Does it make sense to pay off a 30 year mortgage in 6-9 years?
January 18, 2017 11:09 AM Subscribe
If we were to get a 30 year fixed rate mortgage at around 4.1%, and could afford to pay off the note within 6-9 years, would that be a smart financial decision? The alternative, I suppose, would be to instead invest that extra money?
Assumptions: we are already matching 401k and maxing roth ira contributions. Mortgage would be 100-150k, we would be putting 20% down.
30 year mortgage is chosen instead of a shorter term because of the lower monthly payments, should one of us lose our job or some other emergency happen.
Its hard for us not to look at the calculators and say, well this will save 60k over the life of the loan, but the important caveat - it is looking more likely that we will move in 5-7 years, in which case we will either sell, or rent the home(using a property management company). For the sake of the argument lets assume rental market is strong in this location.
Assumptions: we are already matching 401k and maxing roth ira contributions. Mortgage would be 100-150k, we would be putting 20% down.
30 year mortgage is chosen instead of a shorter term because of the lower monthly payments, should one of us lose our job or some other emergency happen.
Its hard for us not to look at the calculators and say, well this will save 60k over the life of the loan, but the important caveat - it is looking more likely that we will move in 5-7 years, in which case we will either sell, or rent the home(using a property management company). For the sake of the argument lets assume rental market is strong in this location.
Best answer: The only case where I might not pay down too quickly is if you don't have many liquid assets.
If you are going to move in 5-7 years make sure you have the down payment for the next house in liquid assets- or you may find that your next down payment is trapped in your current house.
Ideally you would have the option of decoupling the sale of your current house and the purchase of your next. In complicated real estate markets this flexibility could be critical.
posted by NoDef at 11:18 AM on January 18, 2017 [6 favorites]
If you are going to move in 5-7 years make sure you have the down payment for the next house in liquid assets- or you may find that your next down payment is trapped in your current house.
Ideally you would have the option of decoupling the sale of your current house and the purchase of your next. In complicated real estate markets this flexibility could be critical.
posted by NoDef at 11:18 AM on January 18, 2017 [6 favorites]
Best answer: No. That would put most of your eggs in one basket: one house in one RE market. Diversification is important, and you really want most of your worth to be diverse.
If you're going to move, having the $$ tied up in the house makes it much harder to buy another house. Even if you keep it to rent it out, having most of your money tied up in a house you don't live in is ... suboptimal (ask me how I know).
A different option is to invest the extra you'd pay (in diverse assets, like an index fund); and then recast the mortgage at some later point if you feel that works to your advantage, at the time you choose to do it. 4.1 is still a pretty good rate, and it may look REALLY good in 5 years; recasting would let you keep that rate.
You didn't ask this, but if you're more likely than not to move in 5-7 years, I'd really say don't buy in the first place.
posted by Dashy at 11:22 AM on January 18, 2017 [14 favorites]
If you're going to move, having the $$ tied up in the house makes it much harder to buy another house. Even if you keep it to rent it out, having most of your money tied up in a house you don't live in is ... suboptimal (ask me how I know).
A different option is to invest the extra you'd pay (in diverse assets, like an index fund); and then recast the mortgage at some later point if you feel that works to your advantage, at the time you choose to do it. 4.1 is still a pretty good rate, and it may look REALLY good in 5 years; recasting would let you keep that rate.
You didn't ask this, but if you're more likely than not to move in 5-7 years, I'd really say don't buy in the first place.
posted by Dashy at 11:22 AM on January 18, 2017 [14 favorites]
Best answer: If your are keeping the current house as an investment (rental) property AND you plan to move in 5-7 years AND you can also save enough money for a down-payment on your next house, then sure! Pay down the mortgage as fast as you can. But don't put yourself in a position where lack of liquid capital would be disastrous.
posted by JohnFromGR at 11:31 AM on January 18, 2017
posted by JohnFromGR at 11:31 AM on January 18, 2017
I did it. I know some people say it's better to invest the money and all that but let me tell you, it's super awesome having a free place to live. And knowing if we ever do want to buy a new house, we'll have a huge down payment available without having to set aside cash somewhere for it.
posted by something something at 11:34 AM on January 18, 2017 [8 favorites]
posted by something something at 11:34 AM on January 18, 2017 [8 favorites]
If that's something within reach for you, why are you getting a 30yr fixed instead of a 5/1 or 7/1?
posted by AaRdVarK at 12:05 PM on January 18, 2017 [3 favorites]
posted by AaRdVarK at 12:05 PM on January 18, 2017 [3 favorites]
Best answer: this will save 60k
but the opportunity cost of not investing that in an index fund over the life of the mortgage will be much higher.
posted by rebent at 12:14 PM on January 18, 2017
but the opportunity cost of not investing that in an index fund over the life of the mortgage will be much higher.
posted by rebent at 12:14 PM on January 18, 2017
"but the opportunity cost of not investing that in an index fund over the life of the mortgage will be much higher."
I dunno, if the right way to think of the early mortgage payment is as an investment earning a guaranteed 4.1% tax free (is that really the right way to think of it?), that doesn't sound so bad. Long term the index fund's probably been better historically but it's riskier and increases your taxes, so this isn't an apples-to-apples comparison.
This may be a little beyond what ask.metafilter can handle. It could depend on a lot of details (what are your other investments? as others say, how's the emergency fund and down payment for next house fund? What's your risk tolerance?). And it could be complicated to figure out. May be time for a financial planner and/or some serious time spent running the numbers yourself?
posted by floppyroofing at 1:09 PM on January 18, 2017
I dunno, if the right way to think of the early mortgage payment is as an investment earning a guaranteed 4.1% tax free (is that really the right way to think of it?), that doesn't sound so bad. Long term the index fund's probably been better historically but it's riskier and increases your taxes, so this isn't an apples-to-apples comparison.
This may be a little beyond what ask.metafilter can handle. It could depend on a lot of details (what are your other investments? as others say, how's the emergency fund and down payment for next house fund? What's your risk tolerance?). And it could be complicated to figure out. May be time for a financial planner and/or some serious time spent running the numbers yourself?
posted by floppyroofing at 1:09 PM on January 18, 2017
Do consider that mortgage payments are mostly interest at first. I would re-look at a 15 year mortgage if that seems feasible financially, in terms of comparing total cost paid in interest vs principle for paying it off early.
posted by gingerbeer at 1:20 PM on January 18, 2017 [1 favorite]
posted by gingerbeer at 1:20 PM on January 18, 2017 [1 favorite]
Keep in mind that inflation will reduce the effective cost of the mortgage most years as long as your income has cost of living increases. Stretching that out over 30 years can really pay off - assuming there's a 2% inflation rate, if your initial payment was $1,000/month in today's dollars, by year 30 you're only paying about $556 in today's dollars.
Increasing your tax sheltered 401(k) savings or boosting post-tax index fund holdings is likely to give you better financial performance while boosting your diversification. It also gives you greater flexibility if you want to come up with $10K cash to do something like cover moving expenses or fix up the house as a rental unit when you move compared to getting a HELOC.
posted by Candleman at 1:33 PM on January 18, 2017 [1 favorite]
Increasing your tax sheltered 401(k) savings or boosting post-tax index fund holdings is likely to give you better financial performance while boosting your diversification. It also gives you greater flexibility if you want to come up with $10K cash to do something like cover moving expenses or fix up the house as a rental unit when you move compared to getting a HELOC.
posted by Candleman at 1:33 PM on January 18, 2017 [1 favorite]
Check out this forum discussion on the Mr. Money Mustache website: http://forum.mrmoneymustache.com/investor-alley/stop-saying-it-is-not-mathematically-correct-to-pay-off-your-mortgage-early!/ LOTS of hot opinions on this topic from investing gurus! Ultimately, though, only you know your own personal mix of risk tolerance, goals, time to retirement, and total financial picture...
posted by SinAesthetic at 1:45 PM on January 18, 2017 [4 favorites]
posted by SinAesthetic at 1:45 PM on January 18, 2017 [4 favorites]
We had a 15 year loan that we paid off in like 12.5 years. It's great not having a mortgage. Make 13 payments a year and you can be done in 14. Opps, you're not staying that long? You'll have plenty of equity.
posted by fixedgear at 1:52 PM on January 18, 2017
posted by fixedgear at 1:52 PM on January 18, 2017
Don't do this at the expense of all other (non-retirement) saving. Worst case, a natural disaster destroys your house and your insurance does not cover earthquake/flood/whatever happened. Now you have no house and no money.
posted by the agents of KAOS at 2:05 PM on January 18, 2017 [1 favorite]
posted by the agents of KAOS at 2:05 PM on January 18, 2017 [1 favorite]
It is probably slightly suboptimal financially, but we are trying to do this, paying as aggressively as possible. Having no mortgage payment would provide options and flexibility, and I am willing to give up some potential percent of investment gain to get there
posted by Dip Flash at 5:15 PM on January 18, 2017
posted by Dip Flash at 5:15 PM on January 18, 2017
Do you have access to an offset account? You put the extra money in the offset account; for the purposes of interest calculation on the loan the money in the offset account offsets the amount owing, and you can withdraw the money from the offset account whenever you need it.
If you get a 30 year loan and after 6-9 years the money in the offset account equals you owe, you are just left re-paying principal. You can then use the money to close the loan, or use it as a deposit on another property etc. You get the liquidity and tax free interest advantages.
In Australia this is the "normal" way to do property loans - you'd have to go out of your way to get a loan that didn't have an offset.
posted by trialex at 7:09 PM on January 18, 2017
If you get a 30 year loan and after 6-9 years the money in the offset account equals you owe, you are just left re-paying principal. You can then use the money to close the loan, or use it as a deposit on another property etc. You get the liquidity and tax free interest advantages.
In Australia this is the "normal" way to do property loans - you'd have to go out of your way to get a loan that didn't have an offset.
posted by trialex at 7:09 PM on January 18, 2017
Best answer: Financially it may not be optimal. Psychologically, it can be great. Having the house paid off is, as a previous commenter said, "super awesome."
posted by DaveP at 3:41 AM on January 19, 2017
posted by DaveP at 3:41 AM on January 19, 2017
Best answer: The financial/psychological divide might be a good one to think about. After we refinanced at 3.6%, I stopped trying to pay off our 30 yr mortgage early because it didn't seem like the math worked as well, and there wasn't much of a psychological upside. But financial decisions undeniably have an emotional component to them, so my advice is that if you want to pay off your mortgage early so you don't have to look at those ongoing payments every month, then by all means do it -- there may be financial/risk diversification reasons to not do it, but in my mind they're not so overwhelming as to make not paying it off early the obvious "right" decision.
posted by craven_morhead at 7:47 AM on January 19, 2017 [1 favorite]
posted by craven_morhead at 7:47 AM on January 19, 2017 [1 favorite]
Nobody knows what will happen in 6 to 9 years, let alone 30 years. Inflation may go up making your investments sound and lucrative - or it could stop climbing if the standard of living and wages in your area drop enough. You will probably have to refinance your mortgage and when that day comes mortgage rates might be incredibly good or incredibly bad. You might lose the house to a minor natural disaster and your insurance decline to pay out due to an act of God clause. Housing might turn into a bubble and leave you with a house that you couldn't sell worth nothing. Investments might tank totally when the markets crash when China divests itself of the dollar or loses a hot war or instability in the electronic money network becomes all too apparent.
All the financial advice you get will be based on people predicting what is more probable and none of us know. We are all guessing.
My rule of thumb is that something tangible is worth more than something made out of paper if things get bad. A house will be worth more than Enron stock certificates. Even in Detroit a house still has value because you can live in it and it keeps the rain off. Stock certificates that leave you owing taxes on their previous imaginary value cannot keep you dry when it rains. So my rock bottom worst case scenario is that the house is a better choice than paper investments.
Much of the paper investing complex is based on transferring money from smaller and less powerful investors into the hands of bigger and more powerful investors, after convincing the smaller investors that their little nest egg will earn money by investing, rather than losing it. Right now profits don't seem to be coming from increased value, but from providing even lower value for the money than people think (hope) they are getting and that includes investments. Not only is your glass measuring cup more likely to explode in the microwave because they secretly changed the materials, but whatever you invest in is more likely to have been sold to you solely for the purpose of skimming money off you.
Of course - there are non-paper investments that might be worth more than the house, such as education in a marketable skill or paying medical expenses to turn yourself from someone who is disabled in some way into someone who is not disabled in that way.
But there are loads of people who spent heavily on their child's university believing that the university course work led to a marketable skill only to discover that it didn't, and tons of people have taken trades courses only to discover that you had to know someone in order to get hired in the trade and people in the trade only hired one out of one hundred students, in order to control the number of people working and keep wages high. Finding a marketable skill to train in is as hard as finding any other good investment.
A house that you own is one less bill to pay. It means that whatever other bills you have to pay you don't have to pay rent or the mortgage. Your home becomes free of the surcharge that we pay to either the landlord, or the bank, or both. Your house may need repairs, but if an apartment needs repairs the tenants are going to pay for that too in the form of higher rent.
How to decide? Make your decision based on emotions. If the idea of paying off your house sooner makes you happier than the idea of "investing your money wisely" or "having a large nest egg in the bank" then go with paying off your house. If you don't feel safest over the house then go with the option that makes you feel safest and happiest.
You can, after all, always change strategies in six months, or a year, or six years. Remember the earlier you make extra payments the bigger the reduction of the debt over time. Dropping an extra five thousand on the house in the first year is worth more than triple the value of paying off an five thousand on the house ten years in.
So if you want to make extra payments on your mortgage the first one is the best one with each subsequent payment being worth less in long term saving, whereas with investments the first one is often not the best one, because of the fees to research the investment and set it up and the fact that whenever you cash in the investment there is usually another fee to be paid for cashing it out and that fee will take a bigger bite out of the first payment to your investment than the last one. If your guaranteed return on investment, less fees is higher than the interest on your mortgage, plus fees, then it could be worth doing.
To illustrate what I mean, supposing you put eight-hundred dollars into an investment and let it sit for a decade, you might well turn it into one-thousand dollars, but they are very likely to charge you two hundred dollars to close out the investment, because otherwise what would they be handling your investments for? And it's not the length of time they hold the investment for you, it's the amount of money involved, so the fees tend to be scaled so that the more you have in your investment account the less brutal the brokerage or bank fees. They may charge you $200 on an $800 investment, but only $250 on an investment of $1,750. You are matching this investment cost against your interest earned. Investment brokers try to keep the fees as close to the the profit you are making as possible without causing you to take your investment and get out. If they figure you are going to get out they will raise their fees above the profit you are making. And if you are not making a profit at all, well, you will still be paying the fees.
This means that a short term investment is usually worth less than an advance payment on a debt. You might have to keep investing for the entire time before you get to see a more than negligible return, where as the moment an early payment on a debt is made the debt is reduced. In order for investing to be a better bet you have to know, somehow that the investment will continue to increase in value. Your house doesn't have to increase in value for it to be worth paying off. You would be stuck with the debt even if the housing market tanked and the property became un-sellable, and you would have property taxes to pay too. Your mortgage will remain waiting to be fed, no matter if your house becomes worth more, less or nothing.
Disclaimer: Information comes only from what I read and experience with my own mortgage and my own investments. Not a professional. Generalizations have been made.
posted by Jane the Brown at 2:16 PM on January 19, 2017 [2 favorites]
All the financial advice you get will be based on people predicting what is more probable and none of us know. We are all guessing.
My rule of thumb is that something tangible is worth more than something made out of paper if things get bad. A house will be worth more than Enron stock certificates. Even in Detroit a house still has value because you can live in it and it keeps the rain off. Stock certificates that leave you owing taxes on their previous imaginary value cannot keep you dry when it rains. So my rock bottom worst case scenario is that the house is a better choice than paper investments.
Much of the paper investing complex is based on transferring money from smaller and less powerful investors into the hands of bigger and more powerful investors, after convincing the smaller investors that their little nest egg will earn money by investing, rather than losing it. Right now profits don't seem to be coming from increased value, but from providing even lower value for the money than people think (hope) they are getting and that includes investments. Not only is your glass measuring cup more likely to explode in the microwave because they secretly changed the materials, but whatever you invest in is more likely to have been sold to you solely for the purpose of skimming money off you.
Of course - there are non-paper investments that might be worth more than the house, such as education in a marketable skill or paying medical expenses to turn yourself from someone who is disabled in some way into someone who is not disabled in that way.
But there are loads of people who spent heavily on their child's university believing that the university course work led to a marketable skill only to discover that it didn't, and tons of people have taken trades courses only to discover that you had to know someone in order to get hired in the trade and people in the trade only hired one out of one hundred students, in order to control the number of people working and keep wages high. Finding a marketable skill to train in is as hard as finding any other good investment.
A house that you own is one less bill to pay. It means that whatever other bills you have to pay you don't have to pay rent or the mortgage. Your home becomes free of the surcharge that we pay to either the landlord, or the bank, or both. Your house may need repairs, but if an apartment needs repairs the tenants are going to pay for that too in the form of higher rent.
How to decide? Make your decision based on emotions. If the idea of paying off your house sooner makes you happier than the idea of "investing your money wisely" or "having a large nest egg in the bank" then go with paying off your house. If you don't feel safest over the house then go with the option that makes you feel safest and happiest.
You can, after all, always change strategies in six months, or a year, or six years. Remember the earlier you make extra payments the bigger the reduction of the debt over time. Dropping an extra five thousand on the house in the first year is worth more than triple the value of paying off an five thousand on the house ten years in.
So if you want to make extra payments on your mortgage the first one is the best one with each subsequent payment being worth less in long term saving, whereas with investments the first one is often not the best one, because of the fees to research the investment and set it up and the fact that whenever you cash in the investment there is usually another fee to be paid for cashing it out and that fee will take a bigger bite out of the first payment to your investment than the last one. If your guaranteed return on investment, less fees is higher than the interest on your mortgage, plus fees, then it could be worth doing.
To illustrate what I mean, supposing you put eight-hundred dollars into an investment and let it sit for a decade, you might well turn it into one-thousand dollars, but they are very likely to charge you two hundred dollars to close out the investment, because otherwise what would they be handling your investments for? And it's not the length of time they hold the investment for you, it's the amount of money involved, so the fees tend to be scaled so that the more you have in your investment account the less brutal the brokerage or bank fees. They may charge you $200 on an $800 investment, but only $250 on an investment of $1,750. You are matching this investment cost against your interest earned. Investment brokers try to keep the fees as close to the the profit you are making as possible without causing you to take your investment and get out. If they figure you are going to get out they will raise their fees above the profit you are making. And if you are not making a profit at all, well, you will still be paying the fees.
This means that a short term investment is usually worth less than an advance payment on a debt. You might have to keep investing for the entire time before you get to see a more than negligible return, where as the moment an early payment on a debt is made the debt is reduced. In order for investing to be a better bet you have to know, somehow that the investment will continue to increase in value. Your house doesn't have to increase in value for it to be worth paying off. You would be stuck with the debt even if the housing market tanked and the property became un-sellable, and you would have property taxes to pay too. Your mortgage will remain waiting to be fed, no matter if your house becomes worth more, less or nothing.
Disclaimer: Information comes only from what I read and experience with my own mortgage and my own investments. Not a professional. Generalizations have been made.
posted by Jane the Brown at 2:16 PM on January 19, 2017 [2 favorites]
Best answer: One important to keep in mind in doing your calculation is that paying down your mortgage early is not, in the end "tax free" in the sense of "without tax implications," insofar as it prematurely reduces your mortgage interest deduction and therefore increases your income tax burden.
posted by drlith at 12:19 AM on January 20, 2017
posted by drlith at 12:19 AM on January 20, 2017
Response by poster: Thanks all, a lot to think about, especially as rates are going down. Some replies:
posted by czytm at 11:01 AM on February 15, 2017
- You didn't ask this, but if you're more likely than not to move in 5-7 years, I'd really say don't buy in the first place.
posted by Dashy at 11:22 AM - That is certainly a consideration we're taking into account, and we've done lots of math including estimated closing costs/down payment/etc. Our minimum payment after taxes/fees would be less than/eq to our current rent.
If that's something within reach for you, why are you getting a 30yr fixed instead of a 5/1 or 7/1?
posted by AaRdVarK
- As stated in the question, we're aiming for a monthly payment that one of the two of us could handle on our own, should the other lose their income (either by choice or chance). But maybe this kind of security isn't necessary if we could just refinance should something like that happen.
- make sure you have the down payment for the next house in liquid assets- or you may find that your next down payment is trapped in your current house.
- A good point but our current plan to move doesn't include purchasing another house.
- May be time for a financial planner and/or some serious time spent running the numbers yourself?
posted by floppyroofing at 1:09 PM on January 18
- SO's financial planner actually suggested purchasing if only for the mortgage interest deduction, although barring any major purchases, I'm not sure that will put either of us over the standard deduction, especially after the first year.
posted by czytm at 11:01 AM on February 15, 2017
This thread is closed to new comments.
posted by tillsbury at 11:12 AM on January 18, 2017 [10 favorites]