Investment Strategy

What am I missing? Every mortgage I've ever been in (3 so far) had interest payments calculated 30 years in advance and the banks never deviated from the table known at the beginning of the mortgage in terms of the amount that gets applied to interest, regardless of the actual amount of payment. I've sent exact amounts, I've sent rounded up to the next 100,

1000 and at some point I've sent as much as extra $2000 in one monthly payment, all of which was applied to principal thereby reducing the payout amount but NOT the interest payments which were originally based on the total amount of the loan. Since I've never been in a mortgage for the entire duration, I've never actually received the advantage of stopping my payments earlier and therefore the only benefit of overpaying monthly was that I had less payout. I basically just let the bank hold my extra money for free until I paid the loan off.

Is my math failing me here? Is there an actual "savings" benefit to sending increased monthly mortgage payments?

------------------------------------- |_/| | @ @ Woof! | < > _ | _/------____ ((| |)) | `--' | ____|_ ___| |___.' /_/_____/____/_______|

.
Reply to
DA
Loading thread data ...

I am aware that some car loans require to payment of all the interest that would have been owed regardless of extra payments each month. I have a vague recollection that some mortgages in recent years similarly have a pre-payment penalty that is the same or similar. But I am not 100% sure. Maybe someone else can comment.

Gosh yes. Experiment with any of the free online amortization calculators, such as the one at

formatting link
. Add a one-time payment and/or increase the monthly payment, and notehow the time to pay off the mortgage goes down and how the totalinterest paid over the life of the loan declines.

Reply to
Elle

4.25% was the interest rate the OP mentioned. The APR rate would normally be higher.

If the OP can earn more than 4.25% safely, the OP shouldn't pay off his mortgage.

-- Ron

Reply to
Ron Peterson

I agree factoring in any points and other fees will yield a higher APR. Lenders are supposed to state both the mortgage rate and the effective APR etc. and so on. Amend my statement to "at least 4.25 APR interest."

You mean "more than the effective APR of the mortgage" above.

Reply to
Elle

No, the lender is paying the nominal interest rate on the balance of the loan. The APR includes the sunk coasts to get the loan.

If the lender pays off the loan early, the effective APR increases above the disclosed APR.

-- Ron

Reply to
Ron Peterson

You mean because the fixed (one-time) cost of securing the loan is spread over less time? I'd never thouht of that before. I'm too lazy to do the math to get the basic point increase in APR.

Reply to
dapperdobbs

First, you mean "borrower," not "lender." Second, I originally wrote that the borrower "is paying 4.25 APR interest on whatever balance is owed, regardless of what year of the amortization he's in." Above you're saying no, he's paying the "nominal interest rate." The nominal interest rate is 4.25 APR for the remainder of the loan.

Reply to
Elle

I assume you mean "borrower", not "lender" or am I missing something?

Reply to
Bill

The key word here is "safely." To see the total picture, you need to factor in risk. People may think they can earn better than 4.25% in alternative investments, or may be led to believe there are a lot better options, and in some cases that may be true, but in other cases it is not. Paying off the mortgage has a guaranteed rate of return. But investing in equities or something else always carries some risk. And the more attractive the desired return in excess of the 4.25% appears to be, the greater the risk.

Consider 1000 people, half of whom pay off the mortgage, and half of whom keep the mortgage and invest in stocks or mutual funds with the extra money. The 500 who pay off the mortgage earn 4.25%, absolutely. Of the 500 who invest in stocks, maybe some earn 5%, some earn 7% or

10%, and others earn 2% or 3%. Maybe a few who get carried away lose all their money. On the average, then, it could easily happen that the 500 people who go into equities earn 3.75% or 4.00%. Paying off the mortgage could be the best bet.
Reply to
Don

I had not thought of it either - hats off to Ron.

Does it follow that those amortized costs are in the unpaid balance and that the borrower is paying interest on them also?

Reply to
HW "Skip" Weldon

That's correct, you aren't missing anything.

-- Ron

Reply to
Ron Peterson

I meant borrower.

See

formatting link
for anexplanation.

Abid did not mention that the 4.25% was the APR rate.

-- Ron

Reply to
Ron Peterson

Uh, yes ... that would be down the hall, in the loan department! Honestly, I don't know which costs (fees) may be amortized into the unpaid balance, but it makes perfect sense. And as you point out, then one is paying interest on the fees, as well. Some lenders may offer to amortize costs (nodding their heads up and down with a smile).

It would have some bearing on a 15 year loan, but doping out the math behind the lower rates and pro-rating the fees is an exercise, probably. I was thinking of points and up-front fees on the closing document.

Reply to
dapperdobbs

I've read through this thread before responding. Last summer, I decided to pay off the remaining balance on my 5% mortgage. At the time, I had enough invested in a taxable investment account with returns well over 5% to cover mortgage interest cost.

The OP has said that his mortgage is 45K at 4.25%, and that he is paying $200/mo extra; and that he has a portfolio of blue chips which he is adding to by $100/mo plus drips, and that he is sitting on 20K of free cash. Using $10K to prepay the mortgage down to $35K will reduce his interest by $425/yr. He can allocate $10K to high-yield blue chips, and shift to $100/mo. additional mortgage prepayment, $200/mo. to investments, and build liquidity. A total payoff can be a multi-year goal.

I bought my place with an 80% 30-year mortgage in 2003, at the bottom of a bear market. Over the next several years, I harvested profits and allocated a part of those profits to additional mortgage payments, but on an ad hoc month-to-month basis. That maintained my liquidity while deleveraging out of the mortgage. My objective was a payoff in

10 years; the 30-year term was to minimize cash flow needs.

The question is not just being able to invest in quality securities paying enough to offset 4.25%, even in the current market. It's one of building liquidity against leveraging, with a goal of deleveraging at an appropriate rate.

Hank

Reply to
HankVC

Haven't seen you post before - welcome.

Interesting analysis. Even though you have taxable returns easily covering your deductible borrowing costs, you elect what some might call the moral option of repaying the loan.

Reply to
dapperdobbs

I've posted to this group infrequently since it was newgrouped. Been on Usenet since ca. 1984 (before the great renaming).

I left out a great many considerations to keep my response short. The primary considerations in paying off the mortgage in 2010 were financial, but in terms of a total investment/income strategy.

I took retirement in Aug. 2001 at age 67, just before the infamous "911" that started the 2001-3 bear market. At the time I had rolled all my retirement assets from earlier employment into an IRA, and had three years maximum contributions to a 401K in cash/bonds to roll into it. I was able to start a Roth in 1998, but unable to contribute to it because of the income limit until I retired. I had 35 over-maximum years in Social Security, and did not begin withdrawals until summer 2001, to maximize the base for future COLA adjustments.

I've had a portfolio of taxable securities started in 1957, so am not "new to investing." However, a series of financial reverses meant that I had not been able to reach goals set in 1984. Point here is that, having weathered several bear markets, I've long since learned to "buy low/sell high." The decision to leverage with an 80% first mortgage in 2002 when I bought my current house was to maintain liquidity until the markets turned around, which they did in the

2003-2007 period. I did not begin serious deleveraging until 2006. The 2008-2009 market collapse led me to buy value securities (survivors) with free cash and defer deleveraging until I had some profits to harvest.

The decision to do the payoff last fall was based on concerns about

2011 taxes, the ability to harvest enough gains to do a significant paydown, and (with a total payoff), the freedom to reduce my taxable cash flow needs for coming years. A major concern is that, for middle-income retirees, Social Security income may be "means tested" through increased taxation. With no mortgage to service, I've reduced my taxable cash flow needs by about $9K/year, and can restructure my taxable portfolio accordingly.

When I retired, I set up a ten-year amortization schedule for traditional IRA assets, with any withdrawals not needed for cash income to be rolled into the Roth. That is nearly complete, and I was able to roll much more into the Roth than anticipated. It is being restructured for cash generation to offset the reduction in the taxable account.

"Moral option" has had no part in my decisions. The primary consideration is to position myself for the future, with major parameters quite outside being able to invest leveraged assets at a profit.

Hank

Reply to
Hank

I think it's fine if the OP wants to put only around half of his extra $20k towards the mortgage and bet the rest on stocks, but only if he does so for the long run. In other words, I would not call increasing investments in the stock market "building liquidity." "Building liquidity" to me means increasing the amount in short term CDs, treasuries, checking or savings accounts, or money market accounts. "Liquidity" to me means the original dollar amount of an investment is available within a very short amount of time, like a few months at most. This is not necessarily the case when investing in stocks.

I think anyone buying stocks should do so with the intent of holding at least say seven years or more. Even when intending to hold for this long, the stock investor must know there is still risk of not getting back his or her principal.

Reply to
Elle

I think there's a bit of confusion here. Yes, I suggested building liquidity in securities investments. You are implicitly viewing securities as "high risk" because values rise and fall in bull and bear markets. Investing safely and making money at it over a longer term (and I'll put 3-5 years on that) is an exercise in risk management. That is a completely different subject, except that stocks and bonds are "liquid assets" in the sense that you can sell them for whatever price they're worth now to raise cash immediately.

That is something you cannot do with your equity in real estate. When times are tight, as they have been recently, you may have the devil's time raising cash against your equity.

I outlined that I used an 80% mortgage in early 2003 to purchase my present residence property. That was at the bottom of a two-year bear market. In point of fact, I also used margin for most of the 20% down payment as well. That is nothing but a classic case of "leveraging"---borrowing against assets to buy something else and to avoid having to sell anything. I could have liquidated securities in 2003 (note "liquidate" to get cash in a matter of days), but kept my powder dry until we hit a good bull market----and then liquidated at a profit. I think that you are criticizing securities investments based on your perception of volatility. But proper risk management (which is an entirely different topic from "liquidity") translates to "cash flow and capital appreciation," not a litany of overall loss. You can, of course, liquidate securities you own at any time and get immediate cash for them, which is what makes them "liquid." Plus, if the securities account is set up as a margin acount, you can borrow against the margin value immediately without having to apply for a loan. That's also "liquidity."

Money in CD's these days is returning chicken-feed. If you want "loss of shareholder value," (in terms of buying power for food and energy), put some serious money in CD's at current returns. I certainly did not pay off my mortgage with income or profit from CD's. The OP wanted to know if he should pay down his mortgage by $20K. Since that amount won't clear it entirely, my suggestion was that he put half in the mortgage, invest the other half, and shift his surplus to investment to build a portfolio that will allow him to do a complete payoff.

Hank

Reply to
Hank

For the short term, as far as I am concerned stocks are high risk.

I have no objection to your clarification above.

If you are going to add the above caveat, then add that had one bought stocks in 2006, one would have the devil's time getting back the original investment in 2009.

I do not know about "classic." Until around 2000, to me "classic" with mortgages has meant saving up for 20% cash down.

It seems to me you paid off your mortgage by getting lucky in the stock market in the short term. That's fine for others as long as they recognize the risk involved in such a strategy.

These are my opinions, Hank. I understand you feel differently. Please note again I think it is fine if someone situated like the OP puts half in stocks and uses the other half to pay down the mortgage. Even if such a person wants to put the whole $20k in stocks, I would not call this necessarily a bad choice. Given the good financial circumstances of the OP, he can take some risk.

Reply to
Elle

I agree with what Hank is suggesting. An emergency fund doesn't need to be in CDs, it can be invested in the stock market because it can be liquidated quickly.

Emergencies don't occur frequently, so there is little risk that an investment loss will occur, and in addition, the market is more likely to be up than down when that emergency occurs.

With a large and diversified stock portfolio, one can choose which stocks to sell to minimize capital gains.

-- Ron

Reply to
Ron Peterson

BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here. All logos and trade names are the property of their respective owners.