Pay Extra Mortgage Principle or Invest?

[lavidaportland]

Hi folks. I just found Mr. Money Mustache's site and it really got me thinking about what I want my "retirement" to look like, and how soon I can get there. In the Getting Started #1 article, MMM.. er.. I mean... The Realist... suggests the following order:

• paying off any high-interest debt like credit cards
• making sure all your deductions for your 401K plan at work are set to their maximum level, especially if they have employer matching
• paying off any other debts like car or student loans
• paying off extra principal on your home loan
• buying a conservative dividend-paying stock index fund – go to Vanguard.com and start an account to buy some units of the VFINX fund, or if you have a brokerage account you can buy SPY shares.
• last resort: just putting the money into a cash account that pays the highest level of interest you can find – Vanguard’s Prime Money Market fund or ING Direct’s Orange Savings Account.

I don't have any consumer debt; I pay off my credit card each month. I'm maxing out my 401k. I own my 2009 Honda Accord and don't have any student loans. I'm putting all of my savings into a couple of Vanguard index funds.

Should I be putting all or some of my savings toward paying off my house instead?

Thanks,
solofist

[thedayisbrave]

What's the interest rate on your mortgage?

[nanu]

That depends on two things mostly.
First, how high is the interest rate you're paying - if it's above 6% than pretty much everyone will tell you to pay it off first. If below that, then it's more debatable.
Second, your own risk tolerance and aversion to debt. Putting that extra money into the mortgage is a guaranteed return of x% (where x is the rate you pay),
but if x < 6% then investing in the market is likely to produce a better return, but not guaranteed.
Also, if you itemize your taxes then the interest you pay can help reduce your taxes (so that's a reason to invest instead of extra mortgage payments),
though most likely this doesn't have a very large impact.

[lavidaportland]

My mortgage is 4.375% 30 year fixed. I'm not that averse to risk since I have good job opportunities and enjoy my career (I'm a software engineer with 14 years of experience), and no family so I don't worry about kids' college or anything like that, but I am 44 years old so I'm no spring chicken. ;-) I wish I would have learned this stuff way back in my 20's!

It sounds like investing my savings is the better option. I think I'll invest most of my savings, but maybe put a little toward extra principle on the mortgage.

[Yankuba]

I would do both - invest some and prepay the rest

[rpr]

I am investing. I have a 30 year FRM at 3.5% with almost 27 years remaining. Still at least 10 years before FIRE, no hurry to pay off. When FIRE, will reevaluate.


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[lavidaportland]

I can actually see the light at the end of the tunnel!

I'm 44 years old, but didn't start taking investments and retirement savings too seriously until 2010. On my 40th birthday something just clicked! My version of a mid-life crisis I suppose. ;-) Fortunately I've already been doing a lot of what MMM recommends like eliminating debt, maxing out my 401k, investing in Vanguard index funds, living frugally (although I'm constantly working on that... I need to eat out less!) but I just didn't have any idea how much I needed or how long I needed to work.

Currently I have about $510k in investments (two 401Ks, two Vanguard index funds) and $150k equity in a $480k home. Not counting mortgage principle and interest, my annual expenses are about $20k/year. I drive 50 miles per day round trip for work, and my medical insurance is covered by my employer. When I retire I won't drive nearly as much, but I'll have to pay for my medical insurance until Medicare kicks in at 65.

Theoretically I have almost enough in investments to meet the 4% rule, but I would like to have a bit more saved up to buy a couple of acres of land. I'd actually like to build a small off-the-grid home, but that's a whole other story for another day. If I had to guess, I think I have four or five years left working full time. I'll be 48 years old!

When I'm ready, I plan to sell my house and move to the West coast to be closer to my parents. I think I'll still work, but it will be part time doing something low stress that I enjoy. My parents are aging, and I'd like to not have to work all the time while I still have them around.  Fortunately they did well, so I don't worry about needing to support them financially. My ideal retirement will be hiking with my dog, spending time with my parents, hanging out with friends, tending a massive garden, working on interesting projects, camping, fishing, etc.

I don't know why I told you guys all this. :)

[rpr]

solofist:  Thanks for sharing your story. You are doing great and your vision of your retirement sounds wonderful.

Since you do not intend to live in this house post FIRE, I would definitely not be in a rush to pay-off. I assume that you are already maxing the 401K and IRA. With the extra, just keep stuffing that Vanguard account.

[Faraday]

You're blowing my mind ... you just now found MMM, you have the level of savings you've got now and you are just now realizing you could retire at 48?!?! Bless your heart....

Now, for the tough love facepunches:

1) You have said that your ideal would be to sell your house, retire from your job and move closer to your parents. Why, then, are you still making payments on that $480k albatross you're gonna sell in a few years?!?! (and how does the mortgage payment affect your yearly expenses?)

2) Why in the heck are you commuting to work, and do you have any options to work from home? Or, can you go ahead and sell the home, move closer to work and ride a bike or walk?

3) Assuming you've got some valid argument for staying in the house then executing your plan at 48 (you are expected to host the company christmas party?) why not refinance into a 15 or even 10 year mortgage? That would put you back on the high-end of the home finance curve and increase the tax benefits right now on the house payments. (I've just now noted how this question conflicts with other thoughts on mortgage... :-) )

4) Are you contributing the absolute maximum you can to 401k?
http://www.irs.gov/Retirement-Plans/How-Much-Salary-Can-You-Defer-if-You%E2%80%99re-Eligible-for-More-than-One-Retirement-Plan%3F

5) How is your after-tax saving going? What does your FU Fund look like - plenty there to coast on for awhile if needed?

I'm stunned that no one in this thread has facepunched you for those things yet??? Have they done so and I just missed it? :-) :-) :-)

And by the way, GREAT JOB on how you've handled your career and your savings.  You are SO CLOSE. You've probably got everyone here afraid to facepunch - but I'm new at this and probably naive so here I am shooting off my mouth....

[lavidaportland]

*Slips facepunch and counters with a low roundhouse kick to the knee*

1) You have said that your ideal would be to sell your house, retire from your job and move closer to your parents. Why, then, are you still making payments on that $480k albatross you're gonna sell in a few years?!?! (and how does the mortgage payment affect your yearly expenses?)

Since I bought it in 2010 the value has increased by $80k. I also rent a room to a friend, which pays about 1/3 of the mortgage.

2) Why in the heck are you commuting to work, and do you have any options to work from home? Or, can you go ahead and sell the home, move closer to work and ride a bike or walk?

It's funny, I was actually working within biking distance from my house until 2012. I changed jobs because I found one that has amazing pay. I almost doubled my salary by changing jobs! It's the highest salary I've seen advertised in my field in this area. If I moved closer to work I'd be living in an industrial park. :(

3) Assuming you've got some valid argument for staying in the house then executing your plan at 48 (you are expected to host the company christmas party?) why not refinance into a 15 or even 10 year mortgage? That would put you back on the high-end of the home finance curve and increase the tax benefits right now on the house payments. (I've just now noted how this question conflicts with other thoughts on mortgage... :-) )

I'll look at refinancing. If I can get a decent rate and the refinancing fees aren't bad it might be worth it.

4) Are you contributing the absolute maximum you can to 401k?

I'm contributing the max my employer will match. I'm not very happy with the investment options in the 401k, so I put the rest in Vanguard. I earn too much now to be able to contribute to Roth IRA.

5) How is your after-tax saving going? What does your FU Fund look like - plenty there to coast on for awhile if needed?

After tax savings is 59%. I have about $170k in Vanguard funds, $6k in an HSA, and $8k in savings. The rest is in my two 401K accounts.

[jmusic]

Mefla, you're advising him not to prepay his mortgage, then in the same post advising him to refinance to a shorter term.  How is that not in effect doing the exact same thing???

Solofist, unless you're getting a much lower interest rate, DON'T refinance, because you'd be paying a bank extra costs for the privilege of "making extra payments." 

Unless there's something I'm missing, there's absolutely nothing in his situation worthy of a "face-punch."

My thoughts for your situation:
1.  If you're ABSOLUTELY SURE you're going to move when you retire, then a 50/50 prepay/invest would probably be best.  Think of prepaying like getting a tax free bond at 3% interest (lower rate due to the tax advantage).  When you sell your house, you should be able to live on the equity until the IRA conversion kicks in.
2.  If you have ANY DOUBT about moving, then you should not prepay at all, and focus on purely after-tax saving/investing.  Having the cash available gives you options...

[Faraday]

Mefla, you're advising him not to prepay his mortgage, then in the same post advising him to refinance to a shorter term.  How is that not in effect doing the exact same thing???

Solofist, unless you're getting a much lower interest rate, DON'T refinance, because you'd be paying a bank extra costs for the privilege of "making extra payments." 

You guys kill me. I'm not ADVISING him, I'm ASKING questions. This guys has his stuffs together, so I thought I'd ask rather than purely facepunch. In all honesty, I'm not sure I'm worthy of even delivering a facepunch, much less to this dude. But I thought I'd try. I'm gonna do a case study thread on myself and you're all invited to pile on with brass knuckles...

For what it's worth: the last time I refinanced, THEY paid ME. If he refi'ed into a 2.5% 15 year fixed, one lender I checked will pay him $9000 (Provident). You gotta check today's rates man. This stuff shifts around.

Unless there's something I'm missing, there's absolutely nothing in his situation worthy of a "face-punch."

Oh come ON. EVERYBODY gets one every once in awhile. No one gets to be Jesus on this subject...

1.  If you're ABSOLUTELY SURE you're going to move when you retire, then a 50/50 prepay/invest would probably be best.  Think of prepaying like getting a tax free bond at 3% interest (lower rate due to the tax advantage).  When you sell your house, you should be able to live on the equity until the IRA conversion kicks in.

Ha Ha! You said what I said! (sung like an annoying little kid...) And you are exactly right. I particularly like your bond analogy.

[Faraday]

*Slips facepunch and counters with a low roundhouse kick to the knee*

Well Played! I could have written nearly all the answers you wrote. Particularly the one about work distance - I'm in nearly the same boat myself and struggle mightily with moving, but in high tech, companies can be so volatile I could find myself at a different job and having just as long a commute to THAT job. So I'm "sitting and staying" like a good dog.

4) Are you contributing the absolute maximum you can to 401k?

I'm contributing the max my employer will match. I'm not very happy with the investment options in the 401k, so I put the rest in Vanguard. I earn too much now to be able to contribute to Roth IRA.

Your employer must use Fidelity. :-( :-( :-(

I had to get over it. I found Fidelity's Vanguard funds and went into those. I still take it a teeny tiny hit on the chin with fees, but company match and pre-tax benefits far outweigh so I begrudgingly use that one.  I'm at the IRS max and still worried I might be giving away money to Uncle Sam that instead I could be saving.  Are you sure you're not paying money in taxes you could instead be putting in 401k?

5) How is your after-tax saving going? What does your FU Fund look like - plenty there to coast on for awhile if needed?

After tax savings is 59%. I have about $170k in Vanguard funds, $6k in an HSA, and $8k in savings. The rest is in my two 401K accounts.

THAT's the roundhouse kick. Damn good job man. Go Forth and FIRE when ready....