Author Topic: Should I continue to pay down mortgage if....  (Read 1942 times)

chairman5

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Should I continue to pay down mortgage if....
« on: June 21, 2019, 01:57:28 PM »
I have plenty of assets to pay off the remaining 1st home on my primary residence.  It is the only debt I have and I am inkling to be debt-free.  The value of the home is 850k and I have a 155k mortgage left at 3.75% interest rate.  I have over 2M in liquid assets.

So what is the problem?  Well our home equity has exceeded the 500k capital gains exemption for the home.  So If I pay off the mortgage, creating more gains, then I am also incurring more taxes.  Can someone let me know if I am thinking through this straight.  It seems like a very bad idea to pay off the remainder of the loan when it will just expose me to 20-30% capital gains taxes on that additional equity I am creating.

dandarc

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Re: Should I continue to pay down mortgage if....
« Reply #1 on: June 21, 2019, 02:00:46 PM »
You don't have a gain unless you sell the house. The mortgage balance has no impact on your capital gains.

If you're not planning on selling the house any time soon, what you should do is a cash-out refinance to a new 30 year term if you can. Low rates still available - you could have another $500K invested and working for you.

chairman5

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Re: Should I continue to pay down mortgage if....
« Reply #2 on: June 21, 2019, 02:11:18 PM »
Thanks for the response.  I haven't looked at cash-out refis.  We will be moving, likely in 3-5 years.  I am 54 and my wife is 48..just FYI.

If I do cash-out refi 500k won't I have a 650k mortgage payment?

dandarc

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Re: Should I continue to pay down mortgage if....
« Reply #3 on: June 21, 2019, 02:16:19 PM »
Well that short of a term, maybe the risk is too high for the "borrow more money and invest plan" - if you were going to stay for 30 years then you'd be costing yourself a ton by not having a low, fixed-rate mortgage.

Yep - payment on $650K instead of your current $150K. And you'll have $500K working for you in investments. If you were looking at a sufficiently long term, earning say 8% on your investment vs. paying 4% or less on the mortgage works out to a lot of money.

In case it isn't clear, your capital gain will be calculated as Sale Price less Paid Price - whether you pay cash or have a mortgage will not impact that gain at all.

ChpBstrd

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Re: Should I continue to pay down mortgage if....
« Reply #4 on: June 21, 2019, 03:25:43 PM »
1) 3.75% is a damn good rate.
2) I would not pay off that debt or get a cash out refi. Payoff of a very old debt when you have no other debt might harm your credit score by reducing the age of your oldest account and number of accounts open. That would cause your insurance rates to rise. On the other hand, doing a big cash-out refi and investing the proceeds creates too much sequence of returns risk (I assume you are retired or close to retired with a $2M LNW). With only a few years to go until you sell, I donít think you could earn back the closing costs on any kind of arbitrage that would be low risk enough (e.g. what quality of bonds would you get yielding 5%? Junk.).

Saving in Austin

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Re: Should I continue to pay down mortgage if....
« Reply #5 on: June 21, 2019, 08:14:25 PM »
You don't say if you are planning to retire early. If you are retiring then paying off your mortgage is not the worst move you could make. Many early retirees (including MMM) have paid off their mortgages early even if the numbers say pay it out over time. It is a move for your emotional well being and your inkling to be debt free indicates that you may benefit from doing this.

SimpleLifer

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Re: Should I continue to pay down mortgage if....
« Reply #6 on: June 24, 2019, 07:27:02 AM »
I have plenty of assets to pay off the remaining 1st home on my primary residence.  It is the only debt I have and I am inkling to be debt-free.  The value of the home is 850k and I have a 155k mortgage left at 3.75% interest rate.  I have over 2M in liquid assets.

So what is the problem?  Well our home equity has exceeded the 500k capital gains exemption for the home.  So If I pay off the mortgage, creating more gains, then I am also incurring more taxes.  Can someone let me know if I am thinking through this straight.  It seems like a very bad idea to pay off the remainder of the loan when it will just expose me to 20-30% capital gains taxes on that additional equity I am creating.

I believe OP is talking about incurring cap gains on the $155K equities that would be sold to pay off the mortgage.

talltexan

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Re: Should I continue to pay down mortgage if....
« Reply #7 on: June 24, 2019, 01:00:40 PM »
Rather than the cash-out refi, could you apply for a HELOC, then just borrow into it each month to offset the principal you're paying down on your primary mortgage?

chairman5

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Re: Should I continue to pay down mortgage if....
« Reply #8 on: June 25, 2019, 01:47:22 PM »
Thanks for the responses - to add some info.

Me 54; spouse 48.  Both in good health.  Kids in college (it is already paid for and not included in my assets in this post).

Toying around with retiring early but prob work at least another 3-5 years.  I have restricted stock in current company.

Have a 250k HELOC on home.  No current balance.  I have used it to by restricted stock in company but now paid off.  Occasionally used it to make larger purchases like home repairs and such, but now totally paid down.

I had never thought about the cash-out refi and using HELOC to invest in market.  I guess I am not quite that risky.  That is like going on margin in brokerage account correct?  I know a lot of folks in the late 1990s and 2007-08 who lost their houses throwing mortgage money and HELOC money into the market and then it tanked.  No fear of that here?

reeshau

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Re: Should I continue to pay down mortgage if....
« Reply #9 on: June 26, 2019, 02:26:48 AM »
We will be moving, likely in 3-5 years

Quote
No fear of that here?

Short answer:  Yes, any time you are considering a major financial move in less than 5 years, investing money in the stock market has significant risk.  Particularly in a year when markets are making record highs.

But...

Further to your plans, where exactly will you be moving in 3-5 years?  You have an $850k house, and kids in college.  So, as empty nesters, are you downsizing to a LCOL sunny location?  A $200k condo, maybe?  If so, then you could have enough equity left in the house to do it, anyway.  (not that I would; I would not.  But you *could*)

This seems like a big decision, even though it's a specific question.  Seeing the questions that follow on to your initial question, maybe it is worthy of a case study.

Goldy

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Re: Should I continue to pay down mortgage if....
« Reply #10 on: June 26, 2019, 11:55:28 AM »
Isnít the capital gain calculated based on the sale price minus the original purchase price?  If so I donít know why having a mortgage or not would impact that calculation.

chairman5

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Re: Should I continue to pay down mortgage if....
« Reply #11 on: June 26, 2019, 01:15:55 PM »
Isn’t the capital gain calculated based on the sale price minus the original purchase price?  If so I don’t know why having a mortgage or not would impact that calculation.

I think I may have framed the question poorly.  It is more about what makes the most sense to do with extra cash I am looking to invest.  I generally have 10k or so every couple months.  The two options that I am currently considering are: (1) transfer it to Vanguard and put it in VTI. (2) use it toward paying off the only debt I have left - a 150k mortgage at 3.5% interest.  However, the house is worth $800k and I paid $222k, so I have about 578k equity.  When I sell the house we get a 500k GC exemption.  So if I sold today (lets pretend no improvements), I will have to pay CG tax on the 78k in gains over and above the exemption.

So back to hypothetical.  If I use the 10k toward the mortgage I increase the amount of equity in the house by 10k and eventually 150k (when mortgage paid off) and I then have to pay CG tax on more than 225k instead of 78k.  If I put the 10k (and more) in VTI, then I also have to pay CG on the gains when I sell.  So either way I pay CG - question is what would you do and is one more obvious than the other for financial gurus.

PathtoFIRE

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Re: Should I continue to pay down mortgage if....
« Reply #12 on: June 26, 2019, 01:52:19 PM »
https://www.irs.gov/publications/p523

It sounds like you may be a little confused, refer to this IRS publication to 1) determine eligibility for capital gains exclusion, 2) calculating your exemption limit, and 3) details about what expenses you can and cannot deduct when calculating your capital gains.

Your back of the napkin capital gains is around $580k; with some of the deductions listed, like selling expenses, improvements, etc., and if you are married, it's entirely possible that you will owe nothing based on the information you've given. And if you do, it will probably be a relatively small amount of the total. Whether or not you have a mortgage, or pay it down, does not factor in to the calculations.


Zamboni

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Re: Should I continue to pay down mortgage if....
« Reply #13 on: June 26, 2019, 02:16:48 PM »
Congrats on your great real estate investment!

In your shoes, I would just pay off the house. Sure, you could continue to invest in the market, but it sounds like you already have a hefty stash invested. Paying off my home would bring me peace of mind, and it sounds like you feel the same way. It's also a hedge against market risk, of course. Once it's paid off and you have no mortgage payment, then you'll have EVEN MORE cash per month that you can stash.

As you have already read, there are a fair number of people who think you should leverage yourself to the hilt using your house as collateral so you can invest in other things. Personally, I like having somewhere secure to live. I'd love to know the age of the folks giving this advice. It reeks of a mentality I heard from people nineties, including from a bunch of people who really didn't know anything at all about markets but had dubbed themselves financial geniuses. I just know too many people who have lost their homes to consider this (including 2 neighbors on my tiny cul de sac, both near retirement, the last time the market tanked!)

Whatever you decide, good luck!

solon

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Re: Should I continue to pay down mortgage if....
« Reply #14 on: June 26, 2019, 02:20:17 PM »
capital gains does not equal equity

sale price - purchase price = capital gain
In your case, $800,000-222,000=$578,000. The only way this could ever go up is if the sale price of your house goes up. It is not affected by your mortgage.

value of house - debt on house = equity
In your case, $800,000-155,000=$645,000. This is your equity, but it doesn't affect your capital gains at all.

The question about whether to borrow from the house to invest in the stock market is a completely separate question.

Goldy

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Re: Should I continue to pay down mortgage if....
« Reply #15 on: June 26, 2019, 08:41:07 PM »
Isnít the capital gain calculated based on the sale price minus the original purchase price?  If so I donít know why having a mortgage or not would impact that calculation.

I think I may have framed the question poorly.  It is more about what makes the most sense to do with extra cash I am looking to invest.  I generally have 10k or so every couple months.  The two options that I am currently considering are: (1) transfer it to Vanguard and put it in VTI. (2) use it toward paying off the only debt I have left - a 150k mortgage at 3.5% interest.  However, the house is worth $800k and I paid $222k, so I have about 578k equity.  When I sell the house we get a 500k GC exemption.  So if I sold today (lets pretend no improvements), I will have to pay CG tax on the 78k in gains over and above the exemption.

So back to hypothetical.  If I use the 10k toward the mortgage I increase the amount of equity in the house by 10k and eventually 150k (when mortgage paid off) and I then have to pay CG tax on more than 225k instead of 78k.  If I put the 10k (and more) in VTI, then I also have to pay CG on the gains when I sell.  So either way I pay CG - question is what would you do and is one more obvious than the other for financial gurus.

I feel like you are still confused on this.  If you sell now you have 78k of gains taxes at CG rates.  If you decide to pay it off over the next year or two and sell for the same price as today you will have 78k of gains to pay CG on.  Where does your 225k come from?  Are you selling 150k of equities to pay off the mortgage?

All that aside, you and I are in a very similar boat, I also have 1.95m liquid with 166k left on my mortgage and also struggle to decide whether to pay off my 2.5% ARM or invest.  What works for me is to add 500/mo to the mortgage and treat this mentally as my bond allocation.  We have ~12k/mo going into investments and I find this to be a good balance for me for now.  I can pay it off in one feel swoop but I'm choosing not to.

chairman5

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Re: Should I continue to pay down mortgage if....
« Reply #16 on: June 26, 2019, 09:34:09 PM »
Isnít the capital gain calculated based on the sale price minus the original purchase price?  If so I donít know why having a mortgage or not would impact that calculation.

I think I may have framed the question poorly.  It is more about what makes the most sense to do with extra cash I am looking to invest.  I generally have 10k or so every couple months.  The two options that I am currently considering are: (1) transfer it to Vanguard and put it in VTI. (2) use it toward paying off the only debt I have left - a 150k mortgage at 3.5% interest.  However, the house is worth $800k and I paid $222k, so I have about 578k equity.  When I sell the house we get a 500k GC exemption.  So if I sold today (lets pretend no improvements), I will have to pay CG tax on the 78k in gains over and above the exemption.

So back to hypothetical.  If I use the 10k toward the mortgage I increase the amount of equity in the house by 10k and eventually 150k (when mortgage paid off) and I then have to pay CG tax on more than 225k instead of 78k.  If I put the 10k (and more) in VTI, then I also have to pay CG on the gains when I sell.  So either way I pay CG - question is what would you do and is one more obvious than the other for financial gurus.

I feel like you are still confused on this.  If you sell now you have 78k of gains taxes at CG rates.  If you decide to pay it off over the next year or two and sell for the same price as today you will have 78k of gains to pay CG on.  Where does your 225k come from?  Are you selling 150k of equities to pay off the mortgage?

All that aside, you and I are in a very similar boat, I also have 1.95m liquid with 166k left on my mortgage and also struggle to decide whether to pay off my 2.5% ARM or invest.  What works for me is to add 500/mo to the mortgage and treat this mentally as my bond allocation.  We have ~12k/mo going into investments and I find this to be a good balance for me for now.  I can pay it off in one feel swoop but I'm choosing not to.
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Thanks. I like this.