How to be Setup for Life ?

[MonarchDon]

Hope this is the correct forum to post this question.

I'm in my early 40's and have investments in the stock market (trading account, sep ira, roth ira, etc) but I have not made much money with those accounts. The real money I have made is the equity I have in real estate, I have been lucky to buy at the right time.

What would you do in this situation. I have a house worth $800k and I owe 180k I have the $$$ to pay it off right now, I have 29 years left on a 4.875% fixed rate. I want to pay it off but others have advised me not to.

I have a rental property worth 250k that I owe 75k on at 5.375% fixed. I want ot pay it off also and be totally FREE AND CLEAR. I call that having F.U. Money. What do you think?

[deathtoau]

John Waggoner:Investing - Should you pay off your mortgage? Maybe not

[player24]

[ QUOTE ]
What would you do in this situation. I have a house worth $800k and I owe 180k I have the $$$ to pay it off right now, I have 29 years left on a 4.875% fixed rate. I want to pay it off but others have advised me not to.

...and be totally FREE AND CLEAR. I call that having F.U. Money. What do you think?

[/ QUOTE ]

Compare the after tax cost of your mortgage with the after tax cost of a duration matched risk free investment. Thirty year Treasuries are yielding about 4.55% and you will pay Federal income taxes on this income. Many people will make the critical mistake of comparing a risk-free cash flow stream (your mortgage payments) with the returns on a risky investment. These same people probably believe it is free money when you borrow at low short term rates and lend at higher long term rates (the carry trade). Avoid this mistake.

Obviously, you do not want to liquidate tax deferred retirement accounts to pay off your mortgage. There are penalties and opportunity costs associated with doing so.

Given the low rate of your mortgage and the similarly low rates on duration matched Treasuries, you will probably not be much worse off by prepaying your mortgage, unless you lose the ability to itemize other tax deductions.

So, if it gives you psychic benefits, you are probably justified in paying off the mortgages. I paid off my mortgage when I was forty and have never regretted it. With no mortgage payments, you should be able to to fully fund your retirement accounts and rebuild your financial assets (which is important in terms of diversifying your wealth).

If you decide to pay off your mortgage you should take out a home equity line of credit which has zero cost if untapped. This process usually involves zero closing costs and the line can be used for "emergency" liquidity.

Be careful about thinking you are "FREE AND CLEAR". One million dollars is not enough money to retire on - you are off to a good start but have a long way to go (particularly since alot of your wealth is tied to your principal residence).

[adios]

•Taxes. If you pay off your mortgage, you'll lose the mortgage deduction on your federal income taxes. That lowers your overall return from repaying the mortgage. (Taxes also lower the return from most other investments.) More important, the mortgage interest deduction, either by itself or with other deductions, is typically more than the standard deduction on your federal income taxes. Of all the people who itemized in 2003, 82% claimed mortgage interest as a deduction. Unless you're a real saint, it's probably your mortgage that allows you to itemize deductions and pay less in taxes.


I'd like to point out that the AMT limits how much of a mortgage deduction you can take. On your rental property FWIW I would think that the favorable tax treatment of debt would be a factor in keeping the note on the property.




•Leverage. If you pay off your mortgage, you'll also lose the advantage of using someone else's money to invest. Let's say that your mortgage is paid off, and your home gains 5% in price this year, to $210,000 from $200,000. You've gained $10,000.

But let's say you had $20,000 in equity in your home and a $180,000 mortgage. If you were to sell your home for $210,000, you'd repay the $180,000 loan, keep the $20,000 in equity and pocket $10,000 - without tying up $200,000 of your own money.


Leverage is a two way street, you win and lose more than you would have otherwise. You're not that highly leveraged IMO though.




•Liquidity. If you suddenly need money, you may not be able to sell your house quickly. You'll also have to pay a broker's commission to do so. True, you can tap a home equity line of credit - but then you're back where you started before you paid off your mortgage.


But to really make the decision, you have to compare your return with another investment. Over long periods of time, you could probably beat 5.91% by investing in stocks. The stock market has averaged a 10.4% gain since 1926, according to Ibbotson Associates, a Chicago research firm.


And there's the rub. Investing in this kidney stone of a market would make most people balk. When people talk about paying off their mortgage, they're often considering investing the money they save in real estate. Stocks have gone nowhere since 1999, but home prices are going wild in many parts of the country. "I talk to one or two people a week who ask about buying another house and just flipping it," says Malcolm Makin, a financial planner in Westerly, R.I.


That's not the time to load up on real estate. Although the word "bubble" is batted around too frequently - true bubbles are rare - you can make a strong argument that housing gains will ease:

The liquidity you feel comfortable with is a personal decision of course. What you might consider is paying off your house and establishing an equity line of credit if you had liquidity concerns. I would think that you drive a hard bargain and get some really good rates since you have all your equity if you paid it off.


•Rising rates. Every quarter-point increase in mortgage rates eliminates potential buyers from the market. The Mortgage Bankers Association thinks the rate on 30-year fixed-rate mortgages will rise to 6.6% by the end of 2005, and 7.3% by the start of 2007.

Could be a concern.


•Cooling prices. Home prices, like stock prices, don't normally double in a year or two. Typically, home prices rise 1 or 2 percentage points above inflation, currently running at 3.1%.

If this was a big concern just sell your property.


•Soaring expectations. In 1999, people would talk about how much they made from their tech stocks. These days, the topic is usually how much they have made from their houses. That's not a good sign. People who buy now are "doing the same thing they did with tech stocks," says Tim McIntosh, a financial planner in St. Petersburg, Fla. Should home prices actually fall, the magic of leverage will work in reverse. If you buy a $200,000 house with $20,000, you'll be in trouble if your home price falls 10% to $180,000.

Again if you thought prices were going to fall sell. I don't think this has much to do with paying of your loans given the amount of equity you do have.


One thing I'd consider is limiting my liability in your rental property. Perhaps set yourself up as an LLC such that the LLC runs the rental business such that your personal assets are protected like the equity in the property you live in. FWIW I'd tend to pay off the note on the property where I lived and tend to keep the note on my rental property.

My wife and I are debating the merits of selling our property. I look at real estate prices in other markets, compare them to prices in the market I live in, see how fast prices are rising in the market I live in and I'm inclined not to sell at this point. Her opinion is that if we can get a certain price we should sell. I agree but my price target is about 25% higher.

[adios]

Dang you responded while I was writing mine as again you stated this better than I did. Nice post.

[player24]

Thanks adios. Some people will try to overcomplicate the analysis, but you appropriately point out that some of the issues which Waggoner raises in his newspaper column are irrelevant to the decision at hand.

Certainly, it is nice to have been long real estate over the past few years (much better than stocks). I live on the East Coast, in one of the hotter markets. Hopefully your market will make up for lost ground (so to speak).

[MonarchDon]

So, if it gives you psychic benefits, you are probably justified in paying off the mortgages. I paid off my mortgage when I was forty and have never regretted it. With no mortgage payments, you should be able to to fully fund your retirement accounts and rebuild your financial assets (which is important in terms of diversifying your wealth).

If you decide to pay off your mortgage you should take out a home equity line of credit which has zero cost if untapped. This process usually involves zero closing costs and the line can be used for "emergency" liquidity.

Be careful about thinking you are "FREE AND CLEAR". One million dollars is not enough money to retire on - you are off to a good start but have a long way to go (particularly since alot of your wealth is tied to your principal residence).

[/ QUOTE ]

Thank you for what seems like logical, sound advise. I like the equity line idea that way I wouldn't have to look for a first mtg. which may be dificult? I was thinking about buying more investment property and obtaining tax write offs through mortgages on rental properties?

I think the psycological part is right on, I'm from old school upbringing and have been taught that " stop paying intrest and start collecting intrest"

I'm a long way from being "setup" however, if my income changes in the near future at least I'll have a roof over my head, (as long as I can afford the property taxes)

[HDPM]

There were good posts above. I lean towards paying the mortgage for a few reasons. And I am assuming you can pay it off and still have other things working. Anyway, however you cut it, having a house paid for gives you a lot of comfort. Psychological yes, but you need less to live on all of a sudden. That means you might be able to invest in a few riskier things. Or decide to work for less money. And of course, it takes a little less cash to live on if you decide to live on investments. And isn't that why we invest? To be able to live the way you want? Having a paid for house is a massive step in the right direction. Not foolproof. Not a guarantee of course, but it is big. Let's say your mortgage is 1500/mo. How much do you need invested to guarantee a return that gives you 1500/mo after tax, month in, month out. Paying off the house not so bad IMO.

[inishowen]

Since I'm in the same boat heres my two cents assuming that you don't want to sell your home for a long while: My guess is that your rental income covers the nut on the rental property plus a little extra, but the extra is not enough to change your lifestyle at all (meaning you wouldn't miss it if it wasn't there). You have $255k in debt. I'd put the rental into an LLC, refinance both properties shifting as much of that debt as possible onto the income-producing rental (every $60 in positive rental cash flow qualifies you for an add'l $10k in mortgage debt). You'll probably be left with a little more than $100k in debt on your non-income producing home. Set up a separate account. Into that separate account deposit what your currently paying in mortgage payments on your home less what your new mortgate payment will be. This way you are not giving up any tax benefits and are paying yourself every month as long as you keep the unit/s rented. 10-15 years from now you'll have very little debt left on your home, a solid number in your separate account if you haven't invested it elsewhere, and a rental that has equity build up with little $ input from you.

Or, sell your home, capture approx $600k in equity after expenses. You'll pay less in cap gains taxes by using the $500k primary residence exemption, buy a cheaper home (which probably isn't an option in SoCal) and invest the difference.

I wouldn't buy another rental property in this market unless it was a complete steal. Just my two cents

[midas]

If you're in OC then your real estate values are probably safe. Don't pay off the mortgage, where else can you get that cheap of a loan that's deductable? Use the excess cash to invest in another business, more real estate or gradually enter the market over time. If you want the peace of mind, pay off the loans then reinvest the prior mortgage payments in the market over time to build value.