Pay off the house?

[sweet reason]

Hi all-
I am 45 and owe about 250k on my home. Interest rate is 3.7%. I have the cash available to pay off the home and reading differing views on this subject. I understand in theory my cash is better invested and my interest rate is small so thats prob the better use of it but I also think the mental part of having 0 debt is pretty sweet too. My wife has a steady secure job and 150k salary and my income Varys year too year but usually around the same. What are your thoughts on best options for us ?

[Paper Chaser]

Paying off the mortgage would be a guaranteed return of 3.7%.
You can easily find CDs these days that offer a guaranteed return of 5% or higher.

Even if you had concerns about risk exposure of putting that cash into equities, you could make more money via guaranteed investments than if you paid off the low rate mortgage. And that doesn't consider any potential tax benefits that holding a mortgage might have for you.

[NV Teacher]

Paying off the mortgage would be a guaranteed return of 3.7%.
You can easily find CDs these days that offer a guaranteed return of 5% or higher.

Even if you had concerns about risk exposure of putting that cash into equities, you could make more money via guaranteed investments than if you paid off the low rate mortgage. And that doesn't consider any potential tax benefits that holding a mortgage might have for you.

This.  My credit union has a six month cd with a 5.8% rate.  That extra money can be earning you a nice chunk beyond what you would save from the interest you would pay on your house for the next six months.

[draco44]

Only you can decide how much to value the peace of mind factor. Sleeping soundly because you are debt-free is a huge comfort to some people. It sounds like you understand the interest rate math side of things the other commenters are discussing, so the unknown value is your anxiety tolerance for an outstanding debt. If paying the house off early is mentally worth it to you, that's a valid decision.

You could also experiment with splitting the difference by paying off a larger chunk of debt than usual and seeing how you feel. What's your reaction to paying off $25,000 all at once, for example? Or maybe getting the debt under $100k would be your comfort point after which you'd prefer to invest the rest? Even if you do decide to pay down the mortgage early, it doesn't have to be in a single transaction.

Finally, you don't mention what other savings/investments you may have. If paying off your house would leave you with zero retirement money or emergency fund, that's setting yourself up for a bad time.

[sweet reason]

Thanks for the replies ..... We have about a million in 401ks but no potential pensions or anything like that, though we will have health insurance for life from my wife's school in 4 years. So thats a nice peace of mind and reduces costs later. Paying off the house would leave us with enough emergency fund but would def deplete most of our cash reserves. I have about 100k in self managed stocks I could sell if needed for emergency tho. ......I understand the math with investing it etc.. I guess I watched too many Ramsey videos where he pushes just paying off the house early. I dont think it really matters either way was just wondering what the consensus was on here. Thanks for the info

[VanillaGorilla]

Paying off the mortgage would be a guaranteed return of 3.7%.
You can easily find CDs these days that offer a guaranteed return of 5% or higher.

Even if you had concerns about risk exposure of putting that cash into equities, you could make more money via guaranteed investments than if you paid off the low rate mortgage. And that doesn't consider any potential tax benefits that holding a mortgage might have for you.

You pay taxes on interest, so that 5% is probably more like 3% depending on your personal tax situation.

Even at today's rates, beating a mortgage isn't trivial. You're certainly not going to cover the interest and the principal - P&I on a 3.7% loan works out to be 5.5%.

So if you have a $500k loan and you put $500k into a CD or similar, you'll be cashing out your investment to cover the principle and after 30 years you'll break pretty much even. The opportunity for significant arbitrage isn't really there IMO. In my book, either you put your money into high yield assets (equities) and honestly try to beat your loan, or you pay off the mortgage and take a truly guaranteed return. Pretty much depends on your risk tolerance.

Personally I saved up a LeanFI stache and then paid off my small mortgage while still plowing tons into equities. If I did it again I'd carry the loan but I don't regret paying it down either.

The psychological benefit of no mortgage is overstated to me. You're still on the hook for insurance and taxes and maintenance, so carrying a loan vs not is equivalent to me, it's just a different sized fixed cost every month. Your mileage may vary.

[nereo]

]You pay taxes on interest, so that 5% is probably more like 3% depending on your personal tax situation.

Even at today's rates, beating a mortgage isn't trivial. You're certainly not going to cover the interest and the principal - P&I on a 3.7% loan works out to be 5.5%.

Your calculations are grossly inaccurate. You only pay taxes on realized gains, and for a 5% yield to become “probably more like 3%” it would require a 40% capital gains tax rate. Current LTCG rates are 0, 15 and 20%, and that upper 20% requires realized gains around half a million in one year. So the most likely interest rate for most posters on 5% will be… 5%.   Some may see 4.25% - still a in. Remember, using investments to pay off a debt will also trigger capital gains tax, so the tax liability is likely more paying it off, not less.

It’s actually fairly easy to find investments now that exceed 5.5%; paper chaser already listed one.  IBonds we’re very recently paying 6.9%. You are also double counting by ignoring the equity of principle but ignoring it for the sake of inflating the “money saved”. Using your example, the PI on a $250k note at 3.5% vs leaving invested at 5.5% (less than some available vehicles) nets a,most $800k over 30 years. Which is far from “pretty much breaking even”

The real power though is having more liquidity. When things go wrong having an extra quarter million (or much more over time) is much safer than having lower monthly expensives of about ~$1,150

[VanillaGorilla]

Your calculations are grossly inaccurate. You only pay taxes on realized gains, and for a 5% yield to become “probably more like 3%” it would require a 40% capital gains tax rate. Current LTCG rates are 0, 15 and 20%, and that upper 20% requires realized gains around half a million in one year. So the most likely interest rate for most posters on 5% will be… 5%.   Some may see 4.25% - still a in. Remember, using investments to pay off a debt will also trigger capital gains tax, so the tax liability is likely more paying it off, not less.

Correct me if I'm wrong, but I believe that interest on money market accounts and CDs are taxed as income. Everybody's tax situation is different, but my marginal tax rate is around 35%, bringing a 5% yield down to 3.5%. If I was OP I'd need a fixed yield of 5.77% to just break even.

I bonds were recently yielding far north of that, but they adjust - with moderating inflation it's hard to imagine anybody having locked in hundreds of thousands of dollars of high yield i bonds.

Are you suggesting investing in bonds to cover a mortgage? VGLT is currently yielding 4.04%, VFITX less than that. After taxes that doesn't cover OP's rate either (assuming a 24% long term cap gains rate using myself as a proxy).

I just don't see what reasonably safe asset is available to a person with a ~35% marginal rate and a 25% long term rate that will provide more than 4% of yield post taxes. I suppose OP could fund a mega backdoor roth (if available) and hold fixed yield investments that will have zero tax liability, as long as they're committed to several years of contributions to get all their money into the roth. However, that's not available to most people.

The real power though is having more liquidity. When things go wrong having an extra quarter million (or much more over time) is much safer than having lower monthly expensives of about ~$1,150

That depends a lot on individual circumstance and one's personal definition of "safety". Carrying a mortgage when living off a portfolio is riskier than paying the loan off. For some "safety" might be locking up their assets in an illiquid asset that they cannot be tempted to spend. For others, "safety" might mean the smallest possible risk of losing net worth. For others it means the greatest safe withdrawal rate of their portfolio. And for yet others it might mean having the greatest amount of liquid assets on hand at any given time.

None of those are invalid perspectives. I don't see a one size fits all argument.

[Silrossi46]

Thanks for the replies ..... We have about a million in 401ks but no potential pensions or anything like that, though we will have health insurance for life from my wife's school in 4 years. So thats a nice peace of mind and reduces costs later. Paying off the house would leave us with enough emergency fund but would def deplete most of our cash reserves. I have about 100k in self managed stocks I could sell if needed for emergency tho. ......I understand the math with investing it etc.. I guess I watched too many Ramsey videos where he pushes just paying off the house early. I dont think it really matters either way was just wondering what the consensus was on here. Thanks for the info

When you say health insurance for life you mean in her retirement she and dependents get the coverage?   We have similar setup here however here the actual retiree must remain alive for the others to retain coverage.  Is that the case here?  Just food for thought

[simonsez]

Correct me if I'm wrong, but I believe that interest on money market accounts and CDs are taxed as income. Everybody's tax situation is different, but my marginal tax rate is around 35%, bringing a 5% yield down to 3.5%. If I was OP I'd need a fixed yield of 5.77% to just break even.

If an individual's taxable income is >231k or >462k for MFJ, I wouldn't worry too much about these types of decisions.  Just pick one, you can't go wrong, you've either already won the financial game or are WELL on your way at that income level.  If I was at that income level, I'd probably value simplicity instead of maximizing the efficiency of my green soldiers.  There are so many of them that additional efficiency gains aren't going to change where you're headed especially when tax simplicity can mitigate the risk of penalties and improper filing.  Psychological benefits will vary for everyone. 

Yes, interest on CDs is treated as ordinary income.

[VanillaGorilla]

Correct me if I'm wrong, but I believe that interest on money market accounts and CDs are taxed as income. Everybody's tax situation is different, but my marginal tax rate is around 35%, bringing a 5% yield down to 3.5%. If I was OP I'd need a fixed yield of 5.77% to just break even.

If an individual's taxable income is >231k or >462k for MFJ, I wouldn't worry too much about these types of decisions.  Just pick one, you can't go wrong, you've either already won the financial game or are WELL on your way at that income level. 

Not quite - that 35% marginal includes state taxes to the tune of 8.9%. It's a very common bracket to find yourself in - indeed OP would if he lives in CA.

[Dicey]

The Big Secret is that your house is never truly paid off. You will always be on the hook for taxes, utilities and maintenance. In addition, a fixed rate mortgage is a great hedge against inflation.

We paid cash for our current house, because we sold two long-held homes with very seasoned 30 year mortgages. We don't really sleep better at night.

What does make us sleep better is having more money in accounts that we control than we ever dreamed possible. If something happens, we can solve it easily with money. We just took a vacation. Doesn't matter what we spent. Bought $1500 worth of stuff for our kids and grandkids on the trip. Meh. While we were gone, a rental had a washer go out, so we replaced the washer and dryer. The same property's relatively new A/C went out today. The service guy will come tomorrow. It will cost whatever it costs. Oh, and yesterday we paid our 2022 taxes, to the tune of $17,000.

You're always welcome to join the conversation over at the DPOYM Club. https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

[Must_ache]

With all those assets I would probably not pay off the house yet. 

Here is a diagram of the rolling 10-yr annualized returns of the S&P across 82 years.

https://static.fmgsuite.com/media/documents/bc618705-6161-4c00-be7f-c667c90c61b5.pdf

Only about 9 of those years (1937-40, 1975, 2008-2011) resulted in a return below 3%.  A few more are hard to tell (1975, 1977-78).  At worst 13 years.  So one might guess there is a 69/82 = 84% probability that your return in something like the S&P could outperform a mortgage payoff.  Furthermore you can sell off the assets anytime you think things are going south and can change your mind and hold cash or pay it off.

I have a 2.625% mortgage down to $52K and retirement is a couple years away for me.  I want to pay if off and might do so when it is half its current size and interest rates are lower.  I would say your interest rate and tax situation makes it not clear either way.  I would probably hold off and instead think "I have the ability to go to zero debt at any moment I choose, I just haven't chosen it yet."

[nereo]

Your calculations are grossly inaccurate. You only pay taxes on realized gains, and for a 5% yield to become “probably more like 3%” it would require a 40% capital gains tax rate. Current LTCG rates are 0, 15 and 20%, and that upper 20% requires realized gains around half a million in one year. So the most likely interest rate for most posters on 5% will be… 5%.   Some may see 4.25% - still a in. Remember, using investments to pay off a debt will also trigger capital gains tax, so the tax liability is likely more paying it off, not less.

Correct me if I'm wrong, but I believe that interest on money market accounts and CDs are taxed as income. Everybody's tax situation is different, but my marginal tax rate is around 35%, bringing a 5% yield down to 3.5%. If I was OP I'd need a fixed yield of 5.77% to just break even.

I bonds were recently yielding far north of that, but they adjust - with moderating inflation it's hard to imagine anybody having locked in hundreds of thousands of dollars of high yield i bonds.

Are you suggesting investing in bonds to cover a mortgage? VGLT is currently yielding 4.04%, VFITX less than that. After taxes that doesn't cover OP's rate either (assuming a 24% long term cap gains rate using myself as a proxy).

I just don't see what reasonably safe asset is available to a person with a ~35% marginal rate and a 25% long term rate that will provide more than 4% of yield post taxes. I suppose OP could fund a mega backdoor roth (if available) and hold fixed yield investments that will have zero tax liability, as long as they're committed to several years of contributions to get all their money into the roth. However, that's not available to most people.

I think what you may be overlooking is that money is fungible, and (presumably) you will not be in such a high tax bracket your entire life. Particularly at higher incomes, assets like CDs should be held in tax-advantaged accounts.  If its held in a 401(k) or tIRA the taxes will be deferred until you withdraw them and pay taxes on your (presumably) lower 'income' - which can very easily be at or near zero. If you have any Roth IRA, HSA or similar you can hold higher yield CDs or bond funds there and never pay taxes, regardless.

But simonsez's point - if you annual earning are already at that level the mortgage is a small multiple of your annual earnings and whatever choice you make is fairly inconsequential to your total lifetime earnings.