Author Topic: Paying off mortgage early for retirement house land vs. investing  (Read 8347 times)

Katiedawg7

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This is my first post on the MMM site and I am definitely not a financial genius - so all advice is welcome. 

My husband and I have been married for a year and have one debt, the mortgage (no credit card/car payments, etc.).   Our mortgage is around $370,000 with a 5% interest, 30-year fixed loan (we're one year into repayment as well).  We are 37 and 41 years in age and would like to quit our current jobs and relocate to the pacific nw within the next 10 years. We anticipate having second careers, however our goal is to work for fun and not out of necessity. Currently our mortgage payments are $30,000 / year (principal/interest/escrow). 

I have suggested to my husband that I would like to apply an extra $30,000/year towards the principal so we can get the mortgage paid off. At which point we could purchase the land for the retirement house (we would have a land loan for improved property - which is a completely different ketle of fish - I know there are many financing options with different tax implications).

My husband has suggested that instead of paying down the mortgage so quickly that we invest either the full $30,000/year or a portion of that in stocks, bonds, etc. He would expect a ROI inbetween 7.5 and 15%.  We would still pay off the mortgage early, just not as early. 

Is it smarter to pay off the original mortgage more quickly or to invest the extra money and delay purchasing the new property? 

I appreciate all of your feedback...

Another Reader

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #1 on: August 30, 2012, 05:10:23 PM »
It's impossible to offer any input without knowing more about your entire financial position - other assets, retirement accounts, etc.

Relying on an assumption of 7.5 to 15 percent ROI on stocks and bonds is not reasonable, even over a 10 year period.   

I would look at refinancing your primary residence.  Rates are up a little, but still less than 4 percent.  Your current P&I payment based on a principal amount of $370,000 is around $1,986.  At 3.75 percent, the payment is just under $1,714. 

maizeman

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #2 on: August 30, 2012, 05:35:55 PM »
It also comes down to your individual risk tolerance. By investing money instead of paying off the mortgage you're betting that you can earn a >5% return with your other investments. Sometimes you'll be right and come out ahead. Other times you'll be wrong and lose money relative to the guaranteed return of paying less interest by paying off principle faster.

I do agree with the above post though, 7.5-15% ROI in too optimistic a range to be using in your calculations on this.

If you'll be moving soon it may not be worth it to refinance given the up front costs. If you expect to be in your present house for most of the next decade it's probably worth it to try to lock in an lower interest rate (if so you might also want to look into switching to a 15 year mortgage which would probably lower your interest rate even more while paying down principle faster).

gooki

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #3 on: August 30, 2012, 10:20:04 PM »
I'm risk adverse, and my 2 cents say pay that mortgage down.

5% interest is sufficiently high, and the total value of the loan is equally high, that I'd at the very least pay it down aggressively to a point where you can refinance at 3%. Then, and only then would I consider investing excess after tax money.

The big difference between your two scenarios is paying down the mortgage is a guaranteed 5% return on you money, where as the investment alternatives are not guaranteed.
« Last Edit: August 30, 2012, 10:21:37 PM by gooki »

Jamesqf

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #4 on: August 30, 2012, 10:37:26 PM »
The big difference between your two scenarios is paying down the mortgage is a guaranteed 5% return on you money, where as the investment alternatives are not guaranteed.

The 5% return on mortgage (or whatever rate, if you refinance) is not really guaranteed.  Suppose house prices drop again, then you will be stuck with an underwater asset.  On the other hand, if they've risen in the 10 years or so before you plan to sell, you've made that profit off borrowed money.  In addition, you need to remember that some part of the interest you pay is tax deductable (if you're in the US, anyway), reducing your real cost.

Finally, there's the question of liquidity.  If you have the money invested in mutual funds, you can sell a portion at any time if need be (even if at a loss), while it can take months to sell a house, and at least weeks to even get a home equity loan.

arebelspy

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #5 on: August 31, 2012, 07:51:21 AM »
The 5% return on mortgage (or whatever rate, if you refinance) is not really guaranteed.  Suppose house prices drop again, then you will be stuck with an underwater asset.  On the other hand, if they've risen in the 10 years or so before you plan to sell, you've made that profit off borrowed money.

No.  Appreciation has nothing to do with a loan.  Your house appreciates the same (or falls the same) regardless of if it's paid off or underwater.

If you have a loan at 5%, and you pay it down, you are guaranteeing a 5% return.  Conflating appreciation and falling prices with this is not correct.

Also, OP you need to refi.  There is no excuse to be paying 5% in this day and age of mortgage rates.  You could likely save a few hundred per month.

Even if you're moving soon, look into a no cost refi, or do one of the penfed 1% 5 year loans (which will have a crazy high payment, but you use cash reserves to pay it that first year and sell).  If you aren't moving right away, even better. 

Personally I'd refi and invest the money.
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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #6 on: August 31, 2012, 08:20:03 AM »
Did not see the 1% 5 year on the Pen Fed website.  That would be a great deal for someone with a low balance mortgage they just want to pay off.

If these folks have no retirement savings, that's where the $30k should go.  In any event, given the 10 year time frame, refinancing makes sense.  Really need more info to give more detailed input.

arebelspy

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #7 on: August 31, 2012, 08:26:46 AM »
Sorry, 1.99% 5-year.

Agree on needing a little more info, hopefully OP posts again.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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Another Reader

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #8 on: August 31, 2012, 08:37:49 AM »
I think rates went up or the product disappeared, because I can't find that one either.  However, a 10 year fixed at 2.5 percent (half a point origination fee) is entirely doable if these folks want to throw the extra $30k at the mortgage.  If they still wanted to move then, the house would be free and clear.  This idea assumes they have other assets, including well funded retirement accounts.

arebelspy

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #9 on: August 31, 2012, 08:45:57 AM »
I think rates went up or the product disappeared, because I can't find that one either.  However, a 10 year fixed at 2.5 percent (half a point origination fee) is entirely doable if these folks want to throw the extra $30k at the mortgage.  If they still wanted to move then, the house would be free and clear.  This idea assumes they have other assets, including well funded retirement accounts.

https://www.penfed.org/home-equity-loan/

Owner occupied, up to 60 months (5 yr), 1.99%.  80% or less LTV (though if you're trying to pay off that quickly, you'd likely have a lot better LTV than that, so that shouldn't be an issue).  It's classified as a HELOC, but you can use it as your primary, many reports of people calling and getting it to pay off their current loan and accelerate to a 5-year.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Another Reader

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #10 on: August 31, 2012, 08:54:33 AM »
I like the "outside the box" thinking on that one!  Anyone with a small balance and a low LTV ought to be crunching the numbers....

Jamesqf

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #11 on: August 31, 2012, 03:28:32 PM »
If you have a loan at 5%, and you pay it down, you are guaranteeing a 5% return.  Conflating appreciation and falling prices with this is not correct.

How are you getting any return on paying off a loan, if the value of the underlying asset falls faster than the rate of repayment?

Say for instance you bought a new car for $30K, on a 5 year, zero-interest (to keep the math simple) loan.  At the end of 5 years, you have repaid $30K, and have an asset worth maybe $5K.  Seems like you're getting a negative return, aren't you? (Neglecting the value to you of driving the car, of course.)

Jaherman99

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #12 on: August 31, 2012, 03:45:46 PM »
Investing in the stock market wouldn't change the fact that your house lost value.  Your net worth would go down the same amount in either case, since you still own the asset even if you invest in the market.  So you only get a gain by investing if you earn more than 5% that you are paying to the bank on the mortgage, plus the interest tax deduction from the mortgage, plus your personal value of risk.  Not a large difference, especially with the risk figured in.

I agree with you that you lose liquidity by putting money in the mortgage.  I struggle with that too, and will probably use a sinking fund instead of actually paying down the mortgage (maybe in yearly dumps?) to keep DW feeling secure.

arebelspy

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Re: Paying off mortgage early for retirement house land vs. investing
« Reply #13 on: August 31, 2012, 05:32:02 PM »
If you have a loan at 5%, and you pay it down, you are guaranteeing a 5% return.  Conflating appreciation and falling prices with this is not correct.

How are you getting any return on paying off a loan, if the value of the underlying asset falls faster than the rate of repayment?

Say for instance you bought a new car for $30K, on a 5 year, zero-interest (to keep the math simple) loan.  At the end of 5 years, you have repaid $30K, and have an asset worth maybe $5K.  Seems like you're getting a negative return, aren't you? (Neglecting the value to you of driving the car, of course.)

You are conflating asset value with the loan on the asset.  They are two separate things.

If you paid 30k cash for that car, you'd still have a car worth 5k at the end.  Whether you took the 0% loan or paid cash, at the end you paid 30k for a car now worth 5.  That is the asset value.  The result is the same at 0% interest.

Now let's say you had to pay cash or pay interest, and let's say it was 5% interest.  By paying down the loan, you pay less money.  You save yourself from paying that extra 5% interest, and get a guaranteed 5% return on that money paying down the loan.  At the end you still have a car worth 5k (asset value), but if you pay down the loan on it, the money you used to pay it down faster saved you extra interest, at the rate the loan was at.

Or would you say that you'd pay the same amount overall paying cash or paying 5% interest? 

Probably (hopefully) not. 
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.