8

What other opportunity costs of paying off a mortgage early might I be missing? I am in year 2 of a 15 year mortgage at 2.875% with no other consumer debt. I have a 8 month emergency fund, maxing out 401(k) contributions, fully funding our Roths, and a relatively small amount in a regular brokerage account.

I'm currently paying the mortgage payment every 4 weeks (every other paycheck), which I assume kind of works out to bi-weeky. My plan is to put almost as much into a savings account on the alternate paydays. At the end of the year, we'll apply that savings to the principal. Using this method, round numbers put the house paid off in 6ish years.

I realize there's a really good chance I could take that extra money and invest and come out way ahead. Incidently, that's where these extra funds would be coming from - scaling back the brokerage contributions in exchange for this. Otherwise, I suspect this would be main answer. I also feel a little foolish extinguishing such cheap money, but I'd really like to not have a house payment. So, aside from investing the extra, is there anything else I'm missing with my plan?

11

You seem to really have your financial act together.

Your combination of assets, and ongoing savings makes you the ideal candidate for paying it off. One way to look at it is that your mortgage offers you a place to 'invest' at a fixed 2-7/8% rate. "I'd really like to not have a house payment" is all I need to hear.

The flip side is the lecture that talks about long term market returns, the fact that the combination of your deductible mortgage, but 15% cap gain rate means you need 2.5% return to break even, and odds are pretty high that will occur over the next 15 years. "pretty high" does not equal "guaranteed". And I won't debate the value of sleeping soundly vs an excess 5-8% return on this money that you'd maybe achieve.

You haven't missed anything. In fact, though I advocate saving first, you are already doing that. This is above and beyond. Good work.

  • 2
    One minor (and I mean minor) point is that whereas you (might) have to pay taxes on capitol gains, you get to deduct interest paid on your mortgages from your earnings. So, if you're paying 33% in taxes on your income, the 2.875% interest is effectively 1.92625% interest (0.67 * 2.875%), if I understand my tax law correctly (big if). – Ben Hocking Aug 1 '15 at 19:29
  • 3
    I did that. His 2.875 mort costs him 2.875*.75 (I was guessing 25% bracket) = 2.15625 net. now divide by .85 (15% cap gain rate) to get 2.5368% break even. And you are right that he may very well be in 33% land, dropping his breakeven a bit. Welcome to Money.SE, I hope you hang around. – JoeTaxpayer Aug 1 '15 at 21:00
  • I see "deductible" now in your answer (my mind must have skipped over it initially) and understand how you got the number you did now. I almost regret my comment, but I think your comment where you explain the break down makes it worthwhile. :) – Ben Hocking Aug 1 '15 at 21:04
  • Thx Ben. Yes. It can get very complex. Read the question again. I don't know his property tax or whether he can even deduct his interest. We assume a lot when we try to answer these questions. Unless the poster spells out an awful lot of detail, it's a crap shoot. – JoeTaxpayer Aug 1 '15 at 21:10
  • 1
    Thanks for the clarification. I was wondering where the 2.5% was coming from. Incidentally, property taxes last year were around $5k and we just barely got past standard deduction, mostly due to the relatively new loan. I wish I could accept multiple answers. I love this site (and the great info). – InbetweenWeekends Aug 2 '15 at 3:34
9

One other consideration is that by paying off your mortgage early versus, for example, investing that capital in a mutual fund is that you are reducing your net liquidity to some degree. That is, if you find yourself needing an emergency infusion of cash it is easier to sell a stock/fund than to sell your house or get a equity loan.

I suppose if you were planning to need a lot of cash to start a business or invest in real estate, then maybe it would make sense to keep your cash more liquid. However, in your situation I agree with Joe. Pay it off. It feels REALLY good to write that last check!

4

I agree with Joe that you seem to have your stuff together.

However I can't disagree more otherwise. You are getting a loan at such a cheap rate that it would be almost impossible to not substantially beat that rate over the next 15-20 years. You paying off your home early might give you warm fuzzy feeling but would make me queezy. This is a MONEY website. Make money.

For our purposes let's say your home is worth 500k, you can get a fixed rate loan at 3% over 30 years, and you can earn 7% on your investments per year. Note that I have earned 12% on mine the past 15 years so I am being pretty conservative.

So let's not get into your other stuff because that is fine. Let's focus just on that 500k - your house.

Interest only Loan for the whole thing-

  • you would pay $2966 a month- estimate
  • over the 30 year loan you would pay almost 1.1 million.
  • your investment would earn almost 4.1 million.
  • You would clear about 3 million after paying your loan.
  • This doesn't include tax breaks on the loan.
  • So let's just say 3 million

The flip side is you pay off your house. Your house could be worth 400K in 30 years. Probably not but neighborhood could decline, house not kept up, or whatever. Your house is not a risk-free investment. And it fluctuate in many areas more than the stock market. But let's just say your area stays OK or normal. In 30 years you can expect your house to be worth somewhere between 700k to 1.5 million. Let's just say you did GREAT with your house. Guess what? At 1.5 million selling price you still lost 1.5 million because of your decision plus sunk your money into a less liquid option.

Let the bank take the risk on your house price. The warm fuzzy feeling will be there when you realize you could rebuy your house two times over in 6-7 years.

Note: I know my example doesn't use your exact numbers. I am just showing what your true cost is of making a decision in the most extreme way. I am guessing you have great credit and might be able to find an all interest loan at 3%. So not doing this is costing you 1.5 million over 30 years. Given a lower home price after 30 years or a higher rate of return this easily be much more. IF you earned 12% over the 30 year period you would be costing yourself 16 million - do the math. Now you are talking about doing something in-between. Which means you will basically have the same risk factors with less return.

  • 2
    +1 (from me, someone else downed you) - For playing devil's advocate and offering the alternative response from mine. If you re-read the question - the mortgage is 15 years, not 30, so your analysis needs adjustment. Also, he acknowledged both sides, and really was just asking if he missed anything. I started out answering 100% looking at numbers. Over time, I've come to acknowledge the value of a good nights sleep or just as important, happy spouse. – JoeTaxpayer Jul 31 '15 at 17:17
  • 1
    Got it. To be clear, there's a difference between common advice, and my understanding other's risk level. I wrote Retired, with mortgage showing how even in the worst 15 years, I am happily ahead. – JoeTaxpayer Jul 31 '15 at 18:08
  • 1
    I don't understand your comment about letting the bank assume the risk of your house. If you default on the mortgage payments, aren't you on the hook for the balance anyways? If that's the case, then having a lean on your house doesn't affect the sale at all - it's just an unrelated debt assumed when you bought the house. If you owe 300k and sell for 2M you pay off the 300k and pocket 1.7M ? – Chris Jul 31 '15 at 19:26
  • 2
    You all realize, the return of the house is irrelevant. You own the house regardless. The choice here is to invest or pay off the debt. Either way, in 15/30 years you own a debt free house, and the rest depends on the returns from early payment or investing. The house return is the same regardless. – JoeTaxpayer Jul 31 '15 at 19:34
  • 1
    @Chris in the US (as tagged) it varies by state: mortgagecalculator.com/no-recourse-state – dave_thompson_085 Jul 31 '15 at 20:55

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .