Living paycheck to paycheck on $150,000

[James_Dean]

I've never bought the idea that having a mortgage payment is somehow compensated by having a tax deduction.

If you have a 1000/mo mortgage (12k/yr) and you pay 10k in interest, and you're in a 30% bracket, then you just paid 12,000 to avoid paying 3,000...

I'd rather pay the 3 and have the extra 9.

Mind you - the tax break on the interest *IS* a nice thing to have, but its *not* a reason to have a mortgage. Buying a house is...

You're missing the point.

Let's say that you are in the 20th year of ownership of a $250,000 home you bought with a 7% mortgage on a 30 year ammo and financed 100%.

You're making a $1663 payment per month on a principal balance of $143,000 and in the next 10 years you'll pay $57178 in interest. Let's say that 30% of that is saved through deductions. So I will save $40,000 in interest by paying off the loan in full.

I could also take that $143,000 and stick it in a 4 year CD at 5.38%. At the end of this four year period I will alread have earned $33350 in interest.

Why did I pay off that mortgage again?

http://www.ambankiowa.com/Index.cfm?cat=3&Page=deposit/Main.htm

James Dean

 

[Greebo]

Please note, I'm replying BEFORE reading the article, and going on initial thoughts here, so my opinion may change completely after I read the link....

You're missing the point.

No - I was making a different one, but nevermind that...

Let's say that you are in the 20th year of ownership of a $250,000 home you bought with a 7% mortgage on a 30 year ammo and financed 100%.

You're making a $1663 payment per month on a principal balance of $143,000 and in the next 10 years you'll pay $57178 in interest. Let's say that 30% of that is saved through deductions. So I will save $40,000 in interest by paying off the loan in full.

Ok, so the principle is at this point $143,000 and over 10 years you'll pay that PLUS $57,178, for a total of $200,178 being paid out.

I could also take that $143,000 and stick it in a 4 year CD at 5.38%. At the end of this four year period I will alread have earned $33350 in interest.

What $143,000? I'm a little confused here - do you mean you have $143,000 extra with which you can either 1)pay off the mortgage or 2) invest it? If so, then the math is as I listed above - you don't pay $143,000, you pay just over $200k.

Pay off the mortgage NOW and you DON'T pay $57,178 in interest, just the $143,000 in principle (ignoring the payout fees, etc.)

Secenario A: Invest the $143 and you gain $33,350 over 4 years. Over 10 years, call it $70,000, so from investments you're at $213,000 but over 10 years you've paid out $200,000 of it on that mortgage so your net gain is $13,000.

Scenario B: However if you pay off the mortgage now, then you're NOT paying out $1,663 a month. It will take 7 years (plus a few months) to accumulate back the $143,000, so in 7 years you can put it in that 4 year CD and gain 33,350 over the next 4 years, putting you at $176,350, which initially looks like investing it all up front is the better deal when compared to the $213,000 if you invest it, but your NET from investments in Scenario A is only $13,000, while your net from B is the full $33,350 (1 year later actually), but thats ONLY assuming you save up the $143,000 in your mattress and invest it after 7 years. If you take that first $1,663 and put it in a CD, and keep doing that over time, your cumulative interest by the time you get to 7 years will be...well I don't know for sure but it seems to me you'll net a lot better by paying off that mortgage first, then investing.

Ok, time to read

 

[Greebo]

Oh - I see - the link is just a bank link with interest rates. I think I'll run some numbers in excel later to see how scenario A and B compare for real...

 

[Greebo]

Ok, I ran the simplest scenario possible (which is rather complex...)

If you keep the mortgage, and roll your $143k into a 4 year, then roll it again into a 4 year, and then into a 2 year (to stick with an even 10 year range), using this calculator http://www.bankrate.com/brm/calc/cdc/CertDeposit.asp

Your total CD gain will be $100,400.08, plus your initial gives $243,400.08. LESS your mortgage + interest of $200,178, your NET total gain is $43,222.08.

Now, if you pay the mortgage, and every month, put $1,663 into a 3 month CD at a lower interest rate, compounded quarterly (using the bank rates you listed), and you put the CDs in for 6, 5, and 4 months in a cycle (so you you dep Jan, Feb and Mar and pull ALL three in July) and then you put that cash in your mattress, your net yield in July and every quarter thereafter is $5,087.53 per quarter, until July 10 years from now, you will pull out $203,501.20 in cash, minus your $143k mortgage payment up front, your net yield is $60,501.20.

Almost $20,000 more, and thats assuming you DON'T turn around and roll the short term CDs into bigger yielding longer term CDs.

Why WOULDN'T you pay off that mortgage?

 

[James_Dean]

Oh - I see - the link is just a bank link with interest rates. I think I'll run some numbers in excel later to see how scenario A and B compare for real...

Run the numbers and we'll compare notes. Assuming a 5.5% annual return on the 143k if invested, at the end of 10 years I'm showing a $64,000 advantage to keep the mortgage at the end of the 10 years.

Edit: Oops, you beat me to it. I wasn't running the calculation reinvesting the monthly mortgage payment. Doing the calculation your way I'm showing it a wash. Now if we're going to commit the 143k to a 10 year period I would argue that a 9% - 12% return is more realistic. Then it really becomes a no brainer to invest the money rather than pay off the mortgage.

Bottom line for me - I'll never turn down someone willing to give me money at an effective interest rate of 4% or less.




James Dean

 

[Sam D]

It sounds like there are two distinct discussions going on here:

1) Should you keep a mortgage for the sake of the tax deduction you get from the interest?

2) Should you pay off a mortgage early?

I realize these two overlap to some degree, but the earlier post simply talked about keeping a mortgage for the tax deduction. If that is the ONLY reason, it doesn't make sense.

Whether or not you pay off your mortgage early is more of a person than purely financial decision. I could put my family in a one room shack in a dangerous neighborhood for purely financial reasons. But I won't for safety and security reasons. I'm hoping to pay off my mortgage early also for security reasons (granted the shack example is extreme) but that is a personal assessment.

 

[Dwight B. Van Zanen]

One other point. If you have some money to invest or pay off the mortgage, that money would earn taxable interest if invested. So if you pay off the mortgage you lose a tax deduction, but you gain in taxation terms by not having quite as high interest earned added to your taxable income. It really comes down to whether you can earn more by other investments than you are paying in mortgage interest.

Using easy numbers, if you have a $100,000/year taxable income (excluding the CD's), a $100,000 mortgage at 6%, and $200,000 in cash in CD's at 5%, what are your options? At straight interest the CD's would pay $10,000/year in taxable interest. On the same basis the mortgage would generate $6,000/year in tax deductions. So, if you do not pay off the mortgage you have a total taxable income of $104,000. (100,000 + 10,000 - 6,000) If you pay pay off the mortgage you have a total taxable income of $105,000. (100,000 + 5,000) The difference is entirely due to the difference in interest rates, and not a benefit of the tax deductability of a mortgage. The tax benefit of a mortgage is just bogus.

As you can see by the above, it is not a matter of the "effective interest rate" that you are trying to beat. It is the actual interest rate. If your investments earned 6% - same as the mortgage - you have a taxable income of $106,000 in either case.

I agree you are better off paying off the mortgage for more reasons than just finaincial. The security of knowing no market change can put you out on the steet is worth a lot. More as you get older and have less time to recover from investment losses. Your risk tollerance gets reduced later in life.

 

[James_Dean]

Whether or not you pay off your mortgage early is more of a person than purely financial decision. I could put my family in a one room shack in a dangerous neighborhood for purely financial reasons. But I won't for safety and security reasons. I'm hoping to pay off my mortgage early also for security reasons (granted the shack example is extreme) but that is a personal assessment.

Red herring. How are you less safe with the money in CD's vs. having the money tied up in home equity and less money in your pocket?

James Dean

 

[James_Dean]

It really comes down to whether you can earn more by other investments than you are paying in mortgage interest.

I'll agree with your statement if you make one simple change.


It really comes down to whether you can earn more by other investments than you are paying in tax adjusted mortgage interest.


James Dean

 

[Dwight B. Van Zanen]

I'll agree with your statement if you make one simple change.It really comes down to whether you can earn more by other investments than you are paying in tax adjusted mortgage interest.James Dean

If by "tax adjusted" you mean both the mortgage deduction and the taxable interest impact. As illustrated in my post, cash earning interest works out to be about the same net effect.

As for why having your home paid off can be considered a family security issue, lets look at some worst case situations. Say the foreign investors that buy up a lot of the US debt decide not to do that any more, and the U.S. has to increase interest rates significantly to try to attract buyers. We saw inflation of 15%+/year in the early '80's under President Carter. What about inflation of 20 - 40%/MONTH? It has happened elsewhere. Suddenly money is worth less (and may eventually become worthless). What good is the money you have invested in a CD or keep in a can in the back yard if it will not buy lunch? If you own your house, you own your house. Done deal. On the other hand, if your house is not paid off in this case you may be able to pay it off with really cheap money (sell a few gold coins and pay off the mortgage). Unless you have one of those adjustable rate mortgages that will go up as the value of the dollar goes down; and assuming the government does not "revalue" the money and change how you pay on contracts. Some South American countries have been creative.

What happens if all the debt in this country finally overwhelms the system, and instead of trying to pay the interest (or finance the interest with more barrowing) the government defaults on the few trillion dollars of obligations outstanding? The ripple effect would be worse than 1929, with the federal reserve and the government itself going broke. Our money isn't backed by anything now but the trust of the holders, and a Million dollars in the bank could become literally so much paper (or, just 1's and 0's in some computer signifying nothing). Will the banks, if they are still open, accept worthless paper in payment when they still legally own the real estate asset you call "your" home?

The above are just larger scale economic problems like those that happen fairly regularly. Such as when your company shuts down a big plant in your area putting so many out of work your home value goes from $500,000 to $300,000 or less in 8 months. You may decide to lose your equity since the mortgage is now much more than the value of the home. If you owned your home outright, you still have the home. The home still has the same "real" value to you - it is just the money equivalent that has changed in the new situation. It is your choice to sell or not (if you can find a buyer), to move or not, or go into survival mode and wait for the local ecomony to recover. When it happens on a national level, some of those choices are gone.

I am not a doomsday kind of guy. I suspect nothing so dramatic will actually happen, because a lot of smart people are worried about it and working hard to keep it from happening. But smart people make mistakes too, and if they screw this up it could be really bad. And it would not be a bad idea to at least own the home you expect to raise your kids in, just in case.

 

[Sam D]

Red herring. How are you less safe with the money in CD's vs. having the money tied up in home equity and less money in your pocket?

James Dean

The rate difference between a mortgage and an insured deposit is negligible (to me). I'd rather have the home without a lien.

 

[tom clark]

You're trying to beat 4% not 6%. If you can't beat 4% then you need to put your money under a matress, cuz' you don't know what you're doing.

I can get a 90 day CD at my local bank that's paying 4.72%. You could also go buy stock in Pfizer, Ameren, ConEd, WaMu, Verizon, Bristol - all have a dividend yield above 4%.

Don't get me wrong, I'd like no mortgage payment too. However, the best use of my surplus money is not to pay off a low interest loan that I get a government rebate on as well. You know how I finance my airplane and flying? HELOC, tax deductable as well and I keep the surplus funds working for me in the market.

OPM, OPM, OPM.


James Dean

but you're also paying ordinary income tax on the 4.72% so maybe you're netting in the 3's? you can collect ordinary stock dividends of course at a lower taxable rate....for now anyway. but then you also have market risk. some years that works in your favor, others it doesn't, like 02! honestly i don't think it makes a lot of difference. you're just moving numbers around on your balance sheet. but i will say this, i derive a great deal of pleasure NOT having a mtg payment and would find it very difficult to ever go back. to each his own. tc

 

[SteveR]

Better yet, just cut the damned thing up and NEVER use a credit card. If you cannot pay cash for it you cannot afford it. It is well and good that you say you will pay it off every month, but I can tell you from experience that it is hard to do.

Some people shouldn't use credit cards, but for those of us who are disciplined, there is money to be MADE by using credit cards. I will profit well OVER $1,000 by using credit cards this year.

I use a credit card for almost everything I buy; gas, groceries, furniture, gifts, utilities, everything (excluding mortgage). If it can be put on a credit card, I put it on a card, including utilities. Probably 95% of my purchases are on a single credit card. I get maybe $40/month from the bank to pay tips, etc. I also don't buy anything unless I have the cash, and I live a pretty conservative lifestyle. I pay the card balance in full every month. American Express gave me a cashback bonus of just over 2% last year. I made several hundred dollars, and didn't pay a cent in fees or interest.

I also have a 0% interest card for 18 months. ~18 months ago I was getting married so I put my wife's ring, furniture for our new/first house, & some other one-time expenses on that card. Again, I had saved the cash for these items, but instead of giving it to someone else I put it in my Emmigrant Direct savings account, earning 5.05% (emmigrantdirect.com I'm surprised more people here don't talk about them). Anyway, that cash is just sitting there, earning over $100/month now, and I'll pay that credit card bill a few weeks before it starts accruing interest. At that time I may try to find another card and repeat this process (no unneccessary spending, just the usual gas/groceries/utilities/etc.). Its worked great for me.

The car I'm currently driving is a '94 Z28 I bought when I was in college, it now has 257,000 miles on it. Who says American cars aren't reliable? It has the original engine in it, and I've NEVER taken it to a mechanic...I do all my work myself. I like it so much I bought another one for $7k with only 30k miles, and will sell the old one soon. If I drive the "new" one for another $260k miles, I'll be doing good. My wife's Oldsmobile clicked past 155k on our Christmas vacation, and we're currenty saving so we can pay cash for a newer used car for her.

I'm nowhere near rich, I'm an engineer (BSEE) & my wife is a teacher (which means she makes dirt here in Oklahoma) and we're both in our twenties (although I won't be soon ). Almost three years ago I bought my plane (paid cash, but its just a Pietenpol, it was cheap!), got married soon after that and six months later we bought our first house, and put 20% down and paid cash for all costs. Its a new house, but not big by today's standards (1,600SF).

People really throw away a lot of money in this country on cars & credit cards. I figure by living smart and not paying interest on those two items alone, we'll essentially increase our income over our lifetime by 10-20% compared to people who do the opposite.

As for the mortgage debate, before we bought our house I had plans to pay it off in five years and be mortgage free, but I've since decided that it would be better to place that money in a tax-free investment (like a Roth IRA or 401k). I believe I can pretty reliably make 8-10% with mutual funds (VFINX & others to diversify), and considering that I can avoid taxes through my 401k or IRA, it makes more sense to me to take that 10% gain tax free instead of paying the mortgage off to avoid paying the ~4% interest on the house (6% minus the ~2% deduction). We should come out 4-6% ahead annually by NOT paying off the mortgage & investing elsewhere.