Hi Kelt,

1. I get a *tax free* return of 6.12% for every dollar extra I pay down on this mortgage and/or for the life of the time I'm in the "paid off" house.

Not actually. Your "tax free" rate would be calculated by;
Face rate times (1 - marginal income tax rate) = Savings rate when retiring mortgage leverage.

Example:
6.12% Face Mortgage Rate
33% Marginal income tax rate

6.12% * (1 - 33%) =
6.12% * 67% =
4.1004% After Tax Savings

If you are in a state with income tax, upward adjust the marginal rate to combine your local and national marginal rate... effectively reducing further your real mortgage carrying costs.

Further, it won't be a "return" which is revenue gained on funds invested (which is compoundable...)
Rather, it would be a flat savings of the carry-cost (interest) on the loan. (This is not an insignificant benefit... but you cannot grow your wealth with savings, you must also have gains.)

2. I will have permanently lowered my basic cost-of-living.

In a 'static universe,' yes, this could be true. In the real world you will face "life" throwing whatever unexpected curveballs and opportunities (good and bad) at you whereby you'll only be able to effectively manage by using cash. If your cash is trapped inside your real estate equity, you will face great cost in re-liquidating it, and may be at great risk if you cannot qualify to liquidate it (perhaps for the same reasons of the distress causing the need for it in the first place.)

By investing it somewhere else (and keeping my mortgage), this is what I understand are the advantages:
1. Money is free to use when needed.
2. *Potential* for higher returns.
3. Investments can compound, which can result in dramatic savings growth. (Is it correct to see this as an advantage over a mortgage payoff? I mean, does paying off the mortgage result in a kind of equivalent "compounding" benefit)
Any other thoughts?

These are all accurate benefits. #2 and #3 are really part-and-parcel of the same benefit; "potential for higher returns."

I would suggest that the order of prudent priority for MOST financially responsible people is as follows;

A) Safety of Net Worth (this means that you have no unbalanced proportion of your net worth tied into any market you either have control over, or cannot easily and quickly exit from or rebalance without being overly costly,)

B) Liquidity (this means quick access without being overly costly in order to prevent getting trapped in uninsured distress situations, or losing valuable opportunities for the benefit of your family.)

C) Potential Savings/Returns (this means the actual differentiation between your total family costs of leverage (interest, insurance premiums, taxes, etc.) minus your total family growth on assets (appreciation of real estate and other asset holdings, interest paid on safe savings, and individual earnings.)

Use these as your "financial navigation triangulation methods" and you'll be well served, and far far ahead of most otherwise kindly and well-meaning advice.

All the best!
Dave Donhoff
Strategic Equity & Mortgage Planner

I'm all for owning a home outright. It was a goal of our's and we worked very hard to accomplish it; we saved, but not religiously (except for IRAs)... often putting what could have been directed to savings into our home, instead. We have done the finish work ourselves, so much went to materials and contractors with specialized skills/equipment.

Could you not retire your mortage earlier and with less sacrifice by simply rounding up your monthly payment to a comfortably affordable amount and making a 13th. payment once yearly? The "extra" would be automatically applied to the principal of the note, thus saving you interest over time. You would not deplete your savings, thus maintaining your safety net. With some thought, you could probably find an amount to direct to principal that wouldn't preclude monthly saving/investing. It might require some "head scratching", but if you look carefully at your budget there is generally money to be found by asking questions that get at the heart of "want" and "need".

We have found the real "key" was to continue to pay our "mortgage" into savings/investments once the note was retired. We will have a mortgage payment until we're no longer able to work, lol. That's the second step in building wealth, the first is to live below your means. ;)

If I double my current payment, and unload a big portion of my savings... leaving myself with 8 months living expenses... I can have this house free & clear in under 4 yrs.

Eight months living expenses may not be nearly enough. Factors to consider are how easy it will be to get another job at your present salary; if there is another income-earner/mortgage payer around who can kick in if you cannot; and how liquid your other investments are. A friend of mine is a very-well-paid engineer and can spend money freely. But if she ever needed to look for another job in her field which would pay even close to what she's making now, it likely would take her longer than eight months, since positions of that stature in that field are very hard to find here. She needs to make sure there is at least 8 months of savings available.

Thanks for the quality responses!

Dan, I appreciate your time. I'm not fancy financially (I just don't like debt), so I had to put on my thinking cap to follow your post.

So what kind of return would I need to make on my savings to beat the "returns" of having no mortgage debt (assuming 6.12% mortgage)?

Kelton

Greetings well-behaved Kelton,

I understand that your mortgage interest is deductible: it's not, in Canada, on owner-occupied home - but the capital gain on sale is tax-free. That being so, your actual cost is actually your 6.12% less the rate of tax that you are paying on your top dollar of income, as explained above. If it were 6% and your marginal tax rate is 25%, your real after-tax rate is 4.5%.

If you retire your mortgage with funds on hand, that'll be your rate of saving.

If you invest the money, your real rate of return is the stated rate less the rate of tax that you'll pay on the income that the asset produces.

If you retire the mortgage, then take out a Line of Credit using your home as collateral, what kind of set-up costs would be involved?

Is there an annual fee for carrying one that you aren't using?

I set one up a few years ago with no set-up fee, used it for a time until the loan was retired by monthly payments and it has sat unused for a few years recently - with no annual fee involved.

I'm on pension(s), but if I were employed, I'd prefer such a method, for if I go to the bank with good collateral, after layoff, seeking a loan ... there's a very slim chance that they'll accomodate my need. Possibly a bit better with a credit union.

However, with a home equity line of credit (or one fully secured by stocks, mutual funds, bonds, [whole life] insurance, etc.) set up beforehand, you can just draw on it, up to your limit, without an application that would require disclosure of your lack of current employment income.

There would likely be lower or nil set-up fee if using the other types of collateral that I just mentioned, and possibly a lower rate of interest charged.

Also, what type of investment are you planning to use?

If you put your money into an investment vehicle where they offer the guarantee that, in addition to the interest that they pay, they'll repay every dollar that you gave them in the first place, there's another guarantee that they never mention - they won't pay you one dollar more, either.

If you'd put $10,000. into a guaranteed certificate at the bank, 15 years ago, on 5-year paper, and renewed it ten years ago and again 5 years ago, they'd hve paid you their agreed rate of interest throughout on your loan to them.

However - that $10,000. that you gave them 15 years ago would have bought a decent car.

Not now.

Inflation has eroded the value of each of those dollars that they held, every year that they held it.

So - you need to take part of that interest that they pay you to put with your principal, in order to maintain its purchasing power.

The trouble with investing for guaranteed dollars is, all of the earning that your asset makes for you, is earned in the year that they pay it to you. And taxed at that time. If you're in Canada, it's taxed at top rate.

But I bought a stock in one of Canada's nationwide banks 39 years ago for $4.25 (I think) and the value has gone up, down and sideways throughout those 39 years - but last week it was worth $96.00 and change.

I haven't had to talk to the Canada Revenue Agency regarding that increase in value - and won't, until I either sell the stock (rather unlikely, wouldn't you say?) or die (and I don't expect to do that, this week or next).

I prefer to defer paying tax on my asset, when possible.

Not only that - initially the bank paid me dividend of 6 cents or a dime annually for each share, but the percentage of payout has stayed more or less constant as the share price rose, until now they pay me $2.80 annually for each share.

I like them apples better (even though, occasionally, one finds one that's wormy).

Good wishes for wise use of your money.

ole joyful

Hi Kelton,

So what kind of return would I need to make on my savings to beat the "returns" of having no mortgage debt (assuming 6.12% mortgage)?

Assuming a 33% marginal income tax bracket, and ignoring the value to you of the personal security & safety of access to your cash;

You'd need to earn 6.12% or more in a traditional non-qualified savings/investment account.
OR,
4.1004% in a qualified, tax-deferred retirement savings/investment account.

If you were to treat your non-real estate savings as disciplined (and over the same timeframe) as your real estate equity, you can EASILY do much better than 4-6.12% with relatively safe investment & savings methods.

Cheers,
Dave Donhoff
Strategic Equity & Mortgage Planner

I would pay off the mortgage. There is NOTHING like having a roof over one's head that's paid for.

I have always added some dollars my mortgage payment and it should be paid for in about 2 years. I plan to retire in about three years. I could not have a comfortable retirement if I had to make my mortgage payments on what I plan to withdraw each month. I could have invested the extra money, but I did fully find my IRA each year and added to my liquid assets. Maybe I could have done better, but I will be a happy person, when I retire and sell my house and am able to pay cash for my next one!

You can work the numbers all you want (I have), but it comes down to one thing: How good will I feel not having a mortgage? That is something hard to put a dollar sign on, and it has a different value to different folks. Only you can answer this one...

Interesting.

If Dave is correct, then it sounds like the "pay off your mortgage" opinion is based on emotion rather than financial savvy.

As a purely practical matter, paying off your mortgage is:
1. easy (you can be lazy)
----you don't have to decide upon an alternative investment
----you don't have to do anything come tax time

2. comforting: (emotional reasons)
----To many people, debt is experienced as aversive. It's comforting to see the mortgage debt go down.
----It reduces the fear of a stock downturn
----truly owning your own home is rare (heck, most people don't even own their own car)

I don't know what to do. If I put a big chunk of my savings into my mortgage debt...that's a real commitment because I can't easily (or cheaply) gain access to that money if I need it (or want it).
Investing the money is only expensive if that investment goes downhill. Otherwise, I stand to improve my financial standing beyond what could be achieved by simply eliminating the mortgage, AND I maintain easy access to the money.

Of course, easy access to the money has potential pitfalls, too. (this is starting to look like a see-saw) Sudden whims to buy stuff is common. Also, fears of economic storms ahead, can result in ill-timed withdrawals of investments...or sudden changes in investment strategies which can exacerbate the problem. (I have been guilty of this one on more than one occasion)

Still chewing it over. Thanks again!

Of course, easy access to the money has potential pitfalls, too. (this is starting to look like a see-saw) Sudden whims to buy stuff is common. Also, fears of economic storms ahead, can result in ill-timed withdrawals of investments...or sudden changes in investment strategies which can exacerbate the problem. (I have been guilty of this one on more than one occasion)

Sounds like what it comes down to for you is discipline. The folks who have posted in favor of paying off the mortgage have presented largely emotional points. That's not to say that's bad -- but security has its price. For you, right now, paying off the mortgage early sounds like it would cost you in liquidity and possibly in gains. It sounds like you would be perfectly fine paying off the mortgage at the current rate and investing the rest -- provided you weren't too tempted to mess with it.

There are ways to deal with that. Investment firms and banks can deduct directly from your paycheck the amount you want to invest -- you never handle it to be tempted to do something else with it. And you can make sure it's hard to find the phone number or Web site login or "courtesy checks" or whatever will allow you to make changes in your investment strategy. Is there someone else (spouse/partner/relative) to whom you'd be comfortable handing off the task of administrating this and being your "barrier"?

This is the classic argument for never paying off your mortgage (note: I'm not advocating or refuting this -- just putting it out here because it seems relevant to the discussion):

Here is a link that might be useful: Never pay off your mortgage

Suppose you decide to pay off (most?) of the mortgage, then arrange a Home Equity Line of Credit.

Would there be a substantial cost to set it up?

Is there an annual fee if you let it sit there unused?

I had a fully secured one set up some time ago, paid off the loan in a couple of years, and it's been sitting there unused for four or five, I think, without incurring any fees.

If you had one arranged prior to a lay-off, for example, most likely you could draw on it after a lay-off, where a bank would probably refuse you a loan if you applied after a lay-off.

Maybe that'd help you more or less drop two birds using one stone.

As for your determination - either you boss your money - or it'll quite likely boss you.

I prefer the first portion of that alternative: money can be a great servant, but a terrible master.

Your choice (while you have it).

ole joyful

Interesting read.

I think it is already outdated though. The point about your job salary increasing with inflation is not true anymore. Most people are happy they HAVE a job and don't worry about cost of living adjustments. Most companies, even if they do give out raises every year, are giving out raises that are below inflation rate. Also that doesn't even get into the cost of health care increasing each year, so that you actually are making less money!
Also my two car loans apr's are cheaper than my mortgage rate.
We pay extra each month to our mortgage however we do not use credit cards and max out our 401k and IRA contributions WHILE saving for our savings. If I had to decide between doing that and paying extra on my mortgage, of course I would save but not put extra money in the mortgage. However if you CAN do all this, then why NOT pay extra on the mortgage?

So to answer your question: I would NOT use my savings to pay off more of the mortgage however I would set a goal. Suppose you wanted maybe 20 grand in your savings to feel comfortable. Save to that goal and then when you reach it use your extra money for the mortgage and don't touch the savings. Slow and steady wins the race!!

Scryn, are you referring to Ric Edelman's piece on not paying off your mortgage being outdated? I also think he's a bit glib about the possible problems.

I don't know how financially wise this is, but I would use savings to pay off a mortgage only if by doing so I could pay it off in full. That is, if I got a mortgage down to the point where I could pay the balance without undue hardship, I'd do it, but until then, I would rather pay the minimum necessary and keep cash available.

The problem with counting on a HELOC for emergency funds is that you do have to pay it back (interest only for the draw period, but still); if you don't have a job, how are you going to make the payments?

Yes, sorry. I am refferring to the article "Never pay off your Mortgage" that harriethehomeowner provided the link to in his post.

I have such a love hate relationship with the sorts of articles such as "Never pay off your Mortgage" etc. The benefit is that it gets people thinking, the bad thing is that it paints a narrow, ill conceived, rosy picture that doesn't hold up too well under scrutiny. Life is never so black or white.

Several potential fallacies: #1. The assumption that everyone will have other debt in their life. #2. I'd like to find a bank that will give you a 95% 30FRM (as per his example) with out requiring an 80/15, or PMI, etc., all costs which he neglects to account for. #3. If his rosy fellow Ed is out of a job, he'll have no earned income. It's tough to make a deduction from that, so his "after taxes payment" will be readjusted back to original, meaning his $40K will last a much shorter time than this article (which also fails to account for basic costs of living beyond housing) accounts for. Fact is that if either of them are out of work for any amount of time, they're screwed.

I'm not sure yet if we'll pay our mortgage of early or not. As per the article's example, our income has increased so that it's not the drain on us that it was 2 years ago. If we do prepay, we'll do it in a lump sum capacity after the point at which it is not longer a beneficial tax deduction to us. Right now we're investing the money that would go to extra payments.

-meg

If the guy/gal didn't pay off the mortgage and still owes on it, s/he still has to make morgage payments after lay-off, right?

The idea with the HELOC, especially if he can arrange to pay interest-only regularly, is that the monthly payment is lower, so there is less pressure until s/he can find replacement employment.

If, after using the current funds on hand to (partially) pay off the mortgage, s/he is smart enough to use the portion of the income that s/he was paying on the mortgage to purchase investments, they can be used as partial collateral on the potential (but currently unused) HELOC, thus reducing the proportion of the home that may be at risk, if and when the borrower chooses to use the HELOC.

ole joyful

I can look at this from both sides of the fence, as the cliche goes. My primary home is a Main Post and beam on Cape Cod which I purchased in 1993 and wrote a 10 year fixed mortgage at 6%. (Yes, paper was cheap then too). In May, 1993 I started purchasing real estate and found myself getting subprime rates
from lenders since my FICO score had dropped significantly for paying off my mortgage. What sort of weird thinking is this, 120 payments, never late, house is paid. Mortgages are good credit. As much as I hate to see people hawking their homes for everyday items a mortgage is a good thing to have in order to any other type of investing. I took out a first mortgage on a house that was paid for and paid cash for a second home. And again. And again. Great rates, all 15 year fixed at below 6% and my FICO score is the highest ever, no plastic, no cars. It is difficult being self employed a broker is the way to go, I actually had banks tell me that they couldn't work with me since "all of you people cook your books". I am still wondering who are all of these people who need to cook their books? I did get whacked for Roth IRA contributions, but I followed the tax code.

What a fascinating thread - and great posts. I've followed this with a great deal of interest. I'm retired - DH will probably retire this year. Our home is not yet paid for (we have a 15 year 5.5% mortgage that we make biweekly payments on, so it will be paid for in 13 years if we don't pay it off early).
DH wants to take a portion of his 401K when he retires to pay off the mortgage. We can make the payments on our combined pensions without dipping into our nest egg. Last year, our nest egg increased by 20%. I think we should leave well enough alone knowing that we can pay it off any time, but there is something to be said for owning the roof over your head. Especially when you are retired.
We have some friends who paid off their mortgage, and they are very happy about it. However, they are somewhat cash strapped and their taxes are rising, so I'm not convinced they did the smart thing.

We talked to our financial advisor who said if our mortgage was less than 6%, he recommended leaving well enough alone. However, he also said that there is comfort in owning one's home and if it was really important to DH, then he should do it.

I think we should leave well enough alone knowing that we can pay it off any time, but there is something to be said for owning the roof over your head. Especially when you are retired.
We have some friends who paid off their mortgage, and they are very happy about it. However, they are somewhat cash strapped and their taxes are rising, so I'm not convinced they did the smart thing.

How about meeting halfway and earmarking the amount of the mortgage payoff in the 401(k)? Just subtract it and pretend it does not exist (and adjust the amount annually to reflect your continued payments). That way, you can pay off the mortgage in a matter of a few days if you want to, yet you don't lose the flexibility of having real money.

I'm thinking of something like that. DH is 58, so if we take any of the 401K before he's 59 1/2, we'd have to pay a 10% penalty on top of regular income taxes, so that's something else to factor in. But 18 mos from now (when he's 59 1/2).....

Every year, the amount earmarked to pay off the mortgage would be smaller and yet the money would still be working for us..

Remember that if you withdraw money from your 401(k), you still have to pay taxes on the part of the withdrawal that did not come from your own contributions, but if you leave the money there, it grows tax-free. So if you decided to pay off your entire mortgage, you would have to pay taxes on that amount of money all at once, which would push you into a high bracket.

f I put a big chunk of my savings into my mortgage debt...that's a real commitment because I can't easily (or cheaply) gain access to that money if I need it (or want it).

Yes you could, couldn't you, if you immediately got a HELOC for nearly what your mortgage was? Then, you don't pay interest, but if you suddenly NEEDED that money, you could get it (though now you would pay interest on it, though usually less than a regular mortgage)

And you'd have the credit account that's important to your rating.