Case study: Pay off mortgage as fast as possible or invest?

[Chris Evergreen]

I'm in the process of buying my first home ever at the age of 30. The mortgage will probably be just shy of about $400k, and I make a little over $150k per year. My girlfriend and I have been working on our monthly budget and we're trying to cut down to about $1k per month for the two of us (not including the pending mortgage payment, assuming we do get this house). I've been sharing the blog with her and she is just as excited as I am to cut our spending and try to retire early.

My question is, assuming we can get our monthly spending under control, that leaves us with a little shy of $3k per month that I could either invest or use to pay down the mortgage faster. I've been using mortgage calculators and it looks like if I pay $4500/mo instead of the minimum payment, the entire mortgage will be gone in nine years, which sounds very tempting. The interest rate on the mortgage looks like it's going to be locked in at roughly 4.375%.

So, should I pay off the mortgage as fast as possible or invest that extra money, or some kind of split?

[genselecus]

The rate isn't too bad, so you'd probably be better off not paying off the mortgage (from a purely financial sense). There have been a number of threads on this topic and it really boils down to personal preference. Could you feel comfortable having that debt sitting over you and saving the money rather than paying down the debt? People answer that question differently.

I think part of the answer comes from what your other portfolios look like. How much do you have in savings, retirement, and other investment accounts? If you have none, I would certainly recommend that you save some money first and build a nice safety net. If you already have $50k sitting in taxable investment accounts, then I would say you have flexibility to do what you think feels right. Just remember that your house would be an asset of a very particular type (local housing market). Pushing all your savings into one asset type can be risky and people usually are better off diversifying. That said, a house as an asset type is fundamentally less risky, assuming you're always able to make the payments (the idea being that if your house loses 50% value over night, you're still able to live in it).

[MDM]

See this topic in http://forum.mrmoneymustache.com/forum-information-faqs/frequently-asked-questions/

[Chris Evergreen]

Thanks for the tip. I read through a few of the other posts, but, y'know, everybody's situation is different, so I was curious what the recommendation would be for mine specifically. :)

I have about $42k in Betterment right now, plus after the down payment for the mortgage, should have another $20-30k I can invest as well; still waiting to hear back about exactly how much the down payment will be, plus will need to buy some appliances like washing machine and dryer, which I'll try to source from Craigslist to save money. I also have about $34k in my 401k. So I feel like I've got a reasonably decent safety net at this point, but if I pay off the mortgage as fast as I can, it's probably not going to grow very quickly. I'm thinking $1000/mo into the investments and the rest into the mortgage might be a nice middle ground.

[MDM]

There's the "strictly by the numbers" answer: invest in whatever has the highest interest.  But even that requires making some assumption about future market returns.

There's the "do what makes you feel safe" answer: have a paid-off home.  But even that requires making some assumption about how you would perceive a larger net worth vs. the paid-off home.

Good luck either way!

[Chris Evergreen]

There's the "strictly by the numbers" answer: invest in whatever has the highest interest.  But even that requires making some assumption about future market returns.

There's the "do what makes you feel safe" answer: have a paid-off home.  But even that requires making some assumption about how you would perceive a larger net worth vs. the paid-off home.

Good luck either way!

That makes sense.

I really appreciate the link to the FAQ, btw. I've been reading through the MMM blog post-by-post after reading a bunch of the linked posts from the "Start Here" one, but hadn't hit the "Pay Down the Mortgage or Invest More? A win/win question." post yet.

[neo von retorch]

You didn't ask for this particular line of advice and you may have thought through this already. Disregard entirely if you so prefer!

But... are you absolutely sure you want to buy a house? Especially one worth that much? Yes - I realize it's partially a function of income. But it's also a function of life variables. Will you be with this girl and your current job 7+ years from now, such that you cannot imagine moving? Buying and selling homes are very expensive transactions. While you can minimize interest (somewhat), the taxes and insurance will be ongoing costs, and there will be expected and unexpected maintenance costs.

Also, you say "girlfriend" but you're buying a house "with" her. Are you both going to be on the title? Are you buying it and renting space out to her?

[MattC]

I think this is a diversification question.  If you get this house, you have a savings vehicle that will save you 4.375% minus the loan interest tax deduction.  If you look at this from an investing standpoint, no way do you put ALL your money in at the 3% or whatever guaranteed rate, but you do put some in.  And maybe, instead of a more conventionally diversified portfolio containing treasury bonds/cash equivalents etc., you make it more top-heavy with stocks and treat your home equity as the asset you would liquidate (refinance) to plow money into stocks if they were to drastically tank. 

Personally, I'd probably just pay it down on  a 15 year schedule; get the better rate for going to 15 years; you'll be effectively putting like 35k into the house a year; then invest your other money a little stock-heavy.

[Chris Evergreen]

You didn't ask for this particular line of advice and you may have thought through this already. Disregard entirely if you so prefer!

But... are you absolutely sure you want to buy a house? Especially one worth that much? Yes - I realize it's partially a function of income. But it's also a function of life variables. Will you be with this girl and your current job 7+ years from now, such that you cannot imagine moving? Buying and selling homes are very expensive transactions. While you can minimize interest (somewhat), the taxes and insurance will be ongoing costs, and there will be expected and unexpected maintenance costs.

Also, you say "girlfriend" but you're buying a house "with" her. Are you both going to be on the title? Are you buying it and renting space out to her?

Well, we moved to Colorado from California, so the house costs much less than half what a smaller and less-fulfilling house would cost where we moved from, but yes, I realize it's still really expensive. I definitely expect to be able to hold this job for at least the next seven years, and I still work for the same company I have for the past two and a half years, just remotely now. The minimum payment on the mortgage will be significantly less than we've paid for rent in the past, and we both really like the idea of not having to move again for the foreseeable future or worry about rent increases or things we can't fix, like the hot water that stopped working for a week last month while they were doing maintenance on the boilers and had to shut the hot water down for our entire building several days in a row.

As far as the "girlfriend" part - I'll be the only one on the mortgage at least for now (because the paperwork was easier that way and I can qualify solo), but I am planning to ask her to marry me soon, and we've been together for almost three years. So, hopefully, she'll be around for a while to come :)

[gluskap]

I recommend doing something in between.  We just refinanced to a 15 year mortgage for 2.875%.  We plan to pay the minimum payment for the 15 year mortgage and invest the difference.  Once we have enough in the taxable brokerage account then we will pay it off.  We expect to be able to do this in 8-10 years depending on how the stock market does.  I think the difference in interest rate is worth it.  However you have to think about how stable your job is.  If there is any doubt that you'll have any trouble making the higher payment then it might be worth it to keep the 30 year mortgage for the flexibility.

[rpr]

Are you maxing out your contributions to your tax-advantaged accounts such as 401K? This is $18k for this year. At your income levels and tax bracket (I guess 25%+ including state taxes), this can reduce your taxes significantly. If you get married, that will be a total of 36K. This tax advantage space is on a use-it or lose-it basis every year. I would first do this before prepaying the mortgage.

[Catbert]

Are you maxing out your contributions to your tax-advantaged accounts such as 401K? This is $18k for this year. At your income levels and tax bracket (I guess 25%+ including state taxes), this can reduce your taxes significantly. If you get married, that will be a total of 36K. This tax advantage space is on a use-it or lose-it basis every year. I would first do this before prepaying the mortgage.

Absolutely max out all retirement vehicles (401k, IRA, TSP, 402b, 457 etc) before you start working on paying off the house.  Even then from a strictly financial/math perspective you're still better off post-tax investing rather than paying off the house.  But I understand why people want the house paid off.

[frugaliknowit]

To answer your question:  No, I would not pay the mortgage off ASAP.  Diversify.  You're pretty young.  You might consider a 15 year for a better rate and a built in quicker payoff. 

For maximum mustachianism, you might consider a lower priced house.  While you can pretty easily afford the house with the 400K mortgage (2.7X income), in the long run, you would be better off with maybe 2X income for a mortgage.  With that will come lower taxes and less maintenance and more money to invest making you wealthier.

[GetItRight]

At that interest rate I would pay it off ASAP, and in your shoes I'd either buy less house or save more to put down on it. I'm risk and debt averse, value stability and not being tied to a job I'm less than satisfied with. I am aggressively paying off student loan debt and once that's done it'll all be funneled into the mortgage before I build the stash beyond a 401k for employer match. If I had no debt and lost my job I could get by on side gigs or whatever came along indefinitely in a worst case scenario. Your values may differ, everyone is different.

[gomike]

You are getting ripped of, that interest rate is way too high.  Penfed is 3.625% for a 30 year fixed

[rpr]

At that interest rate I would pay it off ASAP, and in your shoes I'd either buy less house or save more to put down on it. I'm risk and debt averse, value stability and not being tied to a job I'm less than satisfied with. I am aggressively paying off student loan debt and once that's done it'll all be funneled into the mortgage before I build the stash beyond a 401k for employer match. If I had no debt and lost my job I could get by on side gigs or whatever came along indefinitely in a worst case scenario. Your values may differ, everyone is different.

Personally, I would disagree with this. First and foremost, max out your 401k and Trad deductible IRA up to the limit (18K+5.5K for single, 36K+11K for married with each having a 401K+IRA). You only get one shot at this every year. Once this space is lost, it is gone forever. You cannot go back and refill it. The tax benefits are huge. In the 25% federal bracket, the tax savings alone amount to almost 12K every year. This is huge. You are paying needless taxes of almost 12K every year for the satisfaction of having no debt. Why would you throw away almost  1K per month?  In retirement, you may be  in a low tax bracket and can pay little to no taxes.

[Glenstache]

This wasn't mentioned earlier, but make sure that your mortgage does not include any early payoff penalties that would negate the benefits of early payoff. Even if you don't pay down early, leaving the option open is a good call.

[GetItRight]

Personally, I would disagree with this. First and foremost, max out your 401k and Trad deductible IRA up to the limit (18K+5.5K for single, 36K+11K for married with each having a 401K+IRA). You only get one shot at this every year. Once this space is lost, it is gone forever. You cannot go back and refill it. The tax benefits are huge. In the 25% federal bracket, the tax savings alone amount to almost 12K every year. This is huge. You are paying needless taxes of almost 12K every year for the satisfaction of having no debt. Why would you throw away almost  1K per month?  In retirement, you may be  in a low tax bracket and can pay little to no taxes.

Maybe if I only had the mortgage, but in my case I have student loans totaling more than I owe on the house. If I stay the course it'll all be paid off within 5 years or so, maybe less depending on side jobs/raises/etc. At that point I'll be maxing out the 401k and working on minimizing taxable income any other way I can. For now it's just the 401k for the match and an HSA for the match in that.

[Chris Evergreen]

Wow, this blew up a bit while I wasn't paying attention!

Okay, so, let me reply to a few of these...

Are you maxing out your contributions to your tax-advantaged accounts such as 401K? This is $18k for this year. At your income levels and tax bracket (I guess 25%+ including state taxes), this can reduce your taxes significantly. If you get married, that will be a total of 36K. This tax advantage space is on a use-it or lose-it basis every year. I would first do this before prepaying the mortgage.

Yep, I'm maxing out the 401k and the traditional IRA already. I'm planning to try the Roth ladder strategy from MadFientist later in life.

To answer your question:  No, I would not pay the mortgage off ASAP.  Diversify.  You're pretty young.  You might consider a 15 year for a better rate and a built in quicker payoff. 

For maximum mustachianism, you might consider a lower priced house.  While you can pretty easily afford the house with the 400K mortgage (2.7X income), in the long run, you would be better off with maybe 2X income for a mortgage.  With that will come lower taxes and less maintenance and more money to invest making you wealthier.

I asked about a 15-year loan instead of a 30-year one, and according to the loan officer, there would be a 0.01% cut in the interest rate. He didn't seem to think it was worth the higher (minimum) payments, but he did offer to work up the numbers for me if I really wanted to see how it would shake out. I decided I'd rather have a lower minimum payment with the freedom to choose to add as much as I want each month.

We've looked at a bunch of houses in a variety of price ranges. Maybe the start of the year wasn't a great time to look for a new house, but things have gotten pretty crazy in the metro-Denver area, and at least a half-dozen times since the beginning of the year, houses that we were interested in that were in a lower price range went under contract literally hours after they were listed, so we didn't even have a chance to look at them. If we could have found a house with solid fundamentals (modern-enough wiring, no cracks in the foundation, close enough to bike to groceries etc) for less that didn't disappear before we even got to see it, we would have jumped on it. When it comes down to it, the mortgage is definitely more than I would want to pay, but it's definitely something I can pay, and I can even afford to pay double or more if I don't put all of the extra money into investments. So I'm not too worried about it.

You are getting ripped of, that interest rate is way too high.  Penfed is 3.625% for a 30 year fixed

Unfortunately, my credit is in the 650-ish range because of some poor choices earlier in my life which will hopefully fall off the credit report in the next two years. I have friends with credit scores in the 750+ range who just bought a house in the SF Bay Area, and they got a 4.0% interest rate, so I was actually pretty happy to get 4.375%. Besides, even if I don't pay it off as fast as I possibly can, making some extra payments (especially the first year) should cut the total interest paid by a pretty substantial amount.

This wasn't mentioned earlier, but make sure that your mortgage does not include any early payoff penalties that would negate the benefits of early payoff. Even if you don't pay down early, leaving the option open is a good call.

Already confirmed this with the loan officer at my real estate agent's office. No early payment penalties! He claimed he hadn't actually seen a loan with early payment penalties in the past several years.

At that interest rate I would pay it off ASAP, and in your shoes I'd either buy less house or save more to put down on it. I'm risk and debt averse, value stability and not being tied to a job I'm less than satisfied with. I am aggressively paying off student loan debt and once that's done it'll all be funneled into the mortgage before I build the stash beyond a 401k for employer match. If I had no debt and lost my job I could get by on side gigs or whatever came along indefinitely in a worst case scenario. Your values may differ, everyone is different.

I've got more saved (an additional $30k in liquid cash at the moment beyond the down payment itself), but I don't want to put ALL of my savings into the down payment. I like having the safety net. And of course the loan officer is trying to get me the biggest loan possible, but I'm still going to be putting down just over 20% of the house's cost as a down payment. I'm not really very risk averse, but I also value stability, and I love my job. Even once I hit the FIRE savings point, I don't plan to quit; I'd rather cut my hours down to 60% and take the 40% pay cut than quit the job, because I enjoy it so much. (Of course, that could easily change over the next decade.)