Any issues to consider in paying off a loan?
January 17, 2011 2:31 PM Subscribe
Just refinanced and now have funds to payoff the loan, any issues to consider?
I just refinanced my house a few months ago. I just got married and my wife has the funds to and wants to payoff the loan. The money is just in a savings account and the home loan interest is much higher than the interest she gains.
I understand there are paperwork filing fees, but are there any issues or downsides to consider before we start this?
I just refinanced my house a few months ago. I just got married and my wife has the funds to and wants to payoff the loan. The money is just in a savings account and the home loan interest is much higher than the interest she gains.
I understand there are paperwork filing fees, but are there any issues or downsides to consider before we start this?
Keep in mind that as interest rates go up (this WILL happen in the next few years as the government tries to stave off inflation) housing prices will go down, since buyers will not be able to afford the same house that they could have bought at a 4% interest rate. This means there's a great chance that you will be paying off an asset that will decrease dramatically in value. If you keep the mortgage, and invest that money somewhere else, you may end up with a better return and you can still pay that mortgage off down the road. Also, there is still the benefit of tax-deductible interest.
posted by brownrd at 2:52 PM on January 17, 2011
posted by brownrd at 2:52 PM on January 17, 2011
As stated you, right now you have the lowest interest rate you will likely ever get on a loan. If you have any home improvement ideas (construction loans right now are difficult to get) or want to buy something else that would require a loan in the near future you may want to leverage this money for something else. There are also pre-payment issues, but most loans these days don't include pre-payment penalties so I doubt you are constrained there.
All that being said, I'd probably pay off my house. While it could decrease in value in the short term if you intend to stick with it for 5+ years it will likely increase in value in the longer term.
But be sure to keep a sufficient nest egg for emergencies.
posted by bitdamaged at 3:04 PM on January 17, 2011
All that being said, I'd probably pay off my house. While it could decrease in value in the short term if you intend to stick with it for 5+ years it will likely increase in value in the longer term.
But be sure to keep a sufficient nest egg for emergencies.
posted by bitdamaged at 3:04 PM on January 17, 2011
Brownrd is right on about the interest rates. If that monthly payment is never going to be an issue (and if you have the funds to pay off the loan now, I can't imagine it will) then I wouldn't pay it off and invest it either in proportional amounts into the rest of your investment portfolio or find some manner of inflation adjusted investments like TIPS
The other thing to consider is that if you pay off your mortgage you're basically making your house a huge portion of your investment portfolio. If you don't have enough other investments, you lose a lot of diversification. If, for example, the cash you use to pay off the loan represent all of your extra funds, your only investment is now your house and you've put all of your eggs in one basket.
Unless you have a big enough investment portfolio that the loan amount seems small (in which case you'd have enough money that you probably wouldn't care or notice either way) leave the loan and invest the cash.
posted by VTX at 3:09 PM on January 17, 2011
The other thing to consider is that if you pay off your mortgage you're basically making your house a huge portion of your investment portfolio. If you don't have enough other investments, you lose a lot of diversification. If, for example, the cash you use to pay off the loan represent all of your extra funds, your only investment is now your house and you've put all of your eggs in one basket.
Unless you have a big enough investment portfolio that the loan amount seems small (in which case you'd have enough money that you probably wouldn't care or notice either way) leave the loan and invest the cash.
posted by VTX at 3:09 PM on January 17, 2011
I would vote to pay it off. I think it makes life simpler. You will own your house outright, and your wife will be happier.
If you think you can invest your savings and make a higher rate of return than the interest rate on the loan, then go ahead. But I don't know what your interest rate is.
posted by twblalock at 3:29 PM on January 17, 2011 [1 favorite]
If you think you can invest your savings and make a higher rate of return than the interest rate on the loan, then go ahead. But I don't know what your interest rate is.
posted by twblalock at 3:29 PM on January 17, 2011 [1 favorite]
Mortgage interest is deductible, so the difference between what you can earn from investment and what you pay in interest is reduced.
If you're bad at saving, a mortgage payment is a way to accrue equity. But you're probably good at saving, so pay off the house, and develop a savings plan for the cash that would have gone into the house.
posted by theora55 at 5:58 PM on January 17, 2011 [1 favorite]
If you're bad at saving, a mortgage payment is a way to accrue equity. But you're probably good at saving, so pay off the house, and develop a savings plan for the cash that would have gone into the house.
posted by theora55 at 5:58 PM on January 17, 2011 [1 favorite]
That's all well and good, but can you guarantee that you will make back the interest every year via investments?
If you have $100,000 mortgage at 5%, you pay $5000 a year in interest. You also have to pay another $1500 on the principal. Now, you might get $1500 back via the mortgage deduction. So you are $5000 in the hole every year. You have to make back $5000 every year to break even.
(Which, depending on your investment strategy, would have been easy or hard to do. Are you a genius at timing the market? No problem. Set it in an S&P 500 index fund? You wouldn't have made it. In the last year, yes. In the last 3, 5 or 10, no.)
But lets say you do manage to break even. You are earning another $5000 in income, which you will have to pay taxes on. Lower cap gains taxes, of course, but you still have to do it. So, you are out 15%, and actually have to make $5750 to break even. (And more if you are timing the market and your gains are short term gains rather than long term ones.)
So, you have a mortgage bill every month and $100,000 sitting around doing nothing except hopefully subsidizing your mortgage payment. Not to mention, you could lose some of that money if the market tanks.
Or you pay off the house and have no mortgage payment, and devote that money to rebuilding your savings.
It almost seems wrong, but I just put the numbers in a spreadsheet.
Scenario 1: invest the $100000 and make a return that matches the 5% interest rate on the mortgage. Actually, making a bit more because you have to pay 15% tax on the interest, and a bit more after that because your mortgage interest deduction gets smaller every year. End of scenario (30 year mortgage): you have a house + the $100,000 you were using to pay off the house.
Scenario 2: pay off the house for $100,000. Instead, put the mortgage payments into the same investment as above. You make the interest, minus income taxes, minus the loss of the tax savings of losing the mortgage interest deduction. End of scenario: you have a house + $558,000.
Because in scenario 1, your investment is covering the interest on the house only for that year. You are still getting charged interest on the rest of the money you still owe them. In either scenario, you have to pay the bank the $100,000 you owe them. The difference is, in scenario 1, you have paid the bank $95000 in interest. In scenario 2, you haven't.
(Interesting note: the higher the mortgage rate, the easier it is to break even on a yearly basis. At a 1% interest rate, you have to make 4.4% on your investment to break even (Maintain the $100,000 principal in the investment acct.). At a 10% rate, you only have to make 9.9% on your investment to break even. It is too late to do the ciphering, but I bet this is a function of the cap gains rate and the mort. interest break.)
(You still always do better paying off the mortgage and saving. In the 10% mortgage and a 9.9% savings rate, you end up with $1m by saving the money.)
posted by gjc at 8:20 PM on January 17, 2011
If you have $100,000 mortgage at 5%, you pay $5000 a year in interest. You also have to pay another $1500 on the principal. Now, you might get $1500 back via the mortgage deduction. So you are $5000 in the hole every year. You have to make back $5000 every year to break even.
(Which, depending on your investment strategy, would have been easy or hard to do. Are you a genius at timing the market? No problem. Set it in an S&P 500 index fund? You wouldn't have made it. In the last year, yes. In the last 3, 5 or 10, no.)
But lets say you do manage to break even. You are earning another $5000 in income, which you will have to pay taxes on. Lower cap gains taxes, of course, but you still have to do it. So, you are out 15%, and actually have to make $5750 to break even. (And more if you are timing the market and your gains are short term gains rather than long term ones.)
So, you have a mortgage bill every month and $100,000 sitting around doing nothing except hopefully subsidizing your mortgage payment. Not to mention, you could lose some of that money if the market tanks.
Or you pay off the house and have no mortgage payment, and devote that money to rebuilding your savings.
It almost seems wrong, but I just put the numbers in a spreadsheet.
Scenario 1: invest the $100000 and make a return that matches the 5% interest rate on the mortgage. Actually, making a bit more because you have to pay 15% tax on the interest, and a bit more after that because your mortgage interest deduction gets smaller every year. End of scenario (30 year mortgage): you have a house + the $100,000 you were using to pay off the house.
Scenario 2: pay off the house for $100,000. Instead, put the mortgage payments into the same investment as above. You make the interest, minus income taxes, minus the loss of the tax savings of losing the mortgage interest deduction. End of scenario: you have a house + $558,000.
Because in scenario 1, your investment is covering the interest on the house only for that year. You are still getting charged interest on the rest of the money you still owe them. In either scenario, you have to pay the bank the $100,000 you owe them. The difference is, in scenario 1, you have paid the bank $95000 in interest. In scenario 2, you haven't.
(Interesting note: the higher the mortgage rate, the easier it is to break even on a yearly basis. At a 1% interest rate, you have to make 4.4% on your investment to break even (Maintain the $100,000 principal in the investment acct.). At a 10% rate, you only have to make 9.9% on your investment to break even. It is too late to do the ciphering, but I bet this is a function of the cap gains rate and the mort. interest break.)
(You still always do better paying off the mortgage and saving. In the 10% mortgage and a 9.9% savings rate, you end up with $1m by saving the money.)
posted by gjc at 8:20 PM on January 17, 2011
My math's a little different from gjc. I can borrow at 4.75%. In the 33% bracket, that's 3.18% after taxes. I just need an after-tax return that beats 3.18%. I can do that now with tax-exempt bonds. Safe investment returns are likely to go up from present levels over the life of the loan, and having the investable cash, rather than home equity, gives me more flexibility. I suspect there's a fallacy in gjc's example in treating the principal payments as a cost, rather than just a shift in the form of your investment from cash/investment into home equity.
Or so I'm betting.
posted by Jasper Fnorde at 1:31 PM on January 18, 2011
Or so I'm betting.
posted by Jasper Fnorde at 1:31 PM on January 18, 2011
Principal payments are a cost, from this perspective, because you owe someone that money. You are buying a house slowly or quickly. Buying it slowly means the interest you are earning on your investments goes to your creditor instead of yourself.
It also doesn't matter if it is a fallacy or not, because the numbers prove out. Your starting point is having $100 000 and owing $100 000. Doing it one way you end up with more money, the other you end up with less.
posted by gjc at 3:17 PM on January 19, 2011
It also doesn't matter if it is a fallacy or not, because the numbers prove out. Your starting point is having $100 000 and owing $100 000. Doing it one way you end up with more money, the other you end up with less.
posted by gjc at 3:17 PM on January 19, 2011
This thread is closed to new comments.
posted by Cuspidx at 2:42 PM on January 17, 2011 [1 favorite]