Author Topic: Mortgage payoff question  (Read 3809 times)

Bashdash

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Mortgage payoff question
« on: November 18, 2016, 01:48:13 PM »
Hi all first post but frequent forum reader.
Have two mortgages.  First one was bought at peak real estate high in suburb of NY in 2007.  Current value of condo is 100kish less than original purchase price.  Has a 4.5% mortgage rate  Currently renting it out and losing roughly 300 per month from break-even point.  Currently live in another house with another mortgage.  This has a 4% rate.  Here are current assets.
104K in ally account 1%
107k in ally account 1%
9k ally in account 1%
Stocks
99k current value ( 30k profit from original purchase price )  Many dividend earners.
403B account
90k in balanced portfolio.  70k for wife in fixed 4%
529 plan
40k
4.5% mortgage has 159K left on it ( 30 year fixed )
4% mortgage has 233,819K left on it ( currently living in this house) ( 30 year fixed )
Wife and I both each have 100k income with pensions and are in our mid 30's

Not sure if deploying our cash is a good idea.  College is 18 years away for one child and 16 for the other.  Would love a good plan.  I have been actively paying down extra principal heavily.

SeattleCPA

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Re: Mortgage payoff question
« Reply #1 on: November 18, 2016, 02:18:44 PM »
I'm not saying that what I'm about to share is only thing you need to think about... but that said:

If you've got a 4.5% mortgage on a rental property and your family income exceeds $150K, you can't write off your passive losses which means you're basically not getting an immediate deduction for your 4.5% mortgage's interest expense. (You will get deduction some day if you sell... or when your cumulative passive income eats up any suspended passive losses.)

So paying off the mortgage on the rental, you're getting a really favorably taxed 4.5%... it's not really tax-free. But it sort of is.

Paying off the primary residence mortgage--if you're paying a top tax rate of 25%-- means you're getting maybe an after tax interest rate of 3% ( that's the 4% less the 25% tax).

And then on your bank accounts you're getting 1% but you're getting taxed on that so if the tax rate is 25%, you're looking maybe at about .75%. That's point seven five so three quarters of a percent.

Liquidity matters, and people like cushions, but IMHO getting a sort of "tax free at least today" return of 4.5% versus earning an adjusted for taxes rate of 3% on the primary residence mortgage versus earning an after tax rate on the bank accounts of 3/4th of a percent... well, that 4.5% looks pretty good to me.

It's not written specifically for your situation, but i've got a blog post that goes into the math of early mortgage repayment with more precision, in case you're interested:

http://evergreensmallbusiness.com/why-early-mortgage-repayment-makes-sense-for-high-income-investors/

robartsd

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Re: Mortgage payoff question
« Reply #2 on: November 18, 2016, 02:27:18 PM »
Your money losing rental property should be assessed with a "If you wouldn't buy it, you probably should sell it attitude." 2007 peak real estate bubble purchase price is not relevant in 2016. If you are upside down in this mortgage, but would sell it if you could, use your cash to pay it down and unload this property. If the rental makes sense to you at current prices, consider using cash to pay down the mortgage to the point where you could refinance at a better rate. Also consider if refinancing your current home's mortgage at a lower rate is feasable (and using cash to reduce this balance if that helps get you to better terms).

The only retirement accounts you mention are 403(b) plans for you 90k and your wife 70k. You can also contribute to IRA accounts to shelter more money. I'll assume your employer sponsored health plans don't have any HDHP's that would make sense for you to access a HSA. Bottom line is you want to maximize your tax advantaged accounts.

Your 40k in 529 plan should be able to grow enough to pay at least a moderately priced 4 year degree program. I'm not sure what exactly you want to do for your kids college wise, but I don't think sitting on a bunch of cash is the best way to meet your goals.

Once you've considered using your cash to help refinance your loans at a lower rate, maximized your 403(b) and IRA contributions, and funded your 529 plan(s) to your desired levels you get to decide between paying down your mortgage(s) and taxable investments. The lower your interest rates, the more investing in stocks makes more sense. In any case, paying off 4.5% interest mortgage is much better than letting money sit in a 1% deposit account.

Bashdash

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Re: Mortgage payoff question
« Reply #3 on: November 18, 2016, 04:11:45 PM »
Thank you so much for both replies.  They are really helping me think this out with some options.  Would it be a bad investment to pay it off and then hold on to it for rental income.  Rental income will most likely increase in the suburbs of NYC in a good area.  Currently $1900 per month.  With no mortgage it may feel like I am actually making money even though that would not be the case I guess.  I think one of the other options mentioned was to pay off the mortgage and then sell it.  Taking the new cash to invest elsewhere.  I feel I would not want to take this major loss of money although maybe I shouldn't consider it a loss. I'm not sure if this is making any sense.  Anyway, thanks for the detailed help I appreciate it.  I am trying to get our act together financially for our family that is growing.  It definitely feels like we have too much cash making literally nothing.  I was thinking of investing partially in a VTI etf or making a dividend basket in my motif account.

robartsd

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Re: Mortgage payoff question
« Reply #4 on: November 18, 2016, 05:10:08 PM »
With no mortgage it may feel like I am actually making money even though that would not be the case I guess.  I think one of the other options mentioned was to pay off the mortgage and then sell it.  Taking the new cash to invest elsewhere.  I feel I would not want to take this major loss of money although maybe I shouldn't consider it a loss. I'm not sure if this is making any sense.
You shouldn't evaluate it based on your original purchase or current mortgage, you should evaluate it based on the current market value. The loss from buying at the peak has already occurred (even if not fully realized yet due to continuing to hold the property). If you can sell the property for a value (after transaction costs) worth more than the income stream you can get from renting out the property, you should sell. Holding the property because you expect rents to go up is a form of real estate speculation. The only reason an investment property you own but would not currently buy is good to hold on to is if it is close enough to the break even point that the transaction costs tip the scales in favor of maintaining your position.

Vagabond76

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Re: Mortgage payoff question
« Reply #5 on: November 18, 2016, 08:47:08 PM »
I see bad situations:

You are slowly bleeding cash every month on the rental.  Why are you keeping it?  Do you plan to move back some day?  Are you hoping it goes back up to where you bought it?  That doesn't seem likely any time soon if you are still $100k upside down after 9 years.

The cash is losing purchasing power if put in savings at 1%.  To make maters worse, there is well over $200k of it.


Bashdash

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Re: Mortgage payoff question
« Reply #6 on: November 19, 2016, 05:15:32 AM »
That makes sense.  I knew there were many problems with my situation.  I guess part of the reason I feel I need a cash hoard is that we experienced major uninsured medical costs that would have impacted my life forever if I didn't have a cash hoard to deal with it.   Any suggestions for an allocation of the 200k?  Thanks for all the replies!

bacchi

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Re: Mortgage payoff question
« Reply #7 on: November 19, 2016, 09:32:04 AM »
That makes sense.  I knew there were many problems with my situation.  I guess part of the reason I feel I need a cash hoard is that we experienced major uninsured medical costs that would have impacted my life forever if I didn't have a cash hoard to deal with it.   Any suggestions for an allocation of the 200k?  Thanks for all the replies!

If you invest your money in the market, even a 50% haircut would leave you with $100k plus your monthly paycheck.

How much risk are you comfortable with? Write up an Investor's Policy Statement. But definitely get that money working.

Radagast

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Re: Mortgage payoff question
« Reply #8 on: November 19, 2016, 02:11:03 PM »
You did noy say the value of the rental or the rent per month. As a rule of thumb, if the annual rent income is not at least 10% of the current value (or 10% of the value you paid for it, I will let you choose :) ) and it is generating positive cash flow then you should sell ASAP. The real warning sign is the negative cash flow right now. Even if you paid of the mortgage right now, you will still almost certainly get better returns from a well considered investment in stock/bonds or an actual investment grade rental. So dump this loser and do something useful with the money.

You are better paying off the house than keeping money in the savings accounts. You may be better investing instead of keeping in savings or paying off, but that is up to you. There is some risk in paying off just a little short of the whole mortgage in that you will then have neither cash nor a paid off house. If you pay off the mortgage I would wait a few months until you can pay the whole thing. By that time you will also be wrapping up sale of the rental, so with the sudden free cash flow you will recover quickly.

The next step is to fund every tax advantaged account up to the max (403b, 401k, Roth IRA, HSA, etc.). In fact if you haven't done so for this year this should be the first priority.

Cash in Ally is not bad but 1% is less than inflation so you are losing money. A more agressive but still reasonably safe method would be to split taxable money equally between a municipal bond fund, an intermediate term treasury fund, a US stock fund, and an international stock fund. Or, allocate it as makes sense as part of a larger whole including the investments in your tax-sheltered accounts.

Bashdash

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Re: Mortgage payoff question
« Reply #9 on: November 19, 2016, 02:35:41 PM »
Thanks for the reply. Bought it for 320k and I would say it is worth around 260k now generating 1925 per month in rent.  Break even would be around 2100.per month.   For some reason I am nervous about using some of that cash.   Any suggestions for a us stock fund?  Thanks again for the reply.

Radagast

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Re: Mortgage payoff question
« Reply #10 on: November 19, 2016, 07:09:37 PM »
The default funds for my suggestion are Vanguard total stock market, Vanguard total international stock market, Vanguard intermediate treasury or total bond (your choice), and New York long term bond fund or tax exempt bond fund depending on your tax rates. However there are other good brokers too, for example I use Schwab for a lot of my money. Some of this or all could just as well be bank CD's.

Bashdash

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Re: Mortgage payoff question
« Reply #11 on: November 20, 2016, 03:35:47 AM »
Thanks for those suggestions.   I can buy some vanguard etf in my tradeking  account.  I was thinking vti.  I will look into the CDs more.  I feel like last time I did the rates were close to my ally account so I figured to just keep it liquid.  I'm thinking those condo needs to go.  I think in my mind I was thinking once I paid the mortgage off, I would be getting income close to 2k with no mortgage which I thought would be a positive.

Radagast

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Re: Mortgage payoff question
« Reply #12 on: November 20, 2016, 10:39:30 AM »
The condo will be returning about 5% after expenses which isn't horrible. It also comes with some extra risks as well, so the idea is there are better investments elsewhere.

Consider bond etfs. BIV is yielding 2.31%. Tax exempt bond fund VTEB is yielding 1.82% which works out to an equivalent of 2.33% (1.82(1+.28)) if you are in the 28% bracket. There is also a New York tax exempt bond mutual fund which is yielding 1.92%, equivalent to 2.6% (1.92(1+.28+.07)) assuming 7% state and 28% federal taxes. However a New York bond fund comes with extra risks (default, credit downgrade) so probably use it for only half your taxable bond money.

Bashdash

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Re: Mortgage payoff question
« Reply #13 on: November 24, 2016, 03:26:22 AM »
I know this may not be the best financial move but I think we are going to do the following:
Pay roughly 2500-3000 per month on the condo which will put the condo mortgage close to an end in around 4-5 years.  When close to the end, finish it with a lump sum.   When finished, rent coming in will cover our current mortgage for our residence and then some extra.  In the meantime focus needs to be on putting some of that ally cash to work.