The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: BaldingStoic on September 12, 2014, 12:55:41 PM
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Hello. I would appreciate the perspective of my wise fellow Mustachians on whether or not to sell $50,000 in TIPS to pay down my mortgage:
Specifics
- TIPS: 50K in Treasury Inflation-Protected Securities (TIPS) at 2.95% taxable interest.
- Mortgage: $280K on a $550K property at 3.75% but of course I get tax deduction from the interest.
- I have plenty of money in taxable Vanguard Index funds that be used as a rainy-day-fund so I'm not too concerned cash reserves.
In terms of pure math, after factoring in taxes, it seems about .5% more efficient to pay down my Mortgage but having some debt is a great hedge against potential inflation. Any suggestions? What have others done to determine the best allocation between investments and mortgage debt?
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What is the highest tax bracket are you in? If you're in the 25% bracket and deducting mortgage interest, then you are saving 25% of that interest money in reduced taxes. If you're in the 15% bracket, it's worth proportionally less.
Pretty easy math from there. I'd say it's basically a wash for you though the fact that the bond income is taxable makes it a little bit trickier. IMO you want to ask yourself whether liquidity or paid-down debt is more important to you. That's going to be what decides this, because it's not an obvious huge win for either option.
-Walt
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What is the highest tax bracket are you in? If you're in the 25% bracket and deducting mortgage interest, then you are saving 25% of that interest money in reduced taxes. If you're in the 15% bracket, it's worth proportionally less.
Hi Walt - thanks for the reply. I'm in a 25% tax bracket, so the %3.75 interest is effectively 3% after considering the tax savings, but by the same token the 2.95% interest on the TIPS is eroded down to 2.4%. I agree it's not a huge delta either way but philosophically I'm curious whether the Mustachian community thinks that it's best to pay down debt as quickly as possible, or is a certain amount of low-interest debt good to have (e.g., as an health inflation hedge) that should be part of diversified portfolio (much like business tend to have an optimal debt level to boost their ROA?)
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Because this is framed as an an either-or, you would still be bitten by inflation by leaving the parcel of money in T-bills at 2.95% instead of paying off debt. In this framing, the debt no longer acts as an inflation hedge over the life of the T-bill (which is pretty short...). Since you would presumably be repurchasing T-bills incrementally to maintain that allocation, you would still be lose against the hypothetical higher inflation rate at each T-bill transaction cycle. Granted, you would *somewhat* keep up with inflation, but... Also, because the real estate is a leveraged asset, there is risk there as well.
Given that it is a break-even now (or pretty close), I would pay off the mortgage as a means of simplifying. Depending on your target allocation, you could then convert what you were paying to the mortgage into purchases of T-bills (which are unlikely to have a rate decrease in the near future).
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If you have an ER why isn't an option to put the money into VTSAX? I'd prefer that over paying down your extremely low interest mortgage
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Are you able to deduct mortgage interest from state taxes? If so, keep in mind that the Interest on Federal debt is not taxable by the states. That has influenced my decision not to pay off the mortgage. But I live in a fairly high tax local jurisdiction.
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Thanks for the perspectives. I took the middle ground and paid off $10K of my Mortgage.
If you have an ER why isn't an option to put the money into VTSAX? I'd prefer that over paying down your extremely low interest mortgage
Investing more into Mutual Funds certainly is a valid option Scandium, but I've already got 1.3M invested with Vanguard and another 250K in my 401K, so my focus is to achieve and optimal asset allocation and investment-to-debt ratio. (Note: While my net worth is pretty respectable, I support a family of 5 in overpriced San Diego). While my mortgage rate is quite reasonable, I don't want to put all my eggs in the Market, so it's either sticking with TIPs (which offer liquidity but low interest) or paying down low interest debt.
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Here's a lot more discussion:
http://forum.mrmoneymustache.com/index.php?topic=20946.0
I would keep the debt. It's not hurting you.
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Is there any reason your investments are 100% in taxable? At the very least, you should be able to do a Backdoor Roth every year, as should your (presumed) spouse.