new to mortgage-vs.-investment-math. Anyone up to helping me crunch numbers?

[neighbor]

Hi!
I hate to be the newbie who jumps in on her first day and requests other participants' help… but honestly, I need to learn how to think about these things and I'm certainly in no position to really help anyone else yet.

If anyone's up to either helping me walk through possible numbers or sharing experiences that seem relevant, I'd be most appreciative.

Backstory: DH and I have been pretty frugal but NOT investment savvy. We were students too long (thankfully only minimal student loan debt accrued, which has all been paid off) and work was too impermanent to get us hooked on saving for retirement. Two nearly grown kids, multiple overseas moves later and … we'll probably get money back from what DH put into his German retirement but we don't have much saved for kids' college (read: none, but my parents put some away in 529s for both kids)  but oldest is staying in Germany (where the rest of us are preparing to move away) to improve her language and see about attending uni here, where it's free (or nearly). She won't be able to access her 529 in the meantime, so we're footing her living expenses for a year until she determines where she's going (coming home to community college?) Youngest kid has 4 years of HS left.

and...
We just bought a mortgage :)
$310,000
@ 3% for first 5 years, adjustable after that
we have no investments and other than the German retirement and  a random few from past jobs that need to be dealt with (but can't be until I'm physically in the US. Yay for weird rules!), there's nothing impressive or consistent.

We have major upcoming moving expenses (some reimbursed by employer, but some not, still unclear) - and some hefty up-front living expenses: for ex. we'll need to buy a car when we return. Obviously aiming for a good used car (pause for a moment to mourn the fact we didn't keep our 1989 Toyota Camry Wagon in which I could get 35-38mpg when driving really smart on the highway)…

And then we were thinking (because we're debt averse) to pay off the mortgage ASAP… and then I bought YNAB to try to help deal with the crazy numbers and the fact that we want to maximize extra money and maybe I can find ways to squeeze more money out of a mustache… and then I found MMM and … here I am!

What a mind blowing idea that it might be better (esp at 3% for 5 years) to invest the extra we would've put into principle into, say, VFINX, and just pay the mortgage as scheduled so as to let the extra do more work elsewhere.

I don't understand the first thing about how inflation affects anything, recognize that the touted 7% is probably optimistic (right?), don't know if 5 years (before refi, if we do so) is enough to generate benefits, etc. etc.

I could come up with VFINX's $3000 start minimum, could possibly add $100/month (or more if it's a good idea and all the moving dust settles a bit so I'd know for sure). We had been thinking of paying the mortgage biweekly, or throwing good money at it anyway…

So, if anyone LOVES to dive into nittygritty stuff like this and wants to walk a non-math, non-finance person through some of this, I'd be delighted to hear what you have to say.

Vielen Dank!

[neighbor]

oh, and in case you wondered, I have been reading the various related posts here on the forums… and just opened this http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478 to read…

I still feel too dumb to figure it out on my own, though.

[marty998]

Well for starters think about tax.

You pay tax on dividend income. You don't pay tax on the interest saved by paying down your mortgage.

So if you can find a decent investment where your capital is not going to go bust, paying a dividend greater than 3%/(1-yourtaxrate), then by all means invest as much as you feel comfortable with.

$100/month is not going to make a meaningful difference. $2000/month on the other hand...then you may really start to see some gains from the strategy...

[neighbor]

marty998 - that's a great start. This is our first property purchase, so I have no idea what's to come with the tax end of things. We've taken the standard deduction every year, so this is all new territory.

Unfortunately, unless I really up my game and have a complete reversal out of "displaced home-maker" status, $2000/month extra isn't in our forseeable future. A couple hundred with my freelance copy-editing and writing, maybe…

We're kind of thinking of the house as our retirement (when it's paid off) - relying on eventually only paying taxes and insurance on it - ideally way before the 30 years of the mortgage. So maybe that does answer the question.

I'm good at saving money and obviously need to get better at making it.

[Emg03063]

Marty's comments on the trade off are correct, but my first concern would be planning for the worst case scenario of your ARM resetting to its max rate after 5 years, not being able to refinance, and being priced out of your house because you can't afford the payment (at a loss, if you want to imagine a real disaster).  Figure out what your max rate is (most are limited to a 5% increase), and whether or not you can afford the payments comfortably if the ARM resets to that level.  If not, I would focus on principal paydown. 

Of course, if you're serious about early retirement and haven't closed yet, look for an out in your contract and go find a less expensive place to live. ;)

[waltworks]

Why did you do an ARM? Are you planning another move imminently? Because ARMs are usually for folks who are looking to use their tons of spare $ for other things (ie investments) and who plan to pay off the loan before it resets. In your situation an ARM sounds like a really, really bad idea - so you may need to think about either paying it off before the reset (probably not going to happen if you can't come up with ~$4k+/month to throw at it) or refi'ing immediately.

You can do much better than 3% with a variety of investments but if you are deducting mortgage interest, the calculation gets a little more complex. Still, I don't think optimizing investment income should be your main goal here - making sure your house doesn't ruin you is.

-W

[myDogIsFI]

Here are a few things to consider:

- Would you be investing in a tax advantaged account (e.g., 401k, roth IRA), or a taxable account?  If you haven't filled up your tax advantaged space then I would recommend starting there.

- The only conventional, passive investment that's going to beat the return on paying your mortgage is stocks.  Over 5 years, you really have no idea what's going to happen in the stock market.  Imagine that you pay into VFINX over 5 years and you lose money continuously, and then your ARM resets to a high rate.  Are you ok with that?  Often investing looks better than paying the mortgage on paper, but you have to be considering the long term.

- Re: tax advantages of having the mortgage.  It's only an advantage if your deductions exceed the standard deduction.  For 2014, the standard deduction for a married couple filing jointly is $12,400.  So, e.g., if you're interest + property tax is less than $12,400 and you don't have any other deductions, then you get no tax benefit at all.  (This is different than the point about comparing to taxable dividends by looking at the after-tax return).

[rmendpara]

Hi!
I hate to be the newbie who jumps in on her first day and requests other participants' help… but honestly, I need to learn how to think about these things and I'm certainly in no position to really help anyone else yet.

If anyone's up to either helping me walk through possible numbers or sharing experiences that seem relevant, I'd be most appreciative.

Backstory: DH and I have been pretty frugal but NOT investment savvy. We were students too long (thankfully only minimal student loan debt accrued, which has all been paid off) and work was too impermanent to get us hooked on saving for retirement. Two nearly grown kids, multiple overseas moves later and … we'll probably get money back from what DH put into his German retirement but we don't have much saved for kids' college (read: none, but my parents put some away in 529s for both kids)  but oldest is staying in Germany (where the rest of us are preparing to move away) to improve her language and see about attending uni here, where it's free (or nearly). She won't be able to access her 529 in the meantime, so we're footing her living expenses for a year until she determines where she's going (coming home to community college?) Youngest kid has 4 years of HS left.

and...
We just bought a mortgage :)
$310,000
@ 3% for first 5 years, adjustable after that
we have no investments and other than the German retirement and  a random few from past jobs that need to be dealt with (but can't be until I'm physically in the US. Yay for weird rules!), there's nothing impressive or consistent.

We have major upcoming moving expenses (some reimbursed by employer, but some not, still unclear) - and some hefty up-front living expenses: for ex. we'll need to buy a car when we return. Obviously aiming for a good used car (pause for a moment to mourn the fact we didn't keep our 1989 Toyota Camry Wagon in which I could get 35-38mpg when driving really smart on the highway)…

And then we were thinking (because we're debt averse) to pay off the mortgage ASAP… and then I bought YNAB to try to help deal with the crazy numbers and the fact that we want to maximize extra money and maybe I can find ways to squeeze more money out of a mustache… and then I found MMM and … here I am!

What a mind blowing idea that it might be better (esp at 3% for 5 years) to invest the extra we would've put into principle into, say, VFINX, and just pay the mortgage as scheduled so as to let the extra do more work elsewhere.

I don't understand the first thing about how inflation affects anything, recognize that the touted 7% is probably optimistic (right?), don't know if 5 years (before refi, if we do so) is enough to generate benefits, etc. etc.

I could come up with VFINX's $3000 start minimum, could possibly add $100/month (or more if it's a good idea and all the moving dust settles a bit so I'd know for sure). We had been thinking of paying the mortgage biweekly, or throwing good money at it anyway…

So, if anyone LOVES to dive into nittygritty stuff like this and wants to walk a non-math, non-finance person through some of this, I'd be delighted to hear what you have to say.

Vielen Dank!

Bad idea. This is basically market timing, and you're not smart enough to do that (don't be offended, none of us are). Here's why:

Good scenario: Market returns 7% for the next 5 years, and the reset rate in 5 years is 5%. In this case, you earned a positive spread from investing extra cash rather than paying down the mortgage, but this is offset by the higher mortgage balance remaining in 2019 which now incurs 5% interest.

Medium scenario: Market returns 4% for the next 5 years, and reset rate in 5 years is 6%. In this case, you barely earned anything by investing excess cash, and now you have a higher balance remaining in 2019 which is going to cost you likely much more than you gained from investments in the first 5 years.

Bad scenario: Market returns 2% for the next 5 years (downturn hits in Y4 and flat in Y5), and reset rate in 5 years is 6.5% (no Fed stimulus this time). In this case, you lost money by investing in the market instead of paying down your mortgage, AND you now have a higher interest rate to pay on the remaining mortgage. Double whammy!

You are making two dumb decisions:

1) ARM. Unless you plan to sell before 6-7 years in the property, this is a sub-optimal decision.
2) Market timing - By playing with #1, you are essentially betting on two things:
a) The market will outperform 3% over the next 5 years (will likely happen, but if a downturn hits, then the timing alone will cause you to be worse off even if it recovers 5 years later)
b) Your reset rate will not increase by a lot... (hint: it probably will)

I'd be happy to come up with some #'s, but there are so many unknowns in there that it's a bit pointless.

[neighbor]

Why did you do an ARM?

well, we got thrown a curve ball when the lender didn't like that my husband's job is on contract - and we were set to close in a week.. . there were issues related to translating foreign documents etc etc.

Why buy in general? Because we were looking at rents of the same or higher cost than house payments. Because we're newbs and supposedly-wiser family members thought it made sense? Because we have some ability to actually pay down principal based on lots of frugality practice.

urgh.

We want to make this work. I see now, by the fears raised here, that it makes no sense to do fancy things other than pay down principal.

I guess one of the first things we'll do upon return to the US is find good tax/investment help. That and I'm going to find a job.

I'm less interested in early retirement at this point - just wanting to do things in a smart way and eventually retire.

We can afford the next rate jump to 5% on current income. Now to maximize income…

pardon me while I disappear for a while and get busy :)

[waltworks]

Well, you got horrible advice, probably, but thinking positive, you can still make it work.

-You don't need a tax/investing advisor. You have a very simple situation (assuming you want to keep the house and aren't planning to move soon)- pay down that mortgage. Still a good idea to have a rainy day fund, of course, but basically you need to put yourselves in a position to avoid disaster when the mortgage resets to 8%. There's lots of good advice and help here, take advantage of it.

-Start making spreadsheets. Can you put away a few thousand a month? More? What scenario do you want in 5 years and how do you get there? Do you want to sell the house before the reset? What will your monthly payment jump to if the rate goes to 5, 6, 7, 8%?

Time to buckle down and start making decisions with good information instead of flying by the seat of your pants. The good news? You can do it.

-W

[nereo]

Why did you do an ARM?

well, we got thrown a curve ball when the lender didn't like that my husband's job is on contract - and we were set to close in a week.. . there were issues related to translating foreign documents etc etc.

Why buy in general? Because we were looking at rents of the same or higher cost than house payments. Because we're newbs and supposedly-wiser family members thought it made sense? Because we have some ability to actually pay down principal based on lots of frugality practice.

urgh.

We want to make this work. I see now, by the fears raised here, that it makes no sense to do fancy things other than pay down principal.

I guess one of the first things we'll do upon return to the US is find good tax/investment help. That and I'm going to find a job.

I'm less interested in early retirement at this point - just wanting to do things in a smart way and eventually retire.

We can afford the next rate jump to 5% on current income. Now to maximize income…

pardon me while I disappear for a while and get busy :)

Well it's not all doom and gloom - make sure you don't loose sight of the bigger picture.  At least for the next five years you have a phenominally low 3% rate.
With $310k at 3% you monthly payments of $1,300 (excluding tax, insurance and HOA fees).  You stated that you can still afford the mortgage if the rates increased to 5% ($1665).   If you start *now* by paying that amount (which is $358 extra per month) it'll shave over 9 years off your mortgage, and save you tens of thousands on interest (the exact amount depends on unknowns, like what your ARM will be years 6-20). 

My advice is at a minimum pay the extra ~$360/month on your mortgage.  AFter that, there is a benefit from having long-term savings, and I'd personally want to balance anything beyond this extra $360/month with savings.  But that's just me.  There's certainly good reason to pay down as much as you can as fast as you can, since there is at least a possibility that your rate in 5 years will reset to 6, 7, or even 8% (historically it's happened before).

cheers
N

[neighbor]

REALLY, REALLY great advice here, thanks everyone. You came through in spades.

We have a decent buffer & emergency funds but are aiming for a tad more. We're also fine-tooth-combing the budget with YNAB's help.

Meanwhile, I'm gung ho to pay off principal. Everything extra will head that way and I'm psyched to FIND that extra.

nereo thanks for easing the doom and gloom, it helped.

On a positive, roll with the punches, note, we're sure we're in for 4 years (til youngest is done with HS) and can be open to downsizing (unless income increases, which it may, incl. with the property's help… yay, rentable room… and unless costs decrease, which they may… yay garden space!).

[FIreDrill]

We just bought a house as well and went with a 5/1 ARM.  I think the biggest thing is to understand how your ARM works as far as adjustment caps, refinance options, early payment fee's, and all that good stuff.  We went with the 5/1 because we wanted to make sure we could max out our tax advantaged accounts in order to save 15-25% on Fed taxes, after we max out our pre tax accounts we will pay down the mortgage principle.  I'll give you an example of the terms and conditions on our 5/1 ARM so you can look into yours.


Starting Rate 3.25%
First adjustment after 5 years.
Each adjustments can increase no more than 2%. (year 6 = 5.25% max, year 7 = 7.25% max, year 8 = 8.25% max. Worst case scenario.)
Adjustments based on 1 year LIBOR index + 2%. ( Currently at .55% so adjustment right now would be 2.55% but this will likely increase a bit by the 5 year adjustment, historical data:  http://www.moneycafe.com/personal-finance/libor/ )
Lifetime cap is intro rate + 5% = 8.25%
Pre payment penalty = None
Loan can be refinanced.
Loan is assumable.


Over the initial 5 year period we will save 14k with this interest rate compared to the 30 year fixed rate that was available to us.  We will be able to handle the worst case 8 year scenario and we understand how the loan works.  There was risk in going for the 5/1 ARM but we understand it and are comfortable with our options.  I guess my advice to you is to know and understand the terms of your ARM, that will allow you to make a better decision on what to do.

Also, check this out for Loan Pre=payment calculator for ARM's, it will give you good insight into the worst case possibilities of the adjustment periods.  http://mortgagemavin.com/adjustable-rate-mortgage-arm/extra-payment-mortgage-calculator.aspx

Hope this helps!

[neighbor]

StudentStacher,

thanks for talking me through the ins and outs of this kind of mortgage.

Here's what we have, broken down the same way you did yours:

Starting Rate 3.00%
First adjustment after 5 years.
Each adjustments can increase no more than (I think - if I'm correct reading this as the APR )2.6325 %. (year 6 = 5.00% max, year 7 = 9%... no higher after that )
Adjustments based on : (this is Greek to me)  1 year treasury constant MAT - Weekly
Interest rate can change every 12 months after the fixed interest period but never increase or decrease more than 2.000%
Pre payment penalty = None
Loan can be refinanced.
Loan is assumable. doesn't say

I felt ok about this loan because it's possible to refinance before the rates go up (as I assume is inevitable). I know it's not guaranteed to be approved, but…

[TomTX]

Why buy in general? Because we were looking at rents of the same or higher cost than house payments. Because we're newbs and supposedly-wiser family members thought it made sense? Because we have some ability to actually pay down principal based on lots of frugality practice.

urgh.

We want to make this work. I see now, by the fears raised here, that it makes no sense to do fancy things other than pay down principal.

I guess one of the first things we'll do upon return to the US is find good tax/investment help. That and I'm going to find a job.

Buying a house right off was likely a sub-optimal decision. I generally suggest living in an area for 9 months (renting) to learn where exactly where you want to live, make sure you like the job and that you're going to be stable there for awhile.

Then, you get serious about buying (if you want to buy) - and time the closing ~2 weeks before the rental contract ends, so that you can move with less hassle.

You don't need good tax/investment help, unless you mean reading this and related forums.

[neighbor]

Good points, Tom - but in our case we had some extenuating circumstances. First, we're moving from overseas (so dependent on things like ending rental contract 3 months in advance… even before we had a house - ready, set, leap!), having lived in the target area for 10 years (before the overseas move) & understanding the market (tight and expensive for renters, requiring 1 year lease on 99% of properties (only rooms in shared apartments sometimes go for month-to-month)… Having purchased we're paying rent price and have the ability to rent one room out... Needing to go back to CA (but at least picking the less expensive town one-over) to be close to a parent with declining health.

Anyway, I'm not here to argue the fine details and "prove" we did the right thing. We want to be settled, have spent too much money and time as renters moving constantly and having landlords with too much say and condescension.

Thanks to the fine explanations provided by many here, though, I see that we can put some of our extra ($100-500/mo) into principal, which answered my original question nicely.