### Author Topic: Stupid simple calculation, probably  (Read 3543 times)

#### highwayskies

• 5 O'Clock Shadow
• Posts: 40
• Age: 44
• Location: CT
##### Stupid simple calculation, probably
« on: February 25, 2014, 12:03:21 PM »
I am embarrassed to say, that, despite information explaining this, I'm still unclear.  With a mortgage at 8.725%, I'd like my money to go there first, rather than savings.  This is in keeping with advice here I've read.

While putting that money towards that mortgage, I'm just trying to get my head right on it, so I feel as good about it as I should...

Paying, say \$2000/mo towards the mortgage is EQUIVALENT to saving with a return of 8.725%?  Or it's just a good idea?  What's my "return" on that money technically?  In other words, is paying down debt with x% the same as investing with a return of x%?

#### MustachianAccountant

• Bristles
• Posts: 433
• Age: 43
##### Re: Stupid simple calculation, probably
« Reply #1 on: February 25, 2014, 12:14:47 PM »
In other words, is paying down debt with x% the same as investing with a return of x%?

Yes.
Also, if you live in the US, and plan on staying in your house 5-ish years or more, look into refinancing ASAP. 8.725% is a ridiculously high mortgage interest rate in this current environment. You could most likely cut that in half, or if you go 15 yrs, even more.

#### ZMonet

• Stubble
• Posts: 212
##### Re: Stupid simple calculation, probably
« Reply #2 on: February 25, 2014, 12:18:27 PM »
Echo that 8.725 is ridiculously high.  Also echo that if you are going to stay 5+ years in the house (or keep it as a rental), you should refinance or throw enough money at it to a point where you can refinance.

In answer to your question, since you can take a mortgage deduction on the interest paid, the "real" rate you are paying on is likely a little less -- but still way too high.

When did you get a mortgage for 8.725%?

#### sol

• Walrus Stache
• Posts: 8474
• Age: 44
• Location: Pacific Northwest
##### Re: Stupid simple calculation, probably
« Reply #3 on: February 25, 2014, 12:29:52 PM »
In answer to your question, since you can take a mortgage deduction on the interest paid, the "real" rate you are paying on is likely a little less -- but still way too high.

You can figure out exactly how much less, with a little work.

Up front, prepaying a mortgage at 8.725% prevents you from paying 8.275% interest on the amount you prepay, so it's mathematically equivalent to getting an 8.725% return on your prepayment.  Technically you're "not losing" 8.725%, which is slightly different from gaining 8.725%, but for growing your net worth it works out the same.

Unless you itemize your deductions on your tax return.  If you're itemizing instead of taking the standard deduction, then you can deduct the number of dollars you paid last year in interest.  Assuming the entire dollar amount of your interest payment is above the standard deduction amount, then you could assume that it's coming off of your taxes at your marginal tax rate.  So if your highest tax bracket is 25%, then you're getting back 25% of 8.725%.  That works out to not losing 6.54% instead of not losing 8.725%.

If you need all of your mortgage interest tax deduction to get above the standard deduction (like if you wouldn't itemize if you didn't have mortgage interest because the standard deduction would be larger) then the benefit is somewhat reduced, and you'll end up with a an effective return on your prepayment of somewhere between 6.54 and 8.725%.

#### jhartt3

• Guest
##### Re: Stupid simple calculation, probably
« Reply #4 on: February 25, 2014, 12:41:14 PM »
yeah refi that.  There are people in the KC area i use that do REFI's for free and i got incredible rates and guess what i paid nothing.  No they didnt roll it into the loan.  I could have paid to lower my rate.  but i have REFI'd 3 times.  First from a 30 years with PMI at 5% to a 20 year with no PMI at 4.25% ... then i went from that to a 20 year at 3.875... then i went from that to a 15 year @ 3%... i paid no closing costs i didnt even pay for the appraisals that were done.  The only thing i brought to the REFI was a check for that month's payment to pay down the interest/principle/Escrow build up so i wouldnt miss a payment.  REFI that loan i'm sure someone up in your area has to do no cost REFI's ...

Note:  You need high credit ratings to do this with the group i use.

#### Cheddar Stacker

• Magnum Stache
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• Location: USA
##### Re: Stupid simple calculation, probably
« Reply #5 on: February 25, 2014, 12:57:34 PM »
Refinance immediately even if you only plan to stay in the house for 2 years. You can get a no cost refi in exchange for a higher rate, which would still be well below your current rate. If you are underwater or have other circumstances preventing you from a refi, fix those circumstances ASAP, then refi.

Everything SOL said makes a lot of sense, but he missed one important thing in evaluating the scenario. The same "tax effect" he explained related to the mortgage interest should be applied to your income as well, but it might be applied at a slightly lower rate depending on the type of income. If you are earning an 8.725% return on capital gains, it could be taxed at 0% (LT gains in 10% or 15% bracket) or 15% (LT gains in 25% bracket or higher) or ordinary tax rates (ST gains) which would make it roughly equivalent to the rate you are saving in mortgage interest. For the sake of simplicity, let's assume you are paying ordinary tax rates on the hypothetical investment return, and you are in the 25% tax bracket.

So invest \$2,000/month (\$24K/yr) and earn 8.725% gross, 6.544% net (8.725% x (1-25%))   OR
Pay extra mortgage of \$2,000/month (\$24K/yr) and save 8.725% gross, 6.544% net (8.725% x (1-25%))

Either way you earn/save 6.544% net of taxes. Now as SOL said your mortgage interest deduction may be limited by the automatic standard deduction effect. You also might not pay such a high tax rate on the investment gains, but this should all be part of your evaluation of what makes the most sense.

It if were me, I would do everything I could to pay this off/down, unless (or until) a refinance is an option.

#### Prairie Stash

• Handlebar Stache
• Posts: 1795
##### Re: Stupid simple calculation, probably
« Reply #6 on: February 25, 2014, 01:52:24 PM »
It's better, it has no risk on the same return.

#### highwayskies

• 5 O'Clock Shadow
• Posts: 40
• Age: 44
• Location: CT
##### Re: Stupid simple calculation, probably
« Reply #7 on: February 25, 2014, 02:27:20 PM »
Thank you for all of the responses!

This horrible rate is on the \$39,000 no-doc 2nd mortgage on a SFH, and was taken out to 100% finance the house in 06.  (Yes, I was one of the last guys to do this foolish thing).

Since I am fully financed, self-employed, etc, refi is not a possibility.  I have excellent credit, just can't at this time.

My wife and I are moving into my mother's rent-free, and my plan was to put all monies toward paying that 2nd mtg down, and then refi if possible, since I'll have some equity at that point.  I think I can do \$2k/mo with more when I have it, shooting for a year until pay-off.