Sunday, November 12, 2006

Paying off a mortgage early...or not?

Should you get a 15 or 30 year mortgage? I personally feel a 30 year because you can always pay it as a 15 year if you choose, yet are not bound into higher payments if you lose your job or any emergency should arise.

Now should you pay off the mortgage faster than either 15 or 30 years? I say yes, but only if you are already maxing out your retirement savings, have a comfortable cushion on savings for new cars, maintenance of the house/cars, vacations, college savings, and any other expenses.

Now why? Because as long you are disciplined and save the excess in say a 401k or Roth IRA then you are making more than your current 6% mortgage rate. Now to max out your retirement you should be saving $19k/year. If you follow Dave Ramsey's 15% rule, that means you need to be making $126k/year.

So my philosophy is this, instead of paying off the mortgage, max out the 401k and Roth IRA and take advantage of the tax break. You also get a tax break on the mortgage, but that's not a reason to keep it. Keeping it for investment purposes will help because when you retire, you need to generate enough income to throw off the property taxes you may owe when you retire. Those never go away, only the mortgage.

Now if you are in the 15% federal tax bracket, by investing in a 401k, you area already deferring an extra 9% on your mortgage, and you have compounding returns on your investment. So you are coming out way ahead by saving in a 401k.

You reply, I'll have my mortgage payment to invest if I pay off the house. Sure you will, but you can not go back to 2006 and max out your 401k. You will be forced to invest in a taxable account where you will pay taxes on your interest/dividends going forward. That means less compounding.

"But I'll catch up.." No you won't if you saw my earlier post on how much a difference 5-10 years can make on compound investing for retirement, you'll never catch up. Especially if I've been saving in a 401k and Roth IRA. You will also save in 401k and Roth IRA, but also be forced to save in a taxable account the overage. I'll have extra money in my account because I won't have to pay on my returns every year like you will on your taxable account, so the Roth and 401k always grow faster.

I will also at this time be keeping my mortgage with it's tax break. For myself personally it's a 28% write off on a family that's double income no kids. The break is substantial. Plus we're maxing out our retirement accounts, and in the future I'm going to divert the rest to college savings. I guess I should add our mortgage is so large that we pay $20k in interest alone a year, way above the standard deduction. But we keep it because we feel that saving the maximum in retirement accounts more important.

It is mostly about risk, but I see very little risk involved with investing in a 401k or Roth IRA where your tax break outweighs a 6% fixed rate mortgage.

So should you personally pay off the house? I don't know, there are a lot of factors involved. But a good rule of thumb would be no, if you haven't saved $19k/annually per person a year into a retirement account. Otherwise, sure go crazy and pay it off.


Chris said...

I would say it depends, if the mortgage is for your own house, or a house you bought for investment.

Your own: of course, pay off as soon as possible. You don't want to waste your money for bankers interest, don't you?

Investment? Let it go and pay off the mortgage with the rent of your tenant (hopefully you got one).

Then you can put those costs against your rent gains and probably still save taxes, while owning the house for your retirement income stream...



Living Almost Large said...

Actually even if it is for your own house it really doesn't make sense for us to payoff a mortgage. It's current rate of 4.25% is effectively after the tax break 3%. I can make 3% in ING with the extra money, or I could buy CD generating that much return.

Now with a rental, definitely I wouldn't pay it off. I'd probably keep the extra cash if there was any and use it to pay fo repairs. OF course I would never buy a renal that did not have positive cash flow because I wouldn't want to count on appreciation. The only caveat is if it's being rented to family in which case I would be willing to take a loss. My mom does this with her parents, it's a money losing proposition, but what can you do?

Anonymous said...

I'm a proponent of paying it off. Money paid in interest is, for the most part, wasted. It's time for a revolution in the way we understand and deal with money!

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