extra mortgage payments vs investing

[thosemiddlesons]

Hello Mustashians,
I'm 28 and my wife is 25, we live in Florida and we're in need of a little financial direction.  After reading several blog posts and combing through the forums I'm a little confused on whether I should be paying my mortgage down or investing.

We currently owe $85,591.21 on our house we bought for $108,468.00 on 01/2009 with 6% interest. Our monthly payments are $842 with taxes and insurance included ($650.33 without).  I have a Roth IRA with $20,920.94 invested with Stocks 71.30% Bonds 28.70% at Vanguard and my wife has a 401k through her work with about $3,000ish saved up.

Right now we're able to save around $1,500 monthly, and we're hoping to grow our mustaches and save more but how should we best utilize these funds?

At the beginning of the year tried to put all of our extra savings towards the mortgage in a mad dash to pay it off.  Our rational is that we'd be saving/earning 6% when doing this.  We recently came to a conclusion that we might be able to do better by investing these funds and making our money work for us by gaining compounding interest.

After reading MMM it seems that we can put our savings towards the Roth IRA that I already have, and start one in my wife's name as well so we can put in up to 10,000 annually (5,000 in each respective account), then invest those funds with indexes and bonds gaining 7% or higher, compounded.  I'm not sure how we would invest the remaining 8,000+ though.  The thought too is that with a Roth IRA if we save up enough we would be able to retire early by withdrawing from our previous contributions without paying any tax penalties by leaving the earnings intact.

Am I learning this correctly or should go back to our plan of paying off our mortgage first then think about investing?
If investing inside the Roth IRA is indeed a good plan, what should we do with our remaining 8,000+ that we wouldn't be able to put towards it?
Thanks in advance for any financial compasses to give us direction.

[thelamb]

I'd too be interested in what the true experts have to say when they weigh in.  I think most would recommend first maxing out your tax-deferred investment options, such as 401k and Roth and then the decision from there would be whether to put money in taxable investments (basic index funds) versus paying down your mortgage.  So short answer, probably do the Roth thing as first priority. 

The longer answer isn't as simple.  My philosophy had always been to invest if the rate of return was guaranteed to be higher than the cost of a given debt-related interest.  For instance, my student loan from a decade ago is right at 3% and the total debt was an amount of money that would have been very easy to pay off.  I haven't.  I've made the minimum payment every month for a decade because I assume my money is worth more elsewhere. 

So, on one hand, 6% is fairly high in the current market and it's right at that threshold where, to me, it's a bit of a gamble of whether you'd get more out of basic index funds.  My guess is you'd do slightly better but that's the gamble. 

On the other hand, while paying down the mortgage is saving the 6% (again, fairly high in current market), you're now tying up cash and capping your potential gains.  For rainy day needs, you will have the advantage of a greater line of credit as your equity grows in case you really really need cash. 

If it were me, I would first look to see if I could refinance at a lower rate then I would look to invest first and, finally, my goal for paying down would be to get rid of the mortgage altogether in order to lower my monthly expenses. 

[sherr]

If it were me, I would first look to see if I could refinance at a lower rate then I would look to invest first and, finally, my goal for paying down would be to get rid of the mortgage altogether in order to lower my monthly expenses.

I would agree. You should see if you can refinance to somewhere in the 3-4% range, and then invest the maximum you can in tax-advantaged ways. After you're maxing out your IRAs (and 401k if you have them) then you can think about whether to pay extra on the mortgage or invest in a taxable account. At that point it's a lot more about what makes you feel secure than anything else. A lot of people are really debt-adverse, so paying extra on the mortgage would be a higher priority for them even though they know they'll make extra money by investing. Other people aren't as bothered by debt, and recognize that at today's super-low mortgage interest rates the investments are the mathematically better option and that the extra potential cash flow could really help in an emergency situation.

The key phrase there is "mathematically better" though, if your mortgage stays at 6% it's less clear cut.

[Numbers Man]

With today's interest rates of for a 15 year mortgage at about 3.25% you can refinance and have a lower payment then what you currently have. Then contribute $17,500 to your wife's 401k plan; this will pretty much wipe out the $1,500 extra a month that you are saving. Maxing the 401k plan will lower your tax bill as well since it will lower your Adjusted Gross Income on your tax return. Any extra money can be thrown at the house's principle balance if you wish or at the ROTH IRA.

[CopperTex]

Mortgage is a guaranteed return of whatever the interest rate is and not having a mortgage is a great part of diversifying and lowering risk.  6-7% is NEVER guaranteed.  Just look at the dow between 1960-1980 and ask yourself if you would of rather invested at -0.17% return over 20 years or have a paid off house.  Not saying you shouldn't invest, but why not do both?

[RobertBirnie]

If you can't refinance to a lower rate, for sure the home loan. 100%. Also, you have a smidgen more than 20% equity it seems, are you in an FHA loan and paying loan insurance on it and just broke the 20% mark? If so you really want to refinance as soon as possible to save on the insurance fees.

[madage]

After reading MMM it seems that we can put our savings towards the Roth IRA that I already have, and start one in my wife's name as well so we can put in up to 10,000 annually (5,000 in each respective account)

Don't want you to miss out on tax-advantaged savings. The IRA contribution limit is $5,500 per person in 2013 (and 2014).

[thosemiddlesons]

Sounds like it's unanimous that I should look into refinancing.  Are there any good resources I should read to research refinancing and what I should expect?
It does seem that there's no clear answer to if I should be paying the mortgage down or saving though.

Then contribute $17,500 to your wife's 401k plan

Wouldn't this be better put into a Roth IRA so that would could retire early and pull out the contributions prior to 59 1/2?  I know the tax advantages of being in a lower bracket with a 401k but do they outweigh the penalties if you were to retire at 45 and start withdrawing from that account?

are you in an FHA loan and paying loan insurance

Yea, in 2014 we'll be able to drop the MIP, which'll save us $50 monthly!  Does that drop off automatically or do we have to fill our a form to an agency?

Don't want you to miss out on tax-advantaged savings. The IRA contribution limit is $5,500 per person in 2013 (and 2014).

Oh, I forgot it had changed in 2013, I was still thinking 2012 numbers.  I know you can still contribute to the previous year up to April though.

[Numbers Man]

You can pull out the 401k money at anytime being taking advantage of Regulation 72T.  Here's an article that speaks to Regulation 72(t)  http://www.obliviousinvestor.com/72t-distribution-rules/

You will be able to drop the PMI once your loan to value ratio is below 80%. In fact, you can apply for the refund of unused PMI.

http://www.bluepage.org/mortgage-insurance/pmi-cancellation.html

[sherr]

It does seem that there's no clear answer to if I should be paying the mortgage down or saving though.

That's just because no one can clearly see the future. If your mortgage rate is 3-4% it's pretty likely that the stock market will give you more money overall. If your rate is still 6% it's less clear, especially when you throw inflation into the mix. In that case do whatever makes you feel safer.

Then contribute $17,500 to your wife's 401k plan

Wouldn't this be better put into a Roth IRA so that would could retire early and pull out the contributions prior to 59 1/2?  I know the tax advantages of being in a lower bracket with a 401k but do they outweigh the penalties if you were to retire at 45 and start withdrawing from that account?

It depends on what tax brackets you are in now and what brackets you'll be in in retirement. If you're going to be paying a higher percentage in taxes in retirement than you are now, then Roth accounts are absolutely the way to go. If you're paying more now than you will in retirement (likely) then Traditional (401k or IRA)  accounts are your best bet.

There are definite ways to get money out of a 401k early without paying a tax penalty. The 72T method mentioned above is one of them, but not my favorite. Once retired, if you have 5 years of living expenses from other sources (including your Roth IRA) then you can set up what's colloquially known as the Roth Conversion Pipeline and be set. https://forum.mrmoneymustache.com/ask-a-mustachian/help-me-understand-the-roth-conversion-pipeline-idea-and-its-benefits/  You'll pay regular income taxes on whatever you convert (at your post-retirement rates) but no penalty.

The "benefit" of a Roth IRA to withdraw early with no penalty is a dubious one when used by itself. A regular, non-tax-advantaged investment account also has the same "benefit". With a Roth IRA of course any interest that your money earned while it was there would be tax free of course, so that's something, but the same principle applies to Traditional accounts. So choose what's best given your current and expected tax brackets, and then go from there.

are you in an FHA loan and paying loan insurance

Yea, in 2014 we'll be able to drop the MIP, which'll save us $50 monthly!  Does that drop off automatically or do we have to fill our a form to an agency?

I called my mortgage broker and asked them to drop it, and they did. It depends on your individual mortgage contract though on whether and when they allow you to drop the PMI early. If you refinanced your new mortgage would not have it.

[tomq04]

I can't help myself with a little "timing" (frowned upon around here) but since paying off a mortage is a form of investment of itself there is something to be said for my opinion.

I have a "minimum" investment I make month in an out no matter what, just like your mortgage.  In my case it's a few DRIPs and a bit of money going into a brokerage account.  I have an extra couple hundred that I have to decide what to do with on a monthly/quarterly basis, options are "more into brokerage account" or "more into mortgage".

Wit the S&P PE ratios 18+ and an awful lot of volatility going on, I am putting extra money into the mortgage for the foreseeable future.  If we get a nice 10-20% pull back I would be back to buying equities.

The answer "a little bit of both" is correct, and if you were asking for a recommendation, currently it would be extra mortage payments.  I am also in agreement with everyone else, REFINANCE! and get rid of that PMI.

[Frankies Girl]

I've had a few discussions on the benefits of paying off the mortgage vs investing over the last couple of months on the forum, and I'm leaning now towards maximizing the 401K (just did that myself) and making an extra payment here and there on the mortgage to make myself feel better about paying that down. BUT I have almost half my mortgage paid off, and a 3.75% interest rate on the mortgage. I also do not have a huge amount of money that will be tied up in the mortgage - my house is roughly the same value as yours. Something else to keep in mind - you don't want to tie up a large portion of your savings/liquid money into a house since you can't easily get it back out.

In your situation with that interest rate, I'd still be inclined to up the 401K as it was already stated, you get the double benefit of saving pre-tax money and you reduce your current income for taxable purposes. It's a win-win to up the 401K if you can.

Roth IRAs are also super as you can tap those earlier, but I understand the emotional draw to paying off the house. So I'd suggest you maybe add in an extra amount each payment - even an extra $100 a month is going to cut YEARS off your payments. Oh, but do look into refinancing. You should be able to get a much better rate even now! Call around to some local banks and don't forget to check into some credit unions in your area too.

[Undecided]

Something else to keep in mind - you don't want to tie up a large portion of your savings/liquid money into a house since you can't easily get it back out.

I think this is an important factor, especially when you're thinking about accelerating repayment of debt at an extremely favorable interest rate. To the extent that the emotional appeal of being debt free is a factor in wanting to make extra mortgage payments, I would encourage the OP to try to act unemotionally in this regard just as much as they would in making other investing decisions.