secure? My guess is mortgage rates in the US are at historic lows. If you want to have some long term debt in your portfolio (at very low rates) this looks like a good time to lock some in.

 

Should interest rates continue higher in the coming years you may find reasonable investments for your cash. Why are you so risk averse? Is it you do not know what you are doing? Do you have a decent track record? I would think it possible to secure at least a 6% return on your investments over time if you spent the time to learn and execute and that is surely better than what you have to pay on your mortgage.

 

I was faced with a similar dilemma (when I bought my house in a suburb of Vancouver 7 years ago) - do I pay cash or take on a mortgage? I decided to go 1/3 cash and 2/3 mortgage (rate is currently at 2.79%). I decided I could earn better than 2.79% by investing and the decision has been a slam dunk as I have been able to earn a much higher rate of return on my investments. And over many years the power of compounding is a very beautiful thing! Now I love all things about investing and I (happily) spend lots of time on it :-)

 

 

[Read the Footnotes]

Hi Joe,

 

It seems like there are some assets such as the aforementioned retirement accounts and the brokerage accounts that weren't mentioned until page 3 of this thread. You'd probably get better advice by disclosing more information that would allow the computation of a ratio of this proposed house purchase to your total net worth and your annual earned and unearned income. Of course, that issue really points out that your best move might be to consult a professional. You might find excellent value for money by going to a fee only financial planner. Some can be very good, and a couple of hours and a couple hundred dollars might set you with an improved financial plan that could increase your net worth substantially given your long runway. With that said, you have gotten some good tips for free here, so here are a few more tips.

 

 

First, I think the issue of affordability of this home is worth addressing. Here are a few approaches:

 

Most lenders won't allow you to go above 36% debt to income, so could you afford a $400,000 mortgage in addition to any other debts you might have?

Another rule of thumb is don't spend more than a third of your income on housing. Including insurance, real estate taxes, maintenance costs, etc, would the cost of this home financed with 80% debt represent more than a third of your income?

Would you be able to afford to rent a similar home? Would your rental housing expenses be more than a third of your income?

Another rule of thumb is not to pay more than 2.5 times annual income. Is it safe to assume you earn in excess of $200,000 per year?

 

I also think that there is an argument that you are putting most all of your eggs in one basket. It's worth remembering that in the high inflation period of the 1970's and early 80's, the best investment available to most people was having a mortgage. It was the closest an individual could come to shorting debt.

 

Think how different it would be to have a $250k house with a $125k mortgage, and a 12 month emergency fund. Without knowing your annual income or whether you have an emergency fund now, my guess is that this would still leave you with several hundred thousand additional dollars to invest in other asset classes. Most assets are priced on the high side these days, but that is a whole other problem. If you're making well over $100k, then this would be very conservative and leave you with a lot of flexibility should the chickens come home to roost regarding those high asset prices.

 

Finally, I know it's been discussed above, but again, your home represents consumption, not investment. A house is only an investment if you can live somewhere else and rent the house to someone. A house is also not a piggy bank unless you intend to downgrade to a cheaper house to tap equity, or tap equity through refinancing. If you think about those options, hopefully it's clear that a house is consumption not investment. The closest comparable is renting. You would think of renting a home as an expense wouldn't you? Owning versus renting is really a financial decision, just as owning outright versus having a mortgage is a financial decision and doesn't magically transform a house from an investment to an expense.

 

You may have sold your previous homes for more than you paid for them, but did you subtract transaction costs? Did you adjust for inflation? Is that a real return or a nominal return? Did you account for any home improvements made? Most people who needed to sell their homes in the US in 2009 generally would not have classified whatever equity they were left with as a savings account. Some studies have indicated that over long periods of time owner occupied homes appreciated less than 1%. Un-levered that's a pretty poor return, and better returns could have been found elsewhere including in a savings account.

 

Many people get lucky and make a real return on their home, but most would have been far better off living in a more modest home thereby consuming less and have more available to save and invest. Also, it sounds like Buffalo is booming now. Could you be buying at a peak? Is it possible that the tide will have turned when you next want to sell?

 

I hope this is helpful. I wish I had fully appreciated these concepts myself 15 year ago. I may have understood them intellectually, but not as viscerally as I do now. I'm not sure I would have acted differently, but I still wish I had understood these concepts as fully as I do now. It's important to fully understand the consequences of your actions even if that understanding would not change your choices.

[Packer16]

Joe,

 

Another Western NY value investor, great!  I live in Rochester.  One item not discussed is taxes & income.  In terms of the value of the mortgage, it may less valuable than you think if you have alot of deductions & you are not in the top tax bracket.  That is what I found.  Typically, between now & when the kids go to college you will have alot of deductions & as you say need for space.  Once the kids are off to college, the need part may decline and also the resources & desire needed to upkeep a home (unless you like doing that sort of thing for fun).     

 

As to the long-term RE market in New York, I am skeptical it will grow unless somehow the taxes are reduced.  The taxes in many case are more the mortgage payments.  It is great to hear Buffalo has had a rebound but from the latest data it appears Buffalo has had a population declined (like Rochester) in 2006 after a few years of increase due to immigration.  I do not see this trend changing as the regulation & taxes in NY are just not competitive with other areas of country & without a magnet like Silicon Valley or Wall Street there is no reason to grow a business here once the start-up tax breaks expire.  It is too bad as I really like the folks here & it is a great place to raise a family.  Even if somehow taxes are reduced and home prices start to appreciate there is tons of land & prices will be capped by new builds, unlike NYC and Toronto that are property constrained.  So as an investment, Western NY real estate I think has pretty limited appeal.

 

IMO opinion you need to make a trade-off between what your break-even rate of return would be considering your tax situation & risk tolerance.  Given the tax & demographic trends I would make an assumption of no home price appreciation.  If you think you can make more (which can be easier if you have not maxed out your tax deferred accounts) then take the mortgage.  IMO I think money is cheap now & will be going forward so I would not be in a hurry to make a decision if you do not need to.

 

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