Pay down mortgage or invest in taxable accounts?

[firefergy]

Hello everyone, I enjoy reading this blog and forums and wanted to ask for some advice.  First some back ground info on me.  I will be eligible for my pension at age 50 which is 13 years from now.  I am maxing out my 457 (17500) and also paying 4500 extra towards my mortgage each year.  My goal was to have my house paid off when my wife is eligible for her pension at age sixty.  Our mortgage is 3.3% and I have been trying to figure out if it is better to invest the money or pay down the mortgage.  We just refinanced a few months ago and we currently owe 398k.  We currently make to much money to contribute to a Roth.

[KingCoin]

There's no "right" answer here. You have to choose between a low, "risk free" return or a likely higher, risky return.

However, your tax adjusted mortgage is probably close to 2%, which makes for a very very conservative investment that will probably at best keep up with inflation. You're making a lot of money, your financial house is in good order, and your investment horizon is 20+ years, so building your taxable equities account is probably the smarter long term play, provided it doesn't keep you awake at night.

[wakkowarner]

I'm only a couple years younger than you.  I am refinancing right now to a 3.3% rate.  I am investing the savings, because I figure I can beat the 3.3% (which is actually going to be effectively lower thanks to U.S. deductions on interest).  I look at it while it may be a guaranteed rate, I would have more of an opportunity loss elsewhere.  While it is nice to be debt free, mortgage debt is one of the best to have if you are going to have any, and having more money invested in higher yielding accounts can be better long term.

On the other hand, investing in your home is a guaranteed rate.  But if your home loses value, you won't necessarily make all that money back.  All you will be doing is reducing your debt.  If you pay for your debt in the future, when inflation has had some time to kick in, then you will need to work less to get the same amount of money together (paying your debt with inflated dollars).  With such a low interest rate, it wouldn't be too hard to do that and come out ahead.  Personally, I am following the route of investing in other areas instead of paying off the mortgage early.

[arebelspy]

Sub-4% debt?  Historical lows?  Yes please.

Will enjoy having all that debt when interest rates are 8%, or even higher. 

YMMV, and people have different risk tolerances.

Do whatever makes you happy and lets you sleep at night.

[Another Reader]

Heck, I even took a car loan at well under 3 percent after negotiating the price down to nothing.  Invested the money instead.  60 months of a much safer than "margin" loan!

[smedleyb]

Timing the bond (interest rate) market is hard to do.   

But it's certainly fun to watch people try. 

[matt_g]

1. You CAN contribute to a ROTH, just create a traditional IRA, then immediately convert it to a ROTH.  Just Google ROTH IRA LOOPHOLE
2. Would you take out a loan at 3% to invest in the market?  That's what you are doing.

[KingCoin]

2. Would you take out a loan at 3% to invest in the market?  That's what you are doing.

I'd argue that this is close to being correct, but a mortgage has a few significant advantages over a standard loan including:
1) Refi optionality. Rates go lower, you refi. Rates go higher, you can invest your borrowed money at a higher rate elsewhere. Win/win.
2) Walk away option. Let's say serious catastrophe strikes and real estate drops 60% in your area. You have a put option on the bank (I know people have disparate opinions on the ethics of exercising this option).
3) Tax advantages of a mortgage over a standard loan.
4) Superior liquidity of a taxable investment portfolio over home equity.

[arebelspy]

2. Would you take out a loan at 3% to invest in the market?  That's what you are doing.

Absolutely!  Where do I sign up?

Heck, I'm considering paying private money lenders double digit returns, backed by real estate, on some of my transactions.

The more cheap money I lock up from traditional banks before I go that route, the happier I am.

[firefergy]

Thank you for the responses. 

[firefergy]

After thinking it over I decided to up my contribution to my children's 529s and put the rest into a Roth IRA.  I hope my AGI will be below the limit.

[BuildingFrugalHabits]

I'm a little confused about paying down the mortgage. What I always thought was that paying extra principle effectively "returned" whatever your mortgage interest rate is i.e. 3.25%.  However, I contacted my lender to confirm and they said that paying extra principal doesn't change amortization schedule. So the breakdown of what amount of interest gets charged doesn't change.  In other words, it doesn't sound like it matters if I check a $10,000 check now or in a year from now.  Was this guy correct or just full of beans? 

For what it's worth, I still feel like it's better to invest in the market given the low interest rate.  Still though, the psychological benefits of a paid off house would be nice.

[arebelspy]

He doesn't understand how it works, or was explaining it incorrectly.

Your payment stays the same, but essentially you jump "ahead' on your amortization schedule.  Paying 10k now versus a year from now will save you money, yes.

See attached excel spreadsheet (best one I've found for putting in additional payments).

Input your own: Loan Amount, Annual Interest Rate, Term of Loan in Years, First Payment Date

In the provided example (100k loan, 30 years at 3.75% started last June) if you pay 10k in a week (Feb 2013, Cell D33) it shows interest savings (in the summary, above the amortization table) of 17,276.  If you wait until Feb 2014 to make that payment, you only save 16,357, a difference of about $900.

[BuildingFrugalHabits]

He doesn't understand how it works, or was explaining it incorrectly.

Your payment stays the same, but essentially you jump "ahead' on your amortization schedule.  Paying 10k now versus a year from now will save you money, yes.

See attached excel spreadsheet (best one I've found for putting in additional payments).

Input your own: Loan Amount, Annual Interest Rate, Term of Loan in Years, First Payment Date

In the provided example (100k loan, 30 years at 3.75% started last June) if you pay 10k in a week (Feb 2013, Cell D33) it shows interest savings (in the summary, above the amortization table) of 17,276.  If you wait until Feb 2014 to make that payment, you only save 16,357, a difference of about $900.

Okay, that is what I thought (and what I had always heard).  However, it's not all that clear when I log into GMAC's website (hence the phone call).  I don't imagine there would be any variation from lender to lender though right?  I just have a standard 15 yr fixed.

[arebelspy]

Lender shouldn't matter.  There could, in theory, be something goofy about prepayment penalties, etc., but those have mostly fallen out of favor, and aren't used in any standard mortgages issued recently.

You do need to specify when you send the payment in that it is an additional payment to principal, otherwise they may (and some - many? - lenders do) hold the payment and apply it to the next month's payment, then the next month, etc. etc.  You want it paying down principal now to reduce interest paid.  Just write it in the memo field of the check, or whatever, you just need to specify it's an additional principal payment when you pay it.  Go ahead and call and ask them and confirm how to make a principal only extra payment.

[sherr]

You do need to specify when you send the payment in that it is an additional payment to principal, otherwise they may (and some - many? - lenders do) hold the payment and apply it to the next month's payment, then the next month, etc. etc.  You want it paying down principal now to reduce interest paid.  Just write it in the memo field of the check, or whatever, you just need to specify it's an additional principal payment when you pay it.  Go ahead and call and ask them and confirm how to make a principal only extra payment.

+1 to this. You should always look and make sure they applied your payment correctly. There was an instance where I had sent in an extra payment that was clearly marked, and the lender ended up taking out another interest payment even though I had already paid the interest that month. It was a completely incorrect thing for them to do, and would have been several hundred dollars that just disappeared into thin air. A phone call got everything corrected, but I had to notice the problem first.