Investing versus paying off Mortgage

I have about 200,000 left on my mortgage principal. I just refinanced where in for the first 5 years I am just paying off the interest. I did this so that I would pay at my own convenience towards the principal.

My confusion is if I should just put huge chunks of money towards the principal and pay it off in 10 years or should I rather invest the money?

I can still pay some towards the principal and some towards investing, but was wondering if it would be a better idea to put most of that money towards the prinicipal than investing?

I am assuming that investing would give me a return of about 10 % ( Too optimistic??). Also the tax deductions from paying interest on mortgage.

Please advice.

Reply to
Slain
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Assuming the interest rate on the mortgage is relatively low (< 6%), I would be in no hurry to pay it off. But I also wouldn't let it go indefinitely. I think a pretty good goal is to have the mortgage paid off by the time you retire. That significantly cuts down on your income requirement post-retirement.

10% is a good estimate only for long-term investing. Of course, you can never count on that return, but for time horizons of 10-20 years... it's a good bet.

Please don't think that paying interest just to get a tax deduction is a good thing. It's not. I think the best way to look at the deduction for mortgage interest is as a reduction of your interest rate. You can estimate your effective interest rate as

r_eff = (1 - r_tax) * r_int

where r_eff is the effective interest rate of your mortgage, r_tax is your marginal tax rate and r_int is the nominal interest rate of the mortgage. For example, if you're in the 25% tax bracket and the interest rate on your mortgage is 5.375%, your effective interest rate is:

r_eff = (1 - .25) * 5.375% 4.031%

--Bill

Reply to
woessner

I think that fully contributing to your Roth IRA is the first thing you should do for sure. Over the years the compounding of this investment will outstrip your savings in paying off your home. It also gets you into the habit of putting money back for the future. I would pay as much as I could toward the house after I had contributed to all tax savings investments like the Roth IRA, SEP, 401K or whatever you have available.

Reply to
W. Wells

I don't see a rate, it sounds like some type of variable mortgage, no? Is it actually fixed for the full time, but interest only for 5 years?

Not knowing your age or YTR (years to retirement) or your tax bracket, I would say that it's not clear. An average 10% over the terms of your mortgage isn't as likely as some hope. I've seen much evidence that the next 10-20 years lean toward an 8% average. If your mortgage is even 6%, then you are still risking being behind in the bad years. Since you say you just refied, you might have been better off taking a 15 or even 10 year fixed rate fully amortizing. I would want to better know the numbers (both int rate and your marginal tax rate) first before committing. Then, still, how you're fixed for other parts of your finances, 401(k), IRA, etc. All that would change anyone's answer.

JOE

Reply to
joetaxpayer

I don't know the answers, I'm just starting out in this whole financial planing thing but I have some questions...

How much is this convenience costing you? Presumably you could have gotten a lower rate if you had gone with a 15 or 30 year fixed without this convenience...

How long do you plan on living in the house? Five years at interest only isn't much better than renting the way the housing market is right now.

Reply to
Daniel T.

Think of it as an asset allocation decision. Paying off your mortgage is essentially a fixed-income investment returning whatever your interest rate is. It's 100% risk-free, but it's also a very illiquid investment. If you need to tap into that money at some point, you'll have to refinance or get a HELOC, perhaps at a less favorable interest rate than you can get now, and if you need the money because you're unemployed or having other financial troubles, you may find it difficult to get a loan.

You might be able to get a higher return over the long term by investing in equities instead of your mortgage.... but what happens if you need to sell unexpectedly and both the real estate market and the stock market are down?

-Sandra the cynic

Reply to
Sandra Loosemore

Read the fine print on these interest only mortgages. Most are reverse-amortization. That is the difference between interest only and amortized portion is added to the principle. And when the princple reaches a certain amont, typically 110% of initial loan, the interest rate resets higher. Very scary.

Reply to
rick++

I am going through something similar (Just refinanced first and second). Here's some thoughts:

Interest only loans have varying terms. You need to understand your loan. One company was urging me to do a "30 yr interest only", which is really 10 years interest only, then ammortizes at 11th year into a

20 yr fixed loan (on remaining balance). I did not consider this, it makes sense if you plan to move within 10 years... but not something I wanted for house I plan to die in (I went in vertical and want them to take me out the last time horizontal).

Here's the math- the earlier you start "prepaying/overpaying", the better your return.

I have a 2nd mortage which I can afford to send extra principal towards... the extra payment is 3X my monthly bill. This will be paid off 15 years early because I can send pre-payments in early in repayment schedule, and the pre-payment is such a large amount relative to monthly payment.

I have a 1st mortgage which I can afford to send the extra payment to in years 16-30, but even witha 9% return, I come out ahead (net worth) wise investing... so I plan to invest. The extra payments narrow it down from 30 years to 26 years, so saving 4 years of payments does not appear "valuable" to me right now.

Paying off is like compounding in reverse small early pre-payments can make a larger difference than later, larger pre-payments.

Reply to
jIM

Many people are a little too quick to use 10%. Its not necessarily unreasonable, however. 10% is commonly used because that is close to the historical average of the S&P 500. But are you planning on investing fully in large-cap equities?

I have seen many cases where investors plan for 10% returns in a portfolio that is 25-40% bonds. If your intended portfolio doesn't match your benchmark, then don't necessarily expect average historical returns.

As someone else here also stated, there is evidence that suggests future returns will not be as grand as they have historically been.

Reply to
kastnna

Keep in mind that the 10% long-term return is gross - to experience what actually happens we must adjust for inflation, taxes and investment expenses. Net-net the real return is somewhere around 3-4% depending on assumptions. And that assumes a starting number of 10%, something we haven't seen in a while.

That's why I usually tell folks that if they want to grow their money, add to it.

-HW "Skip" Weldon Columbia, SC

Reply to
HW "Skip" Weldon

There are truly frightening numbers, about what the average holder of a mutual fund gets, vs. what the mutual fund returns. It turns out that the big money flows into funds, when their performance is already past their peak.

I think I saw numbers that for the largest mutual funds, the average investor was getting 4-5% less, per annum, than the fund was returning.

It makes the 'buy and hold an index fund' strategy even more appealing. Particularly as many of the biggest mutual funds now restrict trading, thus reducing the penalty on long term investors imposed by short term investors trading units.

Net-net the real return is somewhere around 3-4%

c. 8% is probably a safe number for US total stock market return going forward, although 9% is possible. And 4.5% for bonds.

Reply to
darkness39

I read something similar, in either Smart Money or Kipplinger that suggested the typical investor saw 3% at a time when the trailing ten year average was closer to 10%. And numerous 'fund flow' data suggest this is likely true.

What this says to me is that the typical investor is market timing, buying high and selling low. And that with all the discussion around asset allocation, aiming for the perfect mix of 6 - 10 sectors and asset classes, that one would be better off than 'typical' by going low tech, choosing few indexes and holding long term.

If that 3% is created from ignorance, and the person is unwilling to educate himself, then a planner is worth every bit of his fees, and I'd dare say the typical investor would actually be better off going to the paid professional, if only for the fact that the typical investor is so undereducated and doesn't have the confidence or motivation to do otherwise. (Let's face it, how can I continue to argue pro-education when the numbers suggest that's not happening. An 8.5%, after fees, return is great compared to the 3% that many are seeing)

I'm with you on this. JOE

Reply to
joetaxpayer

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