I wrote about some things to think about when deciding whether or not to pay off your mortgage early a few months ago. My wife and I had a discussion about paying off our mortgage the other day (which rapidly deteriorated into planning a year long trip to Guatemala and going to see some Broadway plays). We were considering the merits of paying it off using three different techniques.
Why to Pay Off Mortgage Early
We have over 14 years left on a 15 year mortgage fixed at 2.75%. After tax, that's about 1.84%. With 3% inflation, that's a NEGATIVE 1.16%. It's hard to argue mathematically that paying off a mortgage at a negative real interest rate is a smart idea. However, I'm pretty anti-debt and freeing up the cash flow required to pay that each month would allow us quite a bit of financial freedom (meaning I get to work two shifts less a month.) We never really planned on keeping the mortgage for a full fifteen years. We're still undecided about exactly when to pay it off. I'd like to pay it off by age 50 when I hope to have the ability to retire (12 more years) but it would also be nice to have it paid off by the time my eldest daughter starts college (9 years,) freeing up cash flow to help pay for that. Truth be told, I'd rather not have a mortgage right now, but have a very hard time throwing extra money at it if it requires passing up contributions to our HSA, Roth IRAs, Profit-sharing Plan, Solo 401K, Defined Benefit Plan, 529s, UGMAs etc.
Paying Extra Towards Mortgage Each Month
The easiest way to pay off a mortgage early is to just pay extra each month. I calculate that to pay off my now 14.5 year, $345K mortgage in just 9 more years requires me to pay another $1203 a month. That's probably not the smartest way to do it, however. First, it only earns me a return of 1.8%. Second, home equity isn't particularly liquid. It's tough to spend it on a trip to Europe if you change your mind about your financial priorities. Third, home equity doesn't get much asset protection in my state, not to mention if, for some bizarre reason, we defaulted on the mortgage and lost some of that equity to the bank.
Paying Off Our Other Mortgage
We have another obvious candidate for loan paydown. We have an investment property with a 5.3% mortgage. After tax, that's a 3.6% return, almost twice as much as the previous option. It isn't any more liquid or protected, but we plan to sell within a few years and would then have access to that money, which could either go toward our current mortgage as one lump sum, or used in another manner. We're already throwing $300 a month extra at this mortgage.
Taxable Investing Account
A better option in my opinion, although markedly more risky, would be to invest that $1203 a month into tax-efficient stock index funds in a taxable account. Lots of people worry about taxes when investing in taxable accounts. I don't. It's easy to find a tax-efficient investment. $100,000 invested in a total stock market index fund kicks off less than $2000 in distributions a year, which are taxed at only 15%, or about $300 a year. If the value of the investment goes down, I can tax-loss harvest it, offsetting up to $3000 of my regular, highly-taxed earned income each year. I also never pay capital gains taxes on the gains, as I can use highly appreciated shares for my annual charitable giving instead of cash. In this manner I can continually update the basis on the investment, effectively eliminating capital gains taxes on its eventual liquidation. So if my investment earns 8% a year, I'm going to get pretty close to 8% a year even after the tax man gets his cut.
It will take me 9 years to pay off the mortgage directly with that $1203 a month extra payment, but if I use the taxable account instead and earn 8% a year, I should have a lump sum sufficient to pay off the mortgage 11 months earlier. Best of all, I have the flexibility and liquidity in case I don't want to pay off that mortgage. I can always use the money on something else. I also have the ability to time my withdrawal of that money. If we're in a bear market 8 years from now, I can just hold the investment for another year or three until recovery. If, like now, we're 4 years into a bull, we can cash it out and pay off the mortgage. If the investment performs better than 8%, then I'll get there sooner. It would have to perform much worse than 8% (worse than 1.8%, or at least 3.6%) in order for me to come out behind using this strategy. While possible, that's probably not very likely.
Do you plan to pay off your mortgage early? What strategy will you use? Comment below!
Our youngest will start college in 10 years. Our plan is to have the mortgage pad off by then so that we can cash flow his 4 years. (We should have enough set aside in 529s to cover the older kids.) Our plan was to simply roll extra payments in, but you’ve given me something to consider.
Great post. We are in the same boat. I’ve thought about doing the exact same thing as you are about the taxable account. My major concern about taxable accounts is the inherent market risk. I’d kick myself if I lost money in the market rather than pay off the house free and clear. (For full disclosure, we put away $165K/yr into pre-tax retirement accounts invested in Vanguard Index Funds and we have no other debt.) I guess I feel I’m exposed enough in the market. Paying off the mortgage (3.25% rate with balance of $347K; effective after tax rate of 1.95%) provides emotional peace of mind even if the math favors investing in a taxable account. Any thoughts on maximizing ROI and minimizing risk in a taxable account while maintaining liquidity would be appreciated. Love your blog BTW.
But what about taking advantage of the perverse mortgage interest tax deduction?
The mortgage interest deduction does help lower the effective mortgage rate, making it less attractive to pay off. Many Americans think they’re getting a tax break from their mortgage but aren’t since their interest is less than the standard deduction, so you need to actually calculate your personal tax benefit from the mortgage.
If you are currently in Alternative Minimum Tax (as many doctors are), you are likely to be saving less in your taxes on the mortgage interest than you believe, and therefore your after tax cost for your mortgage would not be as low as you stated.
Mortgage interest is still deductible under the AMT, and may even be worth more for someone in the AMT system. You’d have to run your own numbers to be sure. I’m not in the AMT, so it hasn’t been an issue for me.
i like these types of conversations bc they are real life. Most of us are thinking about this exact issue and grappling with our choices. The trouble is that there isnt a known right answer. Frankly your math showed that either way you would only have the mortgage for another 11 months. Part of this is bc you have a shorter mortgage than some (15 year instead of 30 year). If you had a 30 year mortgage then i think the decision moves further to investing in a taxable account but it would depend on the specifics. I also greatly appreciate pointing out how little one needs to pay in taxes with a taxable account. Too many advisors use this as a fear tactic even though it isnt something to fear. I also think many forget about tax loss harvesting. Might be worth a post showing your tax loss harvesting over the years. I have mixed feelings about using the donation angle in your example (not that im against donating).
My tax loss harvesting wouldn’t be very interesting. Basically I opened a taxable account in 2008, harvested losses all the way down, then donated the appreciated shares in 2009-2011 until the taxable account was gone. I really didn’t pay any taxes on my taxable account. Now I have far more tax-protected space available and it seems a better idea to me to use it rather than a taxable account, both for tax purposes and asset protection purposes.
What tax protected space do you have available outside of retirement accounts? And how is it an asset protection tool?
We’ve got (1) retirement; (2) HSA; 3) 529 plan; and (4) whole life insurance. Is there more space that I’m missing out on? Also, do you invest in a tax protected account with the goal of using that to later pay down the mortgage?
you got the list….retirement can be expanded though…in his case im pretty sure he has a defined contribution plan like a profit sharing or 401k, a defined benefit, and backdoor roth. If you can max out those things in addition to 529 and possibly HSA then i personally think that is enough saving for retirement and one might want to consider “living” today with the additional.
WCI, i agree much better to use tax advantage accounts first. Maybe in a few years (assuming you dont keep uping your lending club and rental property situations) then maybe. Otherwise i guess it would have to be theoretical.
The lending club is in a Roth IRA, BTW. It’s way too painful to have in a taxable account as every $25-100 note is considered a separate investment.
My tax-protected space is extensive with a $51K 401K/profit sharing plan, $15K defined benefit plan, $6450 HSA, $11K Backdoor Roth IRAs, Solo 401K for this blog, 529s, UGMAs etc. I’m only an emergency doc, I don’t make THAT much. $100K in savings is more than enough to meet all my savings goals.
When i refinanced back in April, I chose a 10 year mortgage instead of a 15 year despite getting no additional rate breaks between that and the 15 year.
That was my system of “paying off the mortgage early”
On one hand I don’t care for debt “hanging over my head” and would like to get it paid off even more rapidly than the 9.7 years i have left on the note.. but it defies math so much to pay it off early when my rate is 2.625 that I’ve forced myself to mentally forget about the mortgage and simply take my money and do the cash management account.
And that’s made a lot of money of late.
Sure I’m already HEAVILY invested in the market and i could lose some money…. which is why i’ve used most of my cash management account on different asset classes that hopefully aren’t quite as lockstep with the stock market… things like preferred stocks, reits, high yield bonds, etc.
If the rate isn’t better or the fees aren’t lower, it’s probably better to get the 15 year and pay it off as if it were a 10 year. That way if you get into a financial situation you can reduce your payments and improve your cash flow- increased flexibility is a good thing.
This is probably true. It was my way of forcing myself to do it in 10 years.
However, I’m extremely under-housed relative to my income that there is really no financial situation I can think of that would come up that could compromise me short of a life threatening situation, in which case i wouldn’t care about my home anyway.
I have enough cash on hand to pay the mortgage off now… we’re only taking about a 130k note.
Great post. We’re in a similar situation, but with a 5-year ARM at 2.4%. We are saving money in a taxable brokerage account so that we can make a lump sum payment at the 5 year reset point, but if the rate stays sub 3%, I imagine we’d leave the house mortgaged and continue to grow the investment account.
Great post. Always a consideration for us as well. I opted for the taxable account, for the reasons you outline above.
I am a very aggressive saver (40% of gross), however, I still have a hard time justifying paying off my 2.875% mortgage early given the rate and tax benefit. The mental compromise that I made with myself was that I would refinance from 30 yr to 15 yr, but not pay it off earlier than that. I figure if the market doesn’t return more than 2%/yr over the next 15 years, then there will be plenty of other things to be worried about. If inflation takes off, having the mortgage is a small hedge against inflation. I figure I am saving the money anyway and like the WCI pointed out, if I decide at any point along the way, I can pay it off.
While true that the expected rate of return will be higher from investing in the Vanguard Total Stock Market Index (or in any equity investment, for that matter), unless, WCI’s asset allocation is 100% equity, then some of his investment money must be in fixed income. And the expected return of that fixed income is not 8%. And therefore, I believe that it still makes more financial sense to pay off the mortgage.
Another way to look at this issue, would be for WCI to assume that his mortgage was in fact, completely paid off. Would WCI advocate going out and taking out a mortgage or a home equity loan to invest in the proceeds in an equity product? Would this not the same as buying stocks using margin?
A few other thoughts:
1) I have been donating highly appreciative mutual funds shares to charity for years and highly recommend this tax avoidance strategy. A second benefit from donating these shares is from a rebalancing standpoint. Also, to avoid paying income taxes, I makes gifts of highly appreciative shares to my children and grandchildren (and let them pay the income taxes if they need to sell)
2) Beginning in 2014, for MFJ filing AGI over $450,000, the dividend rate is 20% not 15% for
dividends and long term capital gains
3) Beginning in 2015, for MFJ filing AGI over $250,000 results in paying the extra 3.8% Medicare tax
Since it is within taxable, likely it should be equities. One can make an argument for increasing their “bonds” within the tax advantaged accounts to meet their overall desired ratios. Still likely the return even if you account for your aggressive and conservative investments and come out with some sort of avg return is better than his 3.6% return from paying off the mortgage early since the taxes can be mitigated by the methods mentioned. Many of us have chosen 15 year mortgages for better rates which makes it closer to a wash but if for some reason we were in a 30 then the difference in returns makes a bigger deal. In his example it was 11 months of interest but if we account for the stocks and higher bonds in tax preferred then likely a couple months less.
In theory, yes WTC should be 100% in equities in his taxable account and Roth accounts while holding any fixed income in tax deferred accounts. Likewise, in order to take advantage of Foreign Income tax credits, these international mutual funds must be held in a taxable account (holding international funds in tax deferred or Roth accounts means giving up the foreign income tax credit which is roughly 9% of the dividends paid).
But, in the real world, it is very difficult to rebalance to your asset allocation if 100% of your taxable account is held in equities and likewise for your Roth accounts (and a similar problem if your tax deferred account is 100% fixed income).
So, if WTC (or any investor) holds any fixed income (unless it is held in Roth account), the expected return of that fixed income asset is probably less than the cost of his mortgage. Even fixed income held in a tax deferred account while growing at a higher pre tax rate than his after tax mortgage, eventually must be distributed, and then it will be time to pay the tax piper.
Personally, I believe that WTC should pay off his investment mortgage first as it is at the higher rate.
First, I agree that paying down the mortgage has a higher guaranteed return than my expected return on my fixed income investments (not counting P2P Lending which is far higher risk.)
Second, I disagree with your assertion that bonds should be in tax-deferred preferentially in comparison to Roth accounts. If you tax adjust the accounts, the end result is the same. I also disagree that holding international equities in taxable is preferable to holding them in a tax-protected account. Those discussions of which of your assets should go into a taxable account all presuppose that SOMETHING must go into the taxable account. That’s not true for many investors. 9% of a 1-2% dividend just isn’t that much return to give up, especially when paying 15-23.8% of that dividend in taxes is required to get it.
WCI,
Your response, “I also disagree that holding international equities in taxable is preferable to holding them in a tax-protected account. Those discussions of which of your assets should go into a taxable account all presuppose that SOMETHING must go into the taxable account. That’s not true for many investors. 9% of a 1-2% dividend just isn’t that much return to give up, especially when paying 15-23.8% of that dividend in taxes is required to get it”
has some a valid point in that many investors hold very little money in their taxable account.
But, on the other hand, it would not be unusual for many high income earners to build up their taxable accounts to $1,000,000 or more by age 55, and hold another $1,000,000 or more, in their tax deferred and tax free Roth IRA accounts.
So, let’s pretend that a 55 year old who does have $1,000,000 in his taxable account and $1,000,000 in his tax deferred and tax free accounts, decides on a 50% 50% asset allocation and his equities are split 50% US and 50% Internationally.
Based on this example, this 55 year old investor holds $500,000 in International equities.
And assuming that the dividend yield is just 2% or $10,000 (historically, the dividend yield has been higher), then the potential foreign tax credit if held in the taxable account is $900 (9% of the $10,000 dividend). Saving $900 per year by holding this asset in a taxable account (instead of a tax deferred account where the tax credit would be lost), may not seem much; but, compounded over 30 years say at 8% would result in an extra $101,945. which is not too bad.
There are many things that as investors, we have no control over (what the stock market does, which way interest go, etc); but, I think that with tax knowledge and with a little bit of effort in holding assets in the right tax account (taxable, tax deferred, tax free), we can make a substantial difference in how much money we get to keep after taxes.
William Bernstein was the first financial author that turned me on to considering the importance of holding assets in the best accounts. It is my hope that as investors build up their taxable accounts (as well as their tax deferred and tax free account), they will give some thought as to which accounts to hold each investment.
As a tax preparer, I see very little effort to hold assets in the best account. One good example is that when I have a high income client who does hold a REIT mutual fund, it is usually held in the client’s taxable account where are the dividends are taxed, as ordinary income. (And usually, to compound matters, the REIT mutual fund was a fully loaded commission driven products with the usual 12b-1 kickback fees).
I think we’re in agreement on all those points. I would also note that I find far too many people that aren’t maxing out tax-protected accounts (or don’t even know about some like Backdoor Roths), and many of them have a taxable account to boot.
My long term overall return for my 75/25 portfolio is an annualized 8.45%. I don’t think 8% is too unrealistic of a number to use, mostly because it is extremely realistic for me!
I agree with the other poster that if my portfolio return is really less than 1.8% nominal, I’m going to have much bigger issues to worry about than my mortgage. My entire retirement plan will be shot and I’ll be working a decade or more longer in order to retire.
WTC, since your asset allocation is 75% 25% and not 100% equity, then you do have, by default, 25% of your investments in fixed income. And whether your debt is a mortgage, home equity, student loans, credit card debt, margin, etc, the debt is a negative asset on your balance sheet.
For example, if you have $1,000,000 in financial assets with a $250,000 mortgage and your intended asset allocation is 75% 25%, in reality, you have an asset allocation that is really 100% equities and 0% fixed income once your mortgage debt is subtracted from your fixed income investment.
My mortgage is a superb inflation hedge, maybe the only one I’ve got.
My mortgage expenses make up only a portion of the expenses to live in my house. I still pay property taxes,maintenance,insurance.
A taxable account gives you tax diversification. Only a taxable account allows tax loss harvesting, tax GAIN harvesting at Cap Gains rates, step up at death.
200k in a taxable account makes me feel better than 200k stuck in my home equity.
Lastly, a large mortgage offers near unbreakable asset protection.
I’m not sure you can apply the term “asset protection” to a debt. 🙂 But I understand your point. The non-existent equity isn’t available to your creditors. A good asset protection strategy in some states, but not in others (like Florida or Texas.) I agree it is a great inflation hedge and also agree a taxable account provides tax diversification. Is the diversification worth missing out on a tax-deferred contribution or a tax-free contribution? Probably not. Roth IRAs don’t allow tax loss harvesting, but they’re tax free at death and beyond death if stretched. I can’t quite convince myself to use a taxable account when I still have retirement space available.
I can’t disagree with your logic. However, these are my concerns:
1. It’s not simple. You have to track your cost-basis and capital gains and donate the appreciated shares, etc.
2. There are psychological benefits to being completely debt-free; I felt so much relief when I paid off my medical school loans and can’t wait pay off my mortgage.
3. Me, I’m simple-minded. I just put extra money I have left from each quarter into the mortgage. I get a guaranteed 3.125% return. By decreasing my “negative bond” allocation, this allows me to invest aggressively by increasing the stock/bond ratio in the rest of my portfolio.
Are you assuming 8% return nominal or real ?
Either number is a bit on the optimistic side
I’m not assuming it. I’m earning it (nominal.) I’m not sure I see much reason to assume my returns over the next 30 years are going to be significantly worse than my returns over the last decade. If you prefer using a lower number, it’s easy to do your own calculations of course.
Vanguard tracks my cost basis on my taxable accounts.
A mortgage has a built in “put”, you can refinance at any time.
Why not lock in “once-in-a-lifetime” interest rates for as long as possible? This is what an issurer of a long term bond would do.
How many deductions do you think you are going to have in retiremnt?
Most of your Home ownership expenses continue whether you pay off your mortgage or not.
The issue is entirely behavioral. Most studies indicate taxable investing gives a higher after tax return than early payoff. Money is fungible.
The “3.125% return” is on the declining balance over the remaining life of the loan (which has been reduced).
This is account bias.
You are absolutely right. I guess my risk tolerance, or more correctly “debt tolerance” is lower than most people’s. The one advantage to early pay off is a guaranteed rate of “return”, while there’s always more risk with taxable investing – what if the stock market fluctuates wildly in the next 20 years? (Ask a Japanese investor in the 80’s). One of my colleagues has $80K of student loans at 2% which he is paying off over 20 years. He went out and bought a BMW *and* a Porsche. I could do that too with my 3.125% mortgage, but I wouldn’t be able to take enough Prilosec to keep me from burning a hole in my stomach. To each his own.
Try plugging real numbers into your individual situations. We refinanced 350K at 3.125% over 15yr last year. I tabulated the interest savings over the life of the loan to us for each additional 5k in principal we pay annually. The first 5K of extra principal annually was a no brainer for us. We divided it and added it to our monthly payment. (This total amount was about what we were paying monthly prior to refinancing anyway). The second 5K annually is questionable and will be done in a lump sum if at all. The third and fourth 5K definitely hit diminishing return for us and will go into taxable investing.
A general question. Has anyone reading this blog actually taken one of the 2 following actions in the past 3 years?:
1) Taking out a home equity line, 2nd mortgage or replaced their current mortgage and used the proceeds from this infusion of extra cash to go and invest the money in their taxable account?
2) Instead of refinancing their existing mortgage to a shorter period of time(i.e. from 30 years to 15 years), actually refinanced in other direction (i.e. from 15 years to 30 years)?
If you did not implement one of these two strategies, then that should indicate a strong desire on your part to become debt free. For those who are absolutely convinced that the winning strategy is to invest rather than pay off debt, then to be honest with yourself, you should try and implement immediately one of the above strategies. Go and borrow more money and invest the extra money in your taxable account.
Yes, investing in the equity markets or a combination of equities and fixed income, should (but, with no guarantees) provide a better use of your dollars than paying off your mortgage. But, my bet is that once you have actually paid off your mortgage, you are highly unlikely to go back into house debt just so you can get a higher return.
I am pretty sure that WCI will be fine whichever strategy he decides to follows; and hopefully, WCI, will keep us informed as to which strategy he actually adopts. The least complicated strategy that does offer the only guaranteed rate of return, would be to pay off his mortgages, beginning with the higher interest rate one first.
🙂
I suspect most of us are conflicted on this issue, weighing the math factors against the behavioral factors.
WCI,
In a response to my assertion that it is preferable to hold fixed income in your IRA accounts, and equities in your Roth IRA, you wrote,
“I disagree with your assertion that bonds should be in tax-deferred preferentially in comparison to Roth accounts. If you tax adjust the accounts, the end result is the same.”
And I still believe that it does make a great difference (over long periods of time) whether or not, fixed income is held in an IRA (tax deferred) or in a Roth IRA (tax free). I think that we can both agree that equities have a higher expected annual return (10% would be a rough number to use) and fixed income have a lower expected annual return (5% would be a rough number to use).
Let’s make the following assumptions:
a) You are a 50 year old investor who currently has $100,000 in your IRA, and
$100,000 in your Roth IRA
b) You have decided on a initial 50% 50% asset allocation with no rebalancing will be done in either
account.
c) You will hold each IRA for 10 years before cashing both IRAs completely in
d) That your Federal marginal tax bracket is and will remain at 25% and there
is no State income taxes to pay.
e) Your equity investments will earn 10% and your fixed income investments
will earn 5%
Example 1:
a) Invest $100,000 in fixed income in your IRA, and at end of 10 years, the value of your IRA has grown to $162,889. This IRA is cashed in, you would pay Federal taxes of $40,722 (at 25%), and have after tax, $122,167.
b) Invest $100,000 equities in your Roth IRA, and at the 10 years, the value of your Roth IRA has grown to $259,374. Cash in your Roth and you pay zero Federal taxes.
So, your combined total after tax dollars is $381,541
Example 2:
Reverse the holdings in the two accounts. Your equities in your IRA grow to
$259,374; but, after paying $64,843 in taxes, you are left after taxes with $194,531
Your fixed income in your Roth IRA grows to $162,889. Total after tax for Example 2
Grows to $357,420.
Bottom line, holding fixed income in your Roth IRA and equities in your IRA has just cost you in just 10 years, $24,121!
If you disagree with my logic, I am confident that you will point out the errors in my logic.
Your logic is fine, you’re just missing a key point. Yes, equities in your Roth has caused you to have a higher overall return and more money in the end. But it isn’t because of some magic Roth IRA effect. It’s because you took on more risk.
Think of it this way. You have a $10K Roth IRA and a $10K Traditional IRA. You want a 50/50 portfolio of stocks that return 10% and bonds that return 5%. If you tax adjust the accounts (let’s assume a 25% tax rate), you really have a $10K Roth and a $7500 Traditional IRA. So if you put stocks in the Roth, you really have a 57/43 portfolio. If you put them in the traditional IRA, you have a 43/57 portfolio. Which one do you expect to have a higher return? Stocks in Roth, of course. But it isn’t because you made some brilliant move, you just took on more risk. You could have done the same thing by filling up the entire traditional with stocks and putting a little bit of stocks into the Roth too. Doesn’t matter.
Does that make sense?
WCI,
As Winston Churchill reportedly said, “Personally, I am always ready to learn, although I do not always like to be taught.” and that same thought goes for most of us. So, thank you for reminding me of the importance of looking at the after tax values for each investment in each account.
Actually, my Excel spreadsheet of investments does have not only the after tax values for my IRA and my Roth IRA, it does also, have the after tax values for my taxable account as well. FYI, My 60% 40% asset allocation does follow pretty closely Paul Merriman’s recommended portfolio approach, using mostly Vanguard index funds and a couple of Ishare and Wisdomtree ETFs to invest in the International asset classes that Vanguard does not cover (currently).
That said, since my wife and I are unlikely to ever take any distributions from our Roth IRAs (most likely our grandchildren will wind up with nice “stretch Roth IRAs”), then, it is still my belief that the investments held in (our) Roth IRAs should be equities, in nature while our Traditional IRAs and other tax deferred accounts should be fixed income. I would rather spend a little extra time each year, to figure out how to maintain our after tax asset allocation at the targeted 60% 40%.
Also, for the past few years, we have been following a yearly “do over” Roth IRA conversion strategy as outlined by James Lange and others. Most likely, we will still have a considerable amount of money in our tax deferred accounts, when we turn 70 and 1/2 in 5 years. If the current tax laws that allows one to gift one’s RMD to charities, I will probably employ that strategy rather yours and our current strategy of gifting from our taxable account, mutual funds shares that have a low tax cost basis and have been held more than one year.
I look forward to reading more stimulating blogs by WCI. And ps. you were correct concerning your thoughts about AMT and how it is actually more beneficial to pay mortgage interest than for someone that is not in AMT. A taxpayer in a 33% marginal tax bracket and in ATM, actually, saves 35% (not 33%) on their mortgage interest deduction. Not much difference; but, still, you were correct.
And finally, as you noted, it is behavior that trumps intellectual arguments when it comes to investing. If someone can’t control their behavior (investing at least 15% to 20% of their income by spending that much less than they earn; or can’t stay in equities when the stock market is crashing, and at the same time, can’t find the courage to rebalance from fixed income to equities, then none of these arguments (pay off mortgage or invest in equities, which account to hold equities and fixed income assets in) really matters.
Hopefully, many of your readers are following your well thought out financial advice. Keep up the good work.
I would consider money going to heirs as a different pot of money, but I agree it is far better to inherit a Roth than a traditional IRA. That’s very kind of you to prepay your heirs’ taxes!
Pay off your mortgage in half the time by doubling your principal payments. Not double your payments, just double the principal amount. Print an amortization schedule for your existing mortgage and add the amount of next month’s principal amount to your payment. Keep it going by adding the following month’s principal amount next time. It’s a great way to start low and it challenges you to pay extra each time as the “bar” gets raised a little bit. (Helped by, hopefully, your rising income as time goes on).
How does having the solo 401K for this blog contribute to your savings plan above in beyond the $51K limit on your 401K/profit sharing plan? I was under the impression that $51K was the contribution limit for all qualified plans combined (http://www.solo401kcontributionlimits.com/).
It’s $51K per employer. The blog is a completely different employer and industry than my practice, so I’m eligible for another $51K there if the blog had sufficient income.
WCI,
Have you calculated the long-term capital gains tax hit that you would incur at the point that you liquidate the equity index funds in the taxable account that have been appreciating at 8%/year to pay off the mortgage? How might that affect one’s decision to pay extra principle vs saving in a taxable account? This is not a criticism of your approach, but another tax issue that I didn’t see mentioned in the analysis of your original post.
Personally, I wouldn’t have much of a tax hit (I constantly would update the basis by using appreciated shares to make charitable contributions) but you’re right that it is an important factor that should be taken into consideration by anyone using this technique. But if you’re making 8% in equities and 1% in a savings account or 2% paying down a mortgage, it would have to be an awfully high tax rate for you to come out behind!
I’ve read all the posts and there is a lot of collective wisdom. I finally took a wad of cash and paid off my mortgage. Other than a zero interest car loan, I am debt free. I did all the sort of things many posters suggested- doubling principle payments, refinancing for a shorter loan, etc. Finally, I just pulled the trigger. Feels like a weight off my shoulders. I’m thinking of retirement, but still like what I do, and get bored when I have too much free time. Now I can retire whenever I want to or cut back, no debt. You cannot dismiss the psychological part of being debt free. It feels much better than I would have thought.
I used to be in the “put extra mortgage payments” and invest. This is a beautiful idea as long as you can absolutely forget about, and make sure the spouse doesn’t even know about it(or can forget about it).
But I have moved into the pay everything off, because debt hangs over you like sword of Damocles. When you owe nothing, the sense of security and freedom is liberating. Humans hurt more with loss than feel good with gains, and small losses (debt) hurts more than annual gains.
I think most physicians fail to realize that instead of investing in stocks, they can invest in themelves, or better yet, your practice. There are numerous ways to increase revenues (increased productivity using lean six sigma techniques, hire more staff, offer ancillary services).
You invest $1200/month in any of the above, and you can increase your returns by more than 20%.
Thank you for having this discussion. I thought I was crazy for repeatedly running these numbers and thinking about this. Granted, we had a similar decision with our student loan at an even lower rate.
How is your mortgage doing now…18 months later?
Good question. I’m just getting started as a post next week will show. I’d actually forgotten I wrote this post.
I am paying off my mortgage right now. My thinking is that while it is fixed at 3.375% and as you point out the return is likely low, I’m concerned about putting too much more in the market as we are at historic highs. I’m paying the mortgage as a hedge that we will have a dip and I plan to start putting more money back into the market instead of my mortgage if and when I think I can be buying “cheaper” shares that have more upside.
Guaranteed returns have their benefit.