My husband and I just received approximately $140,000 from the sale of some property he inherited. We want to make smart decisions as to what to do with it, and could use some advice. I would like to pay down our mortgage debt (we owe $225,000 on our house - interest rate is 4.2%). He wants to invest it. We are both in our forties. Together we make about $95,000/year. Our current savings/investments/retirement accounts total around $130,000. We have some credit card debt and a car loan. Any advice would be greatly appreciated!

#1 - No loans to family/friends. Do not even let anyone know this happened if you can help it.

#2 - Credit Card debt

#3 - Car loan

#4 - refi your home loan below 4%.

#5 - beef up emergency fund

#6 - take a vacation (don't spend more than $5-$6k), or buy a jetski or something

#7 - retirement accounts

It gets more vague towards the end b/c I do not know what your goals are, total financial picture etc.

Pay off car and cc debt (and never borrow for those things again!). Always pay cash for cars. Always pay off your cc balance each month. Put some aside into a savings account for misc. expenses and emergencies. Put the rest into the mortgage.

The main reason to favor the mortgage over other investments is it increases your chances to retire successfully. If you pay off the mortgage and investments go up, you won't profit as much but you'll still be in good shape. However, if the market goes down, but you've paid off the mortgage you'll have a place to live without the monthly mortgage payment (which makes living off of a fixed income a *lot* easier). On the other hand, if you put it all into investments, and the market crashes, you probably won't be able to keep your home.

What most people know intuitively but somehow forget when they start thinking of investing is the marginal utility of a dollar.

Can you please explain why not having a mortgage increases your chances to retire "successfully" or at least provide a credible source? What you explained below your un-founded statement is not necessarily true. There are plenty of people who have retired with and without a mortgage, but there isn't a correlation between one group being more successful than the other. What your statement(s) don't capture is the potential upside of having money invested.

Personally, I'd hold off on paying the mortgage early. Refi to today's low rates.

http://en.wikipedia.org/wiki/Marginal_utility

Basically, having a guaranteed place to live is more important than the *potential* upside of money invested if your goal is to retire on schedule. By "investing" in the mortgage you're reducing your downside potential. And when you retire, reducing the downside is more important than increasing the upside.

Again, nothing about marginal utility which has to do with "real world" retirement success. People have been doing both ways for many of years. There is no correlation between retirement "success" and if you have a mortgage.

Then, as it applies to the OP's situation, they are in their 40's and would be well served, IMHO, to diversify a bit more and put the money to work some where other than the mortgage, especially if they can refi down to 3.5% or so. But, some of us are more risk adverse than others. So, do what helps you sleep at night.

I think everyone agrees that steps 1 and 2 are to pay off the credit card debt and the car loan.

I think most would agree step 3 is a fully funded 3-6 month emergency fund. If you are making 95,000 a year and saving about 10% of your income now, that would be over $42,000 in emergency funds (unless you already have that).

Let's say between those 3 steps you are down to $80,000. You are going to need to buy a newer car sometime between now and retirement (probably). I'd save $15,000 in an investment account that isn't retirement alone for that.

I agree you should take a vacation or buy a few experiences, and I think $5,000 to $6,000 is a good figure. That's an awesome vacation or two if you are wise.

Presumably, you have about 20 years until retirement. If you have a 20 year mortgage and you aren't planning on moving, the only reason to pay the mortgage off earlier is interest. You'll have it paid off in 20 years either way.

You've already improved your monthly "income" by getting rid of the car loan and credit cards.

If I knew I was a good month to month saver, I'd pay the mortgage down, refinance and then save the difference in mortgage and debt payments each month in the retirement accounts, hopefully maxing out tax free options. If I knew (as I do ) that I was bad at that and generally used liquid cash to spend on shoes and restaurants each month, I'd put the money in a less accessible retirement account. If you are just going to spend like a sailor when your mortgage is paid off early, it doesn't do you any good to pay it off early. (Not that you would.)

I paid off my mortgage last year (after 8 years) and it was one of the best decisions I've ever made. I have more disposable money than I know what to do with *and* I max out the retirement plans without a problem. I still invest but I no longer worry about whether I'll be able to retire if the market crashes. Another piece of advice I've found useful: never invest more than you can afford to lose. I can invest because I can afford to lose it. Most people can't.

I don't think I saw this mentioned, but could you consider an equity backed LOC on the 140K? rates are cheap now and that's enough money to make some investment income. use the LOC to pay off the car and credit cards at the least.

I agree with BF. We are a few years from early retirement and are seriously looking to take on MORE debt. Why? Because we can now and won't be able to later and because rates are at unrealistically low rates. I would NOT suggest this to most people because we have substantial assets to support the added debt service and are basically doing an arbitrage that we understand.

But I understand where Nelson is coming from too. The key is to balance cash flows with high degree of certainty. A mortgage payment is a certain cash outflow while an investment is an inflow but probably not completely certain.

In the case of the OP, I would generally agree with BFs list. Pay off the credit cards and other short term debt first. A 4.2% mortgage is high enough that it might make sense to prepay it. But personally I would not.

Having $130,000 in retirement saving in your 40s is a bit low. I think that would push me over the fence to advocating investing your windfall rather than prepaying the mortgage.

We paid off our mortgage in 1999 after holding it for 8 years. For a few years we thought it was the best decision we made. But after about 6 years of realizing we had dead money in the house and were giving up a free government handout in the form of tax deductible interest, we started looking for a second home that we ended up buying a couple of years later.

The good feeling is nice. But in the end it is just an emotion. For some people there are advantages to carrying debt. You may not be one of those people nelson. You should definitely do what you are most comfortable with.

Hi,

Can you please explain what you mean by "But after about 6 years of realizing we had dead money in the house and were giving up a free government handout in the form of tax deductible interest..."

Thank you.

In the United States, under certain circumstances, taxpayers may take a deduction for the interest paid on a mortage for a primary residence or second home. To take advantage of this benefit, when you prepare your taxes, you would need to itemize your deductions, and the itemized deductions must exceed the "standard deduction" amount. Taking a deduction like this reduces the amount of income on which the taxpayer must pay tax to the U.S. government. In other words, by paying mortgage interest, the taxpayer gets to reduce his income by a percentage and therefore pay less in taxes than he otherwise would without the mortgage interest deduction. http://en.wikipedia.org/wiki/Home_mortg ... ted_States

Having a mortgage solely so you can deduct the interest is (usually) crazy. If you're married, the current standard deduction is $11,900. This is a deduction that you can automatically take if you don't itemize. To itemize, your total deductions must be greater than $11,900. So let's say you owe $250,000 on your mortgage at 4% interest; your yearly interest paid would be around $10,000 (yes, I know it won't be exactly that...work with me here). You have another $4,000 in deductions (health care, donations, whatever). That's a total of $14,000 in itemized deductions. Ok, let's see how much that house just "saved" you. $14,000 (itemized) deduction - $11,900 (standard) deduction = $2,100 you're getting in deductions over and above the standard deduction. Now, I'm going to assume you're in the 25% tax bracket (yes, lots of assumptions here...I'm not so much trying to point out the numbers, as I'm showing you how to look at your own numbers); having the mortgage helped you to reduce your taxable income by $2,100...taxed at 25%...that's $525 in your pocket.

So...paying $14,000 in interest saves you a total of $525...woohoo! Tell you what...give ME $14,000, I'll turn around and give you $1,050...that's DOUBLE what you'd "save" by having a mortgage and getting to deduct the interest paid.

Now, I can easily picture a scenario where you would indeed be better off financially, solely because of the tax deduction. You're over the income limit to contribute to a Roth IRA. You've completely maxed out your 401k contribution to help bring your taxable income down, but you're still just barely over (we're talking in the low thousands). If only there was some other deduction you could make, that would reduce your taxable income so you could contribute to a Roth IRA...aha! Mortgage interest deduction. Take out a mortgage on your primary residence, make sure the interest paid will be just enough to reduce your income to a Roth IRA eligible amount, and pray your boss doesn't decide to give you an end of year bonus. And no, I'm not gonna say "if you're just throwing away money, might as well give it to a charity, same effect!" because that'd be forgetting all about the cash you got (or freed up) by taking out a mortgage. I'll assume you put that in some kind of savings account or investment vehicle (one that hopefully doesn't make so much money, as to bump your income back over the allowable limits).

Yeah...I'm sure there's other weird crazy circumstances where you'd want a mortgage solely for the tax deduction....but in general it doesn't make sense. I'd look at every OTHER reason for having a mortgage first. Such as...is the interest on a mortgage lower than what can be earned semi-safely (up to you to determine what's "semi-safe"...of course savings accounts qualify, but so would many investments)?

I agree. But "usually" is not the same as "always."


Let's take someone a little better off, but still not uber-rich by any stretch. A couple making $200,000 a year. That's not uncommon for two professionals. Let's call them Mike and Ann.

They live in a relatively low tax state and pay 4% in state taxes. That's $8000 in federal deductions. They give a little bit to nonprofits, not a lot but maybe $4000 a year. They also pay property taxes. Those can be deducted IF they own. That's another $2000 a year on that $250,000 house they live in, on average, roughly. They are healthy and have insurance through their employer so they don't deduct any medical expenses. They have about $12,000 in deductions before considering mortgage interest or the property tax deduction. Thus, they can take full advantage of the mortgage interest and property tax deductions.



Mike and Ann are closer to the 28% federal bracket plus their 4% state obligation. This could be MUCH higher in places like California. So they get a deduction for essentially 1/3 of the interest they pay. They are able to borrow money at 2/3 of the rate published, after taxes. In other words, if their mortgage rate is 3% they are effectively borrowing interest at 2% for 30 years. Interest rate is the price of money. Rates (prices) are exceptionally low right now. Doesn't it make sense to buy low?


Mike and Ann crossed that bridge years ago.


Hardly. Mike and Ann make pension contributions but one might have a government defined benefit plan and the other might already contribute to the limit.


Um, it doesn't work that way actually.



It's not that crazy. And you are actually missing quite a bit of the reasoning. I'll list just a few little things that can come into consideration:

- capital gains on personal residences are tax free up to about $500,000. Capital gains in regular investments and in TIRAs are eventually taxed. (Roth IRAs effectively eliminate capital gains taxes)
- a personal residence converted to a rental can produce passive losses that can offset regular income to some extent. That partially offsets the capital gains advantage mentioned above but these things can be planned and balanced to minimize taxes.
- everyone needs a place to live. You say interest on that $250000 home is $10000 a year. It's probably less because you have overstated the going mortgage rate by about half a percent. But rent on that house would be probably at least $1500 a month or $18000 a year. So property taxes plus interest = $12000 saves you $6000 a year.
- equity in a house earns no return expect possibly through price appreciation. Price appreciation is probably limited to inflation over the long term so your money essentially does not grow.
- Having a fixed rate mortgage gives you inflation protection on housing costs for the most part. Renters are subject to inflation risks. I don't anticipate high inflation any time soon but it should clearly be recognized as a risk.

I completely agree that the math is not the same for everyone and that it usually does not make sense to incur a mortgage for the interest deduction alone. But if I had $250,000 in cash and wanted to buy a $250,000 house I don't think I would want to tie all that money up in a house. I think I would put 20% down, takes out a 30 year mortgage, and invest the remaining $200,000 is relatively safe investments to generate a little more return than the mortgage is costing me. That's not easy right now without taking on risk. But I'm quite confident that in 5-10 years I'll be able to buy low risk assets that pay more than the current mortgage rate. So basically I can buy the money now at cheap prices (low rates) then use it later.

It's not much different than stocking up on tuna when it is on sale. (High five to the first person to identify that reference!)