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

[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.

[DesertCat]

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•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.


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Good advice. There are two things to consider, maximizing the value of your properties and how you finance them.

Paying off your mortgage really is a financing decision that has little to do with their value (in most cases). Property goes up, down, doesn't matter. What matters is whether you want to tie up X amount of money financing it at a Y interest rate, or put that money in an alternative investment at what you think is a better return.

[NoTalent]

Has anyone ever heard someone say "Damn, I sure wish I didn't pay off that house", or "Man I wish I had a mortgage" ?

[Misfire]

[ QUOTE ]
Has anyone ever heard someone say "Damn, I sure wish I didn't pay off that house", or "Man I wish I had a mortgage" ?

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[TN_POKER_MAN]

yes

That's why they created reverse mortgages. I'm not saying its wise, but there are folks out there with paid for houses and no nest eggs.

[BradleyT]

[ QUOTE ]
Has anyone ever heard someone say "Damn, I sure wish I didn't pay off that house", or "Man I wish I had a mortgage" ?

[/ QUOTE ]

nh sir.

[imported_bingobazza]

[ QUOTE ]
[ QUOTE ]
Has anyone ever heard someone say "Damn, I sure wish I didn't pay off that house", or "Man I wish I had a mortgage" ?

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nh sir.

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Actually, its quite common in the UK. There are plenty of older people who want to mortgage their house to invest the capital into a trust and get income from it, whilst moving the capital outside their estate for tax purposes when they die. When the tax man tallys the estate on death, the kids get more as the trust isnt taxed, and the settlor, while alive, gets income fronm the trust that he wouldnt have otherwise enjoyed. In some cases, the interest is rolled up and further reduces the estate value and the tax bill on death. Ironic that most people spend most of their lives with a mortgage they want to get rid off, and wish they had one on their death bed.

Bingo

PS - estate and trust law is prob different in the US.

[DesertCat]

[ QUOTE ]
Has anyone ever heard someone say "Damn, I sure wish I didn't pay off that house", or "Man I wish I had a mortgage" ?

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That's because they usually never do the math on how much it cost them. Or if they did, they're too depressed to talk about it.

I have a 5.875% mortgage. I have more than enough to pay off the mortgage sitting in my brokerage account, where it has earned far in excess of 10% a year for the last five years. If I had paid off my mortgage, I'd be very much poorer. But I might be a special case, I actually work as an investor full time.

It's not a simple decision for most people. You need to be confident that your long term return (risk adjusted) on your investment will be in excess of your mortgage rate. Some people (Buffett) think that index funds (the market) will be returning around 8% for the next 20 years, so it's not a huge win, esp. if you are borrowing at 7%.

And when I say risk, I'm not talking about "beta", a little number tha signifies how much variance an investment's price has (and is mostly useless for investors other than in option trading). Real risk is the likelyhood of permanent impairment in the value of your investment.

The risk of index funds is overpaying, i.e. you buy them at a market top and have to deal with bad returns for a few years until you catch up. Since an index fund is a claim on the net worth and income of a huge number of companies, there is little risk of permanent impairment. You buy a single stock (let's say, "enron") with all your money, you have a high risk of permanent impairment. A "risk adjusted" return is you r estimate of the +EV of an investment, incorporating the percentage likelyhood of a permanent impairment and how big that impairment might be.

The other side of risk is liquidity. You can't play games where you invest long term if you borrow short term. I.e. index funds aren't one or two year investments, you have to be committed to them for at least 5-10 years, if you are forced to sell at inopportune times, you're returns will be horrible. So any money you put in them you shouldn't require for living expenses or mortgage payments.

The grandest part of paying off your mortgage is that it's a "risk free" investment. You save what ever the current mortgage rates are each year, guaranteed, so any alternative "risk adjusted" investment returns have to beat that. Note: There is some liquidity risk, i.e. if you don't have a job it might be hard to get a bank to loan you the money back.