Ask the Readers: Pay Off the Mortgage or Keep the Money in Savings?
Published on - June 17th, 2011 (by J.D. Roth) It’s tough to write a personal-finance blog for five years without repeating topics. New readers come and old readers go. Meanwhile, the needs of existing readers are constantly changing. I try not to repeat material too often, but sometimes it’s clear it’s time to revisit a subject. Now is one of those times.
Lately, I’ve received several questions like this one from Robin, who wants to know if she should pay off her mortgage:
I’ve been reading your blog for a while now. It’s good for both entertainment and advice, and I like reading through comments on the articles I’m interested in and getting all the various points of view from people.
Something I don’t think I’ve seen addressed yet is this: I’ve saved up enough money to pay off our mortgage. Should I do it? Should I pay off part of it? Should I keep it as our emergency fund?
Here are some of the rough details of our situation:
- Current mortgage amount: $250,000
- Current mortgage rate 4.625%
- Years left on mortgage: 13
- Years until retirement (at 58): 15, solid salary expected until then
- Current place the money is parked: savings account making 1%
- Thoughts about moving: unlikely anytime in the next 4-5 years, can’t say beyond that
- Other retirement savings: substantial IRAs, 401(k), and other investment accounts (not concerned that this will be a problem even if we live to 100).
- House value: probably around $500,000 in Seattle
- Other debt: just monthly credit cards that are paid in full, no car payments, no student loans, etc.
I think it would be great to live mortgage-free, and I hope to do it sooner than later but I also get that there may be better uses for the money and we aren’t in any circumstance to rush about it. What do you think?
We’ve discussed this dilemma several times in the past. In fact, it seems to come up every six months! Let’s review the basics.
By repaying the mortgage early, Robin would generate a guaranteed return on her cash: She’d be getting 4.625% on $250,000, which is no chump change. On the other hand, this move has drawbacks. Most notably, cash in a savings account (or even in stocks) is liquid; it can be accessed when needed. But if that cash is converted to home equity, it’s more difficult to get at.
And, of course, there’s the opportunity cost. Sure, the 4.625% guaranteed return is greater than the one percent Robin would earn in a savings account. But it’s less than what she could probably expect to earn if the money were in a diversified investment portfolio.
Some other notes:
- First, this is a good problem to have. Whether Robin pays off her mortgage or keeps the money in savings, she’s in good shape.
- Second, the experts don’t agree on the best move here. Many argue in favor of getting rid of the mortgage, but many argue in favor of keeping it. There’s nothing close to universal agreement.
- Third, as with many money issues, this question is often more about psychology than it is pure math. For many folks, not having a mortgage provides peace of mind they can’t find anywhere else. There’s no way to quantify how much this is worth — but it’s worth a lot.
Whenever this question comes up, I offer the same advice: Unless your mortgage rate is very high, it makes more sense mathematically to invest your money. But psychologically, you should do what works for you. If paying off your mortgage would take a weight off your shoulders, then pay off your mortgage. Sure, you might be losing a bit in the long-term, but you’re still making a smart choice. It’s like choosing between an apple and an orange; one may be better for you, but they’re both good.
And, of course, it doesn’t have to be an “either-or” situation. Instead of paying off the mortgage completely, Robin might opt instead to eliminate some of the balance (or to make accelerated payments) while keeping some of the money for emergencies, or investing it elsewhere for potentially greater returns.
What do you think? Does it make sense for Robin to pay off the mortgage? If not, what should she do with her money instead? Have you been faced with a similar situation in the past? What did you choose to do? Would you make the same choice again?
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I think that in THIS situation I would pay most of it off, perhaps leaving a substantial emergency fund in place. But that is because there is a secure job and large investments already in place. The money is meant to provide security so it doesn’t seem as if she is interested in taking any risk with it, so why not go for the 4.625 return? I would probably do it over one or two years, though, and not all in one lump sum. In other situations I might not make this choice and would instead invest the money.
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I’d agree for this situation, paying it off is better than leaving it in the bank. That said, I’m assuming they aren’t planning on putting themselves at risk by paying it off and leaving no emergency fund. I’d suspect with the mortgage paid off, they’d have enough for at least a year of living (property taxes, utilities, necessary living expenses). Even with a few years, having already saved $250K with a mortgage, I’m sure they would be in fine shape a year or two mortgage free.
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I agree with paying the mortgage. A house is not a liquid asset but if the price is slightly below market it will sell quick.
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Agreed. Also: props to Robin!! Awesome problem to have, lady!
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Don’t discount the ability to use the mortgage interest as a tax deduction. Often the combo of that tax deduction and opportunity cost can make a strong argument for keep the mortgage and investing the nest egg.
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BJ makes a very interesting point. I took a swing at the numbers to see what the true advantage is on both tax and savings rate.
Based on the information in the article, Robin is paying roughly $700 per month in interest on the mortgage. I assumed her situation puts her in the highest US tax bracket (35%) and can see that this mortgage interest saves (avoids) payment to the feds of $245 per month. Add that to the 1% she is making on her savings account ($208 per month) and the effective savings rate on the $250k becomes 2.175% at this given moment in time. Still less than the 4.625% of her loan, but better than the lowly 1% of her savings account.
However, one thing to remember is that Robin still has to pay interest ($700 per month) to the bank in order to receive the monthly tax savings of $245. Tax savings from mortgage interest is only realized if she has no other way to reduce her taxable income below the threshold of the standard yearly deduction. She could likely still come out ahead by paying off the principal of the loan, keeping $700 interest payment in her pocket each month, then taking the standard deduction at the end of the year.
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Shoot! My math is even worse than my writing skills…
My comment should say that Robin is paying roughly $840 per month in interest on the mortgage. That makes her tax savings $295 per month and her effective savings rate on $250k 2.415%. Next time I’ll have my coffee first… Sorry!
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I have a 24K mortgage and a 190Kmortgage, a difersified 150k portfolio, a rental property and my own apartment. My spouse just passed and I our household is now I am a one income widower. I have consolidated a couple accounts and cut utility companies pork. My dilemma is my 24k mortgage. should I just pay it of from the portfolio money that keeps going down due to our current poor market? Please advise. Much appreciated. (by the way, I have no dependants)
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If she’s scared to tie up that much cash all at once, why not use some of the savings to accelerate the mortgage? She could plan out a six year plan for paying it down, so she’d save some interest, but the majority of her cash would still be liquid.
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Or maybe use half or more of the emergency fund to pay down the balance and then do one of those ING orange, 5 year loans at super low rates. That’s sort of like accelerating the payoff, too, but would probably be locking in a lower rate for the shorter term.
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she is obviously scared to take on risky investments that is why the money is tied up at 1%. so i suggest paying off the mortgage in full, you now save approx $700 a month on interest, now that you don’t have mortgage fear you can invest the money the banker would otherwise have more aggressively for higher returns.
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Robin,
If by paying off your mortgage, your emergency fund will be wiped to $0, then I suggest not paying off the mortgage in full. Perhaps you could pay off $200,000 worth, and then hold the rest for emergencies for a while until you build up that account again.
If paying off the mortgage will result in an emergency fund that is still substantial (more than $20k), I say go for it. It’s a guaranteed money-maker when considering the interest that you would avoid, the peace of mind will be overwhelming, and you’ll have an asset that the bank can keep their hands off of, even if you begin struggling to pay the bills.
Hope this helped!
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Agreed. If you will still have an emergency fund, pay it off and be done with it. Mortgage payment can then be used to invest, re-build e-fund or to do something completely foolish with, like buy a new boat:D
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I’m with the psychology aspect, I’d like my mortgage gone, but I’m only 3.1275% right now, so I know I should keep it.
So what is better for me, an Apple or an Orange? Seriously!
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The psychology aspect is very important. You can sleep soundly every night without any worrying debt to service. Besides, wealth accumulation really starts furiously when you are debt free. i have chosen this path and it works and is still working.
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If your house was paid off, would you take out a home equity loan to put it in a savings account? Or to invest it? The answers to those questions will help decide what’s right for you.
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@Matt – you put it brilliantly.
JD, comparing the return from paying off a mortgage to investing in equities is like comparing government bonds to equities. Apples and oranges.
You can’t just look at the return, you also have to consider the risk.
4.625% guaranteed return? I would take that in a heart beat. Especially if I already have quite a bit of money invested in equities (which it sounds like she does).
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Home mortgages provide guaranteed returns only so far as the home retains its value. The value of the home is determined by any number of things–favorable development, economics of the city, school districts–so I don’t think we can say it’s risk-free. We don’t even know what the real risks are, or how they might affect her income, or the value of her assets.
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Paying off a mortgage is the equivalent of a guaranteed return regardless of your home’s value because your home value does not affect your loan amount. If you are underwater and you pay off your home you didn’t just lose money. You still have the house you payed for and no more mortgage. The only time the rate is not guaranteed is if you don’t expect to have to pay off the loan. Like in bankruptcy or foreclosure. Even in most short sales it still makes sense to pay down principal.
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@brent, the question is one of risk assessment. if you would not borrow the money on your house to put it in its current investment you should cash out and pay off the house. when you phrase the question if your house were paid off would you borrow the money on it to invest? it brings up a new twist to the thinking and really makes you question whats important to you, a paid off house or the investment.
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This is frequently Dave Ramsey’s response to the same question and it completely makes sense. Risk is also not to be ignored.
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Well, if experts do not agree in paying it off or not, I would say it’s better to be in the middle.
What if you use half of the money to pay part of the mortgage and invest the other half?
By doing this, you make your risks lower than if you decide to be in any of those sides.
You get the best (and worst) of both.
But I would prefer this, than paying everything off knowing that I could use the money to get higher interests rates.
We have here in Brazil a commentator that says exactly this: try to be in the middle.
I had here in Brazil a student loan which had a 15% per year interest rate. Since it’s hard to get something higher than 15% per year under investments, I decided to pay off and since I knew it would be hard to get something better than the 15% ratio, I did not find it difficult to leave the money.
It was a good approach.
Now I am free and rebuilding my emergency fund, as well as my other (opportunity, desired products etc) funds, investments accounts and so on.
Well, I know brazillian and U.S. economies are completely different, but risk is risk everywhere, as well as opportunity cost is opportunity cost everywhere.
So I guess this makes sense!?
Regards,
Lauro
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Ahhhh,,,,
So your point is: Why choose between an apple and an orange when you can make a fruit salad instead. I like it.
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I don’t know if they’re available in her neck of the woods, but if you can get one, an offset mortgage is a good middle ground. You “make” the 4.625% interest *tax free*, plus you still have the full offset balance in a savings account which you can draw on at any time, effectively giving you the facility for an instant-access, pre-approved, no-paperwork loan at 4.625% for up to your outstanding mortgage balance ($250,000) in case of emergencies.
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I had never even heard of those, thanks for posting that.
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Offset accounts are offered in Australia, right? While I agree that they are an excellent way to manage your mortgage, they are not available in the US to my knowledge.
I have been comparing Australian and US mortgages recently, and find the Australian offerings much more innovative and customer focused. Of course, interest rates are generally higher, most mortgages are adjustable, and mortgage interest is not tax deductible in Australia, so anything you can do to reduce your mortgage balance there is highly favourable.
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It’s the same in the UK. We were ready to pay off our mortgage a couple of years ago, but first decided to leave it in the offset account until we were out of our pre-payment penalty period and have since decided to leave the offset there indefinitely for some ‘just in case’ liquidity. It’s even better that the mortgage payment is auto-paid from the offset account, so they are coming down simultaneously without any effort from us – all just running in the background.
If an offset account weren’t available (as I’m assuming is the case with Robin), I’d still suggest taking the guaranteed return. Yes, the stock market may have an average inflation-adjusted performance of 7%, but that’s not a risk-free rate. It sounds like there are substantial investments elsewhere, so might as well free up some cash flow, have the peace of mind, and maybe look at setting up a monthly investment if she’s keen to invest more (then she’s also dollar-cost averaging rather than biting the bullet now).
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I agree, this often is more about psychology & PF=personal freedom than straight numbers. In my view, the bigger factor than comparative rates in the pay-off-vs-invest-nest-egg question is certainty (of a fixed rate mortgage disappearing) vs. uncertainty (volatility of stock market or other monetary investments).
JD, curious if you consider 4.625% to be a “high” mortgage rate? “Unless your mortgage rate is very high”
Thoughts…over the very long term stocks have typically had a *real return* (that is, above CPI-U inflation) of about 2%. With inflation in the 2-3% range right now, it’s hard to say whether one would expect investments to do better in the short or medium term.
Data on how stocks have a much higher volatility than a fixed rate mortgage— Historically (monthly data 1928-2010; similar results looking at sporadic [as infrequent as 1x/decade] data 1800-2010), you have to go to a time horizon of 33 years before you could get to a point where almost no matter when you invested in the past you ended up with a return better than inflation (for the 15 year time horizon here, the median *real return* would be 3.0%, the standard deviation [a measure of volatility] is 4.9%, and 69% of time you beat inflation – based on monthly data from Oct 1928 to July 2010, this is not my day job & haven’t updated since then).
Bias report: I am a big believe in indexing; I worked on Wall Street for 15 years but have been gone for 5+ years now and have a degree in Math.
Even more data: in that same 1928-2010 batch of monthly data, at a 31 year time horizon you beat inflation 90% of the time; at 32 yrs it’s 96%; at 33 yrs, 99%). The point where the standard deviation (a measure of volatility) is equal to or lower than the expected median return is 25 years (or longer).
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I am by no means an expert, but I think that you are right and what truly matters in this scenario is the age of the person. She is close to retirement, so the chance that her investments will get a large payoff is very small. I always hear advice that the older you get, the more you should invest in very stable vehicles. In this case, the interest she pays is pretty significant, so that would be the way to go in my view.
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It’s true that inflation will erode the value of investments, but also the “real” value of the debt. It’s an issue, but one that applies to both sides of the equation.
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Yes, both sides of the monetary balance sheet would see real values shrink with future inflation. Inflation would be a headwind to values of both debt (at least if it is fixed rate) and some investments (especially to monetary assets like debt or cash).
In fact, from a net worth perspective there is no difference between keeping savings high and paying down the mortgage to zero (on day one that is, without worrying about future investment returns, real estate values, etc).
However, real assets (like real estate) historically have tended to hold their values in periods of inflation. That is, if you pay off a mortgage today, you are likely insulating yourself against future inflation (if you expect significant future deflation, cash or monetary assets would be relatively more attractive than hard assets like real estate).
Once again, seems like certainty and volatility are the big factors in a personal decision of pay-off-mortgage-vs-keep-savings-high, since who really knows if inflation is likely to go and stay higher, remain in a similar range, or drop lower…
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We paid off our mortgage in 2008, and people told us we were silly because we could invest at a much higher rate than 5%. The market promptly took a huge nose dive. Our investments were at about -20% for the next 12 months. I figure that was a good move, as we are already putting the max into our tax-deferred investments.
To beat the illiquidity, we immediately opened a home equity line of credit after paying off the mortgage. For a $50 annual fee we had access to as much cash as we needed. Once our bank account hits our comfort level we’ll dump the HELOC, hopefully unused.
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If she keeps the money in savings and loses her job (even though she thinks this is unlikely, it happens) then she can pay the mortgage easily via the savings. If she has taken all the savings to pay it and then becomes unemployed it could pose a problem without having an emergency fund to fall back on.
I agree with the PP who say to accelerate payments. I imagine while doing that she would be able to replenish some of the savings during the same time.
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On the flip side, if she pays off the mortgage and loses her job, she could take a significant cut in pay for another job and still be able to live and save easily. If the mortgage is currently 10-20% of her pay, she could be able to take that kind of pay cut and not see any drop in her standard of living. She could likely even take a much steeper pay cut and reduce her savings rate (considering they’ve funded retirement and other goals and still put $250K away in cash) and get along very well. This would make it more likely she’d be able to get a job quicker, reducing her risk of unemployment.
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Why should she be precluded from taking a lower paying job only if she is mortgage free? Can’t she use that large cushion to make her loan payments then? I would think I would be more likely to take a lower paying job as a necessary evil if I had a large cash cushion + mortgage debt versus being low on debt (and cash).
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There are a few other issues to consider in this decision:
1. Does she itemize and get the mortgage interest deduction – this will affect the effective guaranteed return she gets.
2. Is the family concerned about liquidity – will paying off their mortgage lock up all their cash reserves.
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This is a quote from one of the threads in the forum by Kombat ….. “As I see it, the best time to pay extra on your mortgage is when interest rates are low. That’s when you can maximize the portion of your payment that goes toward the principal, and minimize the amount lost to interest.”
It pretty much sums up how I feel about pre-paying mortgages.
Robin could stop saving and leave her cash liquid and shove money towards the mortgage while still having the security of cash.
I think this is more of an emotional “dilema” than a mathematical one.
Think of all the cash you would have freed up once you pay the mortgage off.
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I agree, though I swim in a lot smaller financial pool. Why not put the cash in an investment like microplace. I know they offer in my state loans to the poor that return 4.5% if one invests $25000. That almost covers the mortgage interest. Then she can take the money that was going into savings to pay down the mortgage faster. When the term of the loan is over she can reinvest or get the investment back. I have been loaning money to microplace for about 3 years and have not been burned yet. Worth a look.
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Almost 5 years ago, I cashed in mutual funds to pay off my mortgage (about $135,000). Shortly after that time, the market crashed. I can’t say that I planned it this way, but if I left the money in the mutual funds, I would have been left with about 50% of my investments and a mortgage. By paying off the mortgage, I have peace of mind and made maximum use of my funds.
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Past performance is no guarantee of future returns.
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I think that just because paying of the mortgage is the next check list for a financial pat on the head doesn’t mean you should do it.
Why pay off early? At this point the numbers don’t seem to matter all that much. You have no debt and a healthy retirement fund.
Will it help you retire early? Or is there something else you would rather spend your money on than a mortgage?
If you are paying off your mortgage simply because you have run out of things to do with your money, get creative! Really list out what you could do with the extra money. If paying off the mortgage still ranks high, than by all means pay off the mortgage! But don’t do it just because that’s what you’re “supposed” to do.
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How can you say the numbers don’t matter that much? She’ll be guaranteed $9.062.50* in the first year!
*$250k x (4.625% – 1%)
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Don’t do it!
But before I get into details I want to correct one minor math error that J.D. has. He says there’s a guaranteed 4.625% return. Assuming you’re in the US, your interest is tax deductible. If you about about 30% of your income in taxes, that means that you only have a guaranteed return of around 3.2%.
From my point of view you’re NEVER EVER in your lifetime going to get money at a 3.2% rate again, and there are so many things you might want to use it for.
Let’s run thought some scenarios of the future. Imagine there are three couples… think about which you’d want to be in each of these situations:
No Mortgage – $100k in cash on hand, 50% in stocks/bonds
Half Mortgage – $350k in cash on hand, 50% in stocks/bonds
Full Mortgage – $600k in cash on hand, 50% in stocks/bonds
Scenario 1 – Stock Market and Real Estate do what they’ve done over the past few years. Stocks broke even, Real Estate lost 5-10%. You’re better off being #3. You can now negotiate with your bank, or worse case let them foreclose on your house (which will take a while) and the bank will be responsible for the fact that your house lost money. Or you can just absorb that cost and carry on with a manageable loss.
Scenario 2 – Stock Market and Real Estate do what they traditionally does which is goes up around 8%-10% annually. Scenario 3 is the best. You’ve maximized your income, and still gotten the benefit of increased Real Estate value.
Scenario 3 – Personal crisis. One of you is unable to work, and the other is dealing with whatever the issues are. Again Scenario 3 is the best. You have the most cash to weather something. The bank is NOT likely to foreclose on you, they don’t want to own your possibly underwater property, they’ll cut you a better deal than #2, and you’re not going to want to deal with selling your house quickly to get more cash (#1), esp if the housing marketing is poor…
I recently went from owning my house free and clear to taking out the largest mortgage possible on it.
NOTE: If you’re going to SPEND the money instead of saving it, you’re definitely better off paying off your house, but you guys sound like savers, not spenders, so you can do the safest thing and pay the bank a small amount (3% of your mortgage) to have them take most of the housing market risk, while you can benefit from any upside.
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If she’s maxing out her tax deductible retirement accounts, she’ll have to pay capital gains taxes on any market returns. I’d urge her to pull out her tax returns and check exactly how much the return would be.
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You assume they itemize, but they live in WA which has no state income tax (the other most common itemized deduction). Unless they have high real estate tax or contribute to charity, they may take the standard deduction.
Personally, I’d rather be debt free and free up that cash flow than get a potentially useful tax deduction.
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Nice-agree to pay a price for the home and when it drops in value, stick it to the bank.
No wonder this country is in the shape it is in. People won’t honor their word, a contract isn’t worth the paper it’s printed on.
Yes, I know it is just business and the bank won’t hesitate to foreclose, but if you honor your side of the contract and pay as you have agreed there won’t be a foreclosure.
It is dishonest/unethical to let the bank foreclose just because the value has gone down and you have the means to continue to honor the original contract.
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Um, a contract has two sides. The borrower agrees to pay x amount over a set term. If not met the bank takes the house. The bank made the money/loan/debt up out of thin air. The borrower stops paying. Bank takes house. All legal. There was a 1965 trial whereby the house loan borrower proved that he was not liable for the payments because there was not any consideration by the bank at the time the loan was made.
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So if two parties agree that the price of house is $200k, the purchase is made. Then a year later due to market demand, the house is now worth $150k the person who agreed to pay for the house should just walk away because they still owe $180k on the loan?
That is unethical and IMO dishonest.
If the house appreciated to $250k, should the purchaser pay extra to the bank since it went up in value?
When you buy a stock and it goes down in value do you get to go back to the broker and say, “I didn’t realize that it would go gown, I want my original investment back.”
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I’d rather have an extra $1,900 per month in cash flow than $250k in the stock market that might increase in value.
Ask someone to guarantee you a 4.625% return for a 13 year CD and they will laugh at you, but that’s exactly what you would be doing if you pay off the mortgage.
Since you’d be paying capital gains taxes on earned money in most other investments, I think the tax benefits of having a mortgage are a joke. Pull out your 2010 tax return and check.
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Another thing to consider for those of us in the UK is that we don’t get any tax relief on mortgage interest as I believe is the case in the US. This makes sways the decision slightly further towards paying off the mortgage.
Investments while generally a better earner do not have the guarantees that paying off the mortgage does have – by paying off the mortgage you’re guaranteed to have X hundred dollars all of which can be invested if you wish.
Finally, the money within a house can be accessed in a number of ways – even if Robin suddenly needed $250k she has the option to sell or could remortgage for that amount at any point in the future without having to move.
I’m definitely on the side of paying off the mortgage asap – I prefer the freedom that comes from not having large outgoings. Then again, I could probably make a very large dent into my mortgage but have ended up investing in various ways instead, I’m glad there’s no right answer to this one
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Some people mentioned that they paid off their mortgage and got themselves a HELOC right away. I think that is a good idea, because the older you get, the harder it is to get a mortgage–at least in some countries.
I know my mother, in Italy, cannot get a HELOC or any large secured loan because she is 70 years old. They assume she will not be around very long to pay it off.
I’d be curious how such a thing goes in the US.
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Actually, with such a substantial amount of equity already, I would apply for the HELOC *first*, then pay off the mortgage. The line of credit gives her the ready liquidity if an emergency comes up, but she can immediately pay off the mortgage an stop accruing interest.
That avoids the risk of locking it all in home equity and then not being able to get the HELOC if an emergency strikes.
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I would refinance with 10 year mortgage. The interest rate would drop about a percentage point and the payments would be excellerated.
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Why would you waste all that money on closing costs to refinance when you could just pay it off?
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Have them use a zero cost refinance with a 10 year term. I would have them check with the current mortgage holder first as they may have a zero or very low cost refi program available. The current market rates on a ten year would still bring the interest rate down significantly, likely under 4% even when using a zero cost refi. With zero cost refi any reduction in the interest rate is worth the effort to refinance the mortgage.
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Since Robin states that her money is currently invested in a savings account paying 1% interest, I’d ask her if she feels comfortable even investing it in stocks at all if she opted to keep her mortgage. That’s a pretty conservative investment.
Not all of us feel comfortable with supporting publicly held corporations and are willing to make less money if it means we aren’t supporting investments that don’t support our values.
Other people feel uncomfortable with investing in the stock market for other reasons. As J.D. said, this is a psychology question more than a financial question.
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I agree. I personally don’t want to invest any of my money in companies that are ethically challenged. I feel more comfortable using a savings account with 1% interest. There needs to be some real reform before I trust any of those goons on Wall Street with my hard-earned cash.
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You do realize that by keeping your money in the bank, you are essentially “investing” in the bank, since your money is circulating through their financial system, to their gain?
If you’re comparing, then there are quite a few public companies that are less “ethically-challenged” than most banks.
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Good point, David. That’s why I keep my money in a Community Development Credit Union.
I know index funds are a good way to go for the best return. But I feel more comfortable looking at individual companies on their own merits.
I might be in the minority but I know I’m not alone.
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I wouldn’t pay it off. If I was Robin, I would buy a rental home and generate some extra income. Or just wait a few years for interest rate to go up and then just buy CD.
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I don’t hear this advice often, but it’s what my husband has always planned to do, buy investment property and become a landlord. He is already in real estate, and he learned from his father growing up, so I’m confident he knows what he’s getting us into.
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It depends on why you want to pay it off. What are you going to do afterwards? Quit your jobs and travel? Keep right on working and earning the same income? Start a non-profit fund to cure cancer? Or what? How if at all will doing this help you achieve other goals?
If you know why you want to pay it off, that will shape your plans, but in the absence of other information, I think the middle ground is the way to go.
First, there must be a tax-free mutual fund you could invest that money in and get better than 1%. Poke around and see what you can find. At the very least Vanguard has a couple that are fed tax free, even if there isn’t a state or municipal bond tax free fund for Washington state.
Second, I agree with those who have said you will want an emergency fund. If one of you gets some rare disease not covered by insurance or your home is damaged in an earthquake and your insurance doesn’t cover everything, you’ll want a big wad of cash. I would put, say, 100K in a tax-free mutual fund, and make that the emergency fund.
Third, I would figure out how much property tax I would have to pay annually after the mortgage is paid off, and figure out how much I spend on house maintenance annually, and figure out how to pay for those things once the mortgage is gone (this will partly be answered by what you plan to do with your mortgage-free life).
Then I’d take the other 150K and make a big dent in the mortgage. And figure out how to accelerate payments to get rid of the last 100K in a very short period of time, say 3 or 4 years. When the debt is paid, if you plan to keep working, divert all that monthly payment money back into the e-fund, house maintenance, and property taxes etc.
But that’s just me.
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Wish I had this problem
Actually, I do — but on a much, much smaller scale. Over the past few years, I’ve had enough money in my savings to pay of my small student debt. As much as I love the idea of living “debt free”, I liked having a healthy cash cushion. I took the middle ground and accelerated payments. I was glad I did as I had a couple of scares along the way.
I’m not saying this approach is right for everyone, but I think we get a lot of pressure to live “debt free” or “mortgage free”. You have to decide what’s best for your peace of mind, and sometimes those labels are just a different kind of status symbol.
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I have a similar problem! Hubby would rather keep paying my student loans at the minimum and use the cash to buy investment property. I would love to be rid of the debt first, but I can’t argue with the low home prices and low interest rates that we have right now. Waiting a few years might miss this golden opportunity.
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In a heartbeat…pay the mortgage off. I like Dave Ramsey’s take…100% of foreclosures occur on homes that have a mortgage. Ha!
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Ha, true. Unless your are that poor man in Florida who paid cash for his home and then the bank forclosed on him. He ended up threatening the bank with forclosure.
The story is here: http://www.suntimes.com/business/5809430-417/couple-threatens-bank-with-foreclosure.html
But generally your right, it’s better to not have the mortgage to worry about!
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not recently! banks have been foreclosing on homes that don’t even have a mortgage!
http://abcnews.go.com/Business/bank-america-sued-foreclosing-wrong-homes/story?id=9637897
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Well, wait a minute…
Instead of paying off, can you refinance into a 3-5 year ARM? Pay it off as a 3-5 year loan using the $250K in savings.
This will substantially reduce your monthly interest.
The Easy Orange 5-Year mortgage from ING is running at 2.99%.
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If you re-financed to a shorter term loan (say 3-5 year), you’d probably end up paying more for the refinance process than you’d end up saving with the 3-5 year loan versus keeping the loan you have and accelerating payments to 3-5 years on your own. Just sayin…
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I would drop the emergency fund down to, say $50k, which still leaves plenty of a cushion, and put the other $200k toward the house. Then I’d aggressively pay down the rest of the house until it’s paid off, then build the emergency fund back to where she feels comfortable again. But a 50k emergency fund should be plenty, especially since it’ll only be for a few more years.
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For those talking tax deduction, keep in mind that you are getting a tax break on money you have already spent. Say your mortgage interest is $15,000, you would likely get one third of it back as a deduction (e.g. 33% tax bracket), but you’ve spent two thirds, or $10,000 that year to get it!
If you earned $15,000, you’d owe 33% and would have $10,000 in hand! That would be the situation if you hadn’t spent it on mortgage interest and had to pay taxes on it.
And that’s assuming you had other deductions that put all of the mortgage interest deduction above and beyond the standard deduction because if it didn’t, then your benefit is even less. For example, if your total itemized deductions were $20,000 and the standard deduction was $11,000, you’re only $9,000 above what the standard deduction can get you and you are only getting a third of that, or $3000 versus $5000. So you spent $12,000 instead of $10,000.
While I do feel tax considerations need to be taken into account when looking at your total tax picture, the mortgage deduction shouldn’t in itself be a reason for keeping a mortgage since getting the deduction is just spending less, but still spending.
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Everyone always has a strong opinion on this topic, although I can’t recall ever seeing a single comment from someone who has paid off their mortgage and expressed regret about it. Go for it! Someone should create a blog celebrating people who have paid off their mortgages….would be pretty cool to read those type of success stories, how they did it, what their motivation was, etc… (JD?)…
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Have you heard of Dave Ramsey, he has a radio dedicated to paying off debt and then people call in and scream “I’m Debt Free”
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We paid off our first mortgage when I was 40 and never looked back. That was two houses ago. Thirteen years later we live in a house worth the same as yours- only paying insurance and property taxes. It is a freeing experience.
Once we paid off the mortgage we accelerated our savings and quickly had put together the money we had used again.
Brokers have always said you can make more money in the market and you should leverage your house. That management does not promote sleep- or quell my “bag lady”nightmares. I am glad we did what we did- and now can easily live on a pension so my husband I am can do what we want in retirement.
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I’m in a similar situation although at a smaller scale. I have enough money invested to pay off a student loan in full, but I am afraid to do it and then not have the money!
JD is right when he says that this is a GOOD problem to have… I think I’m going to go for it! You should too!
Can’t go wrong getting rid of debt, right?
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What about for a student with student loans but no other payments?
I bought my house 2 years ago and I am currently enrolled in MBA program. I contribute 20% of my paycheck to 401K and 4% to Roth IRA. I currently still have balance from undergrad loans. I’ve been paying 5% more on my monthly mortgage payment. I am not sure which loan to pay off first.
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google debt repaymant calculator and play around with the numbers. They tell you what inputs pays off the debt the fastest with the least amount of interest owed. That is, they structure your payments to pay off the loans the soonest, thereby paying the least interest.
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Though I’m nowhere near this position (still saving up for a down payment for a first mortgage!) I can imagine myself being there, and I would definitely want to pay it off (leaving a liquid sum for an emergency fund). Once it’s paid, your monthly expenses will be so much lower. I remember how much more relaxed my parents got about money once their mortgage was paid.
The only reason I might not pay it off is if I thought I might want to use the money for something else (rental or vacation home, start a new business, etc).
Congratulations! And good luck
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You know, that is a really good point. I am the youngest of five, and when my parents paid off their mortgage, I was still in HS and things definitely started to change. On the other hand, my brother had graduated and saw not much of the “hey, why not?” phase of living with my parents.
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I would pay it off and open a home equity line of credit to use as my emergency fund along with whatever cash is left. We’re good with money (and it seems you are too), so having that open line of credit (to potentially run up on Stuff) isn’t an issue.
You are guaranteed to lose 3.625% by keeping it in savings. I guess you have to figure out if you’re willing to accept that versus whatever alternatives you’ve considered.
I would DEFINITELY NOT refinance to a shorter term loan like a few have advised. Why would you throw away money on refi closing costs when you could just pay it off and be done with it?
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Clearly an excellent option. This is what I’d do: in the worst case scenario (injured, unable to earn a living, limited disability income), you may want to downsize anyhow. Owning the house outright means no constraints on your timing: no mortgage penality, for instance. And HELOCs offer some of the best rates around, if you should need to use it as a bridge to another solution.
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She just needs to get a loan with no closing costs. It will have a slightly higher interest rate than the advertised rates, but given Robin’s financial comfortable financial situation and with the rates as low are they are now, it would be very easy to significantly lower the interest rate without paying a dime.
If she decides not to pay off the mortgage, then not refinancing would simply be throwing money away.
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I didn’t read all of the comments, but one thing the article failed to account for (and other readers) is the tax deduction on mortgage interest by keeping the mortgage.
In my current situation that mortgage saves me thousands of dollars per year in money that would otherwise be paid in tax.
Given the tax break. Given the historic low rate. Given the state of the economy and the likelihood that interest rates will go up (and possibly WAY up). I think its definitely smarter to keep that mortgage as long as you can and invest the money elsewhere.
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…but you’re only saving money you already paid on a mortgage. it’s not saving, as such, it’s just redirecting a portion of what you’re paying. I think JD previously did a good article discussing why ‘keeping a mortgage for the tax write off’ is a false economy.
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Matt:
Most people grossly overestimate the tax benefits of having a mortgage. For a family of four, the standard deductions are actually pretty generous. Keep in mind that only about 1/3 of all Americans use itemized deductions. Also, the amount of the interest you pay on the mortgage declines over time, as does the tax benefit.
From a purely financial perspective, the mortgage interest deduction is overblown. From a practical perspective, it’s a bit like your wife telling you how much money she saved by purchasing an expensive new purse on sale. I’d gladly take $1,500 in cash flow monthly by having no mortgage and keep $18,000 in my pocket each year over telling someone I saved $1,000 on my tax return. You’re still out $17,000 on house payments.
Great article on this topic by Scott Burns can be read here: http://assetbuilder.com/blogs/scott_burns/archive/2010/11/19/would-you-miss-the-mortgage-interest-deduction.aspx
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If it were me, I’d let the mortgage stay. Why?
First, I value the emergency fund. Second, the mortgage is clearly not a substantial portion of her income, given the size of the emergency fund saved.
If the emergency fund is large enough to pay off the mortgage completely, then unanticipated unemployment still leaves you in a very comfortable position (ie, able to pay the mortgage and grocery bills for a very long time while finding new work).
Third, inflation is inevitable and will only serve to make the mortgage easier to pay as time passes.
I’d keep the emergency fund, but invest a large portion in a diversified manner to reduce risk but increase performance – 1% is way too low for that kind of money.
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But if you become unemployed with no mortgage, that is a lot less cash you’ll have to come up with each month, no?
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Without very specific details, let’s just play with some pretend numbers…
Figure a mortgage of 250k and an emergency fund of 250k.
If you pay off the mortgage completely, you’re left with no emergency fund. Unanticipated inability to earn money leaves you in a house without food, power, water, or regular maintenance.
If you pay the mortgage down, leaving 50k for emergencies, you can reduce the size of remaining payments by refinancing. You’d also have enough money to cover any unanticipated expenses over the next few years without jeopardizing your family’s future.
Also, you completely overlook the power of inflation. If you took a 30 year mortgage on a $50k property 25 years ago, you’re probably making a payment that barely hits your income.
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I totally agree that it’s all about psychology. I can tell you what we’re doing. We bought our house with 10% down and pay PMI. We are paying extra on the mortage but only until we’re at 20% and can cancel PMI. Then I’m going to stop prepaying it. I figure the extra payments at the beginning of the loan will have the biggest impact in saving me interest, but 5% is so cheap that after PMI is gone, I think I can do better in the market. Of course, I’m also in my early 30′s so I plan on investing over a fairly long time period.
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My goal would be to have the house paid off by the time I retired. Why not put some of the money to work for you in a good mutual fund, but accelerate the payoff of the mortgage by putting extra toward the principal with the goal to have the mortgage paid off when you are ready to stop working (or earlier). If you’ve saved up that much just from working, my (good) guess is that you have discretionary funds you could put toward paying the mortgage down, without tapping your savings.
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I’ll toss my hat in with the psychological crowd, paying the mortgage off just sounds way more appealing.
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Pay off the mortgage debt is better if we are sure that we don’t have any business/investment plan in the future. Otherwise, Savings in bank or somewhere else with good liquidity will allow us to have good investment opportunities whenever there is a chance.
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My vote would be to pay it off and then open a HELOC for an emergency fund.
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My sister did something really different. She wrote it up and financed her own mortgage! Sounds silly- but she pays herself 4.5 % interest and has an income and a job. Seems silly until you understand that unless you have a job in retirement you are not allowed to invest in your IRA.
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I hope you’re not suggesting borrowing money from your IRA to finance a home? That would be disastrous since the IRA would be nullified and deemed distributed in the tax year the loan closed.
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If you had a paid for house would you take out a mortgage against it to make money in the stock market?
…via Dave Ramsey
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Yes, I would take money out of my house to invest in the stock market. So I should not pre-pay my mortgage but for people who could not answer that question positively, paying the house off may be good for them. Well, as long as you are already saving 15% of your income to retirement accounts.
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Although the peace of mind that comes from paying of the mortgage would be nice…one should also have much comfort just knowing that they have the ability to pay of their mortgage if they so choose. With that said, instead of paying of the mortgage, make accelerated payments. To allow you to make those accelerated payments, I would keep an above average emergency fund in savings (say 4-5x the recemmended 8 month fund. With the remaining money, I would diversify into investments to minimize risk.
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I don’t understand why someone would choose the middle ground option. To me, the advantage of paying off the mortgage is security of owning your home outright and increased monthly cash flow. The advantage of keeping the mortgage is security by having a large cash reserve. By going half way, you’ve essentially reduced the advantage that either option gives you. You no longer have the security of a large cash reserve and you still need to make a monthly mortgage pmt. While I personally would choose to pay it off, I can understand why some might not, but I don’t think you’re gaining much by going half way.
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Under normal circumstances investing and getting a return in excess of your mortgage rate makes sense these are not normal times .The current outlook for the u.s.a. is very gray as it is for a great deal of the rest of the world. It could be very stressful to invest $250,000 and see 50% of value evaporate in 6 months . Think about and build a spreed sheet to compare various options .Pay the mortgage off and apply the former payment to an investment and savings account ,or make a significant payment towards principal and this will lower your overall rate on the loan . work each method out and see what is best for you think of other possibilities and compare.Normally timing the market is a fools game these however are not normal times the next few months could be very volatile.Now this may sound nasty but it is not meant to be,if you are asking for advise you do not know enough about how to handle your current situation go self educate until you are confident on the subject only you truly understand your current situation and only you will have your best interests at heart Good luck
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for myself, I would suggest to Robin that they double the monthly mortgage payment and if they are comfortable doing that for three years and if at the end of that third year, they are comfortable paying the balance and have the amount that they need to pay off the loan, then they should do it. By then, they have paid 6 years worth of mortgage payments so their mortgage balance will be lower, then they can take the money that they normally put toward the loan and then put that money in an high interest savings accout, CDs, retirement accounts until it is time to retire. With 13 years left on the mortgage, I am assuming that they really don’t need the mortgage interest deduction. but that is me. After all, this is a decision that Robin and her significant other must make and decide if they are comfortable with that decision or not.
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I have a similar “problem” (not a bad one to have) although I don’t have quite enough invested to live to 100. In my case, I’m a widow with a small child, so I’ve chosen to be conservative and maintain a large emergency fund vs. paying off the $150K left on my mortgage or investing the amount. I do have many other investments, including my son’s college fund, that are subject to market fluctuations so this is my “peace of mind” account. If I should lose my job and the market tank, I could pay all bills (not just the mortgage) for a very long time. It stings a bit to have such a large amount making 1%, but psychological benefits are high.
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Karen,
If you paid off your mortgage, how large of an Emergency Fund would you have left? If your Emergency Fund was equal to 6 months to a year of monthly expenses would you feel more comfortable paying off your mortgage. Plus, if your mortgage was paid off, that payment would be freed up to apply to your other monthly bills, savings and investments.
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Scott, if I paid off the mortgage in full I’d be down to a $5k emergency fund in terms of cash/liquid savings. So that wouldn’t be a comfortable place to be. I pay extra on the mortgage each month so as that balance goes down I might feel better about it. I do still invest a good amount every month, so I don’t feel like I’m missing out entirely on growth opportunities. But it’s definitely an emotional thing; the bank account represents years that I could support my son without a job, and even thought it’s unlikely that I would spend multiple, consecutive years unemployed, it’s nice to know I COULD.
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I paid off my mortgage without much thought..I am soooo glad that I did. Trust me I’ve read at least 100 books on finance and maybe 60/70% say don’t pay it off. Well in the real world it works out very very well. It took me awhile to agree with Suze O. on this one–it frees you up to do a lot with your money. Your life becomes much simpler and more secure. I hope more people do it and if you do, you will be amazed at the results!
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I recently inherited a stock/bond portfolio worth about $220K. We owe about $145K on our mortgage. I’m using the interest and dividends the portfolio generates to accelerate mortgage payments. I’m comfortable with this decision for now.
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Where did the writer’s money come from? Saved or inherited? We don’t know but I think it makes a big difference in what she should chose to do. If she is a natural saver, then I say pay it off full force or at least the 200K as others have said, the cash amount will be replenished quickly. What is appalling to me is when I look at my mortgage how much of that is just pure interest. How could this saver not have noticed that before she saved 250K? I plan to be done with my 30 year fixed in 12 years by accelerating payments. On the other hand, if this was an inheritance, then maybe she needs to take a slower pace with how the money is spent, as it will not come back again.
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I only noticed 1 other reply that suggested refinancing. I agree this is a psychological decision more than a financial one. However, If the poster chooses to keep a mortgage, I would recommend looking at a 10 year which I just found for 3.375%. I also would reinvest part of the savings account to give higher potential returns. It doesn’t make much sense to be invested at a negative 3%+ return.
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If Robin really doesn’t have anything else to do with the money, but wants the security of having a significant amount in cash, a refinance is definitely the way to go.
I would do two things:
1. Refinance into the product at the lowest rate possible whether that’s a 10 year fixed or a 5 year ARM. Make sure to not pay any closing costs which will require buying up the rate a bit, but it will still be significantly lower than 4.675%. Pay the exact same monthly amount as she pays now regardless of the new payment amount.
2. Take the $250K in cash and split it up into a few 5 yr CDs. Ally Bank has 2.4% CDs with only a 2 month withdrawal penatly if she needs it sooner.
If she is able to get a 3.5% rate and a 2.4% CD, then she’ll have instant savings of $6,300 per year (over the 4.625% mortgage with 1% savings), but will still have the peace of mind that the cash gives her. If she gets an ARM and the rate goes way up in 5 years, she can pay it off then and the loan amount will be much lower, so there still should be plenty of cash left.
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I agree with Steve partially. If she doesn’t have the emergency fund if she pays down the full mortgage, a careful refi can leave her with enough for that fund. But I would recommend that she look at a 15 year with lower required payments without a prepay penalty. That way if something goes awry with her finances, she has a lower mortgage to pay until retirement but she can still pay it off earlier if finances continue smooth.
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If that savings is part of her retirement plan, I would say she shouldn’t pay off her mortgage. But, if she has a solid 401k or other retirement fund than she can use to retire when she plans to, I would say pay off the house.
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There are lots of things you can do to reduce the amount you spend, and the following suggestions are some of the best ways to save money, because they can have the biggest impact on your spending.
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