Mortgage Payoff Revisited

15 years ago

I asked this question probably a year ago, didn't find the thread on a search to revive it. Opportunity arises again, and I suppose it can be said that national economic conditions have changed.

I owe ~$50,800 on my mortgage. Per the contract time, 8 years remain. 4.875%

I have a $50K CD matured. Current best deal at my bank is 2.05% for 13 months. 2.65% for 60 months, too long. I'm sure a better rate can be found, but not *that* much better.

Although one never knows what may happen, I have no plans to move or sell in the foreseeable future ... so the $50K must be paid, sooner or later, one way or another. I can save approx $9,600 in interest with early payoff.

True, the interest is an income deductible, along with property tax (~$4400) plus a little more from medical expense/insurance. Federal tax on $9,600 in the 15% or 25% bracket isn't much compared to the $9,600. I'm all for avoiding paying interest. What's the prognosis for gaining more than $9,600 in 8 years by keeping the $50K in a CD (withdrawing the interest monthly, no compounding)? I'm not willing at this time to go the market route with it. Already have some funds there.

The $50K is about 20% of my current cash, including the scorched market funds. Approx half of the total is "untouchable" in IRAs.

I have no other debt. No car payment (8 years old, may need to replace it in a couple/few years), do not carry ccard balances. My income dropped considerably 2 years ago, but I live very frugally and am getting by OK. The monthly mortgage payment could immediately start going back into savings.

WWYD?

Comments (12)

Kathsgrdn
15 years ago
I would pay it off.
harriethomeowner
15 years ago
I'd keep the cash. Once you put it into the house, there's no telling if you can access it again.
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lucy
15 years ago
No brainer - pay it off.
dave_donhoff
15 years ago
Hi Dadoes,

Several "slam dunk" answers in either direction already.... but you didn't touch on the most critical concerns;

What multiple of your total annual living expenses (inclusive; food, clothing, housing, taxes (all of them,) insurance, entertainment, vacation, gifts, etc.) do you have in reserves? Generally speaking, 100% of one year's living expenses is considered safe/conservative.

Next question; How much of your annual income requirements are provided by your passive investments (not personal earned income)?

If either of those answers are "less than 100% still" then you're going to be sabotaging yourself by sending your working and safety capital into your real estate equity prematurely.

First things first;
A) Safety (sufficient reserves to cover emergencies and time to recover from tragedy,)
B) Financial independence (passive income so you do not have to personally work,)
C) Leverage elimination (retiring the interest on excess income-producing capital... if there is ever such a thing. ;~)

Never try to kill the donkeys to save hay, unless you have no further to go.

Luck,
Dave Donhoff
Leverage Planner
dadoes
Original Author
15 years ago
What multiple of your total annual living expenses (inclusive; food, clothing, housing, taxes (all of them,) insurance, entertainment, vacation, gifts, etc.) do you have in reserves? Generally speaking, 100% of one year's living expenses is considered safe/conservative.Based on 2008 figures (incl mortgage pmts, not incl IRAs as reserve): 3.7

Next question; How much of your annual income requirements are provided by your passive investments (not personal earned income)?Based again on 2008 figures, approx $3K of investment revenue was used. Cash-flow-out would be reduced $705/month by eliminating the mortgage, which is enticing.

I'm 46 years old, so full retirement is years away. Working at two part-time jobs, one of which had been concurrent for 8 years with the now-gone full-time job. Haven't looked for another full-time job because it hasn't been urgent to do so, and I wanted to slow down a little.
dave_donhoff
15 years ago
Hi Dadoes,

You say $50k is 20% of your reserves... so your reserves are (let's see, carry the one, take off my socks for extra counting) $200,000.

You say your reserves, as a multiple of your total annual living expenses, is 3.7... so your total living expenses inclusive of everything (as above) is $54,000-ish.

You say your total passive annual income is $3,000...

Assuming no inflation until your retirement (theoretically 'years away',) which isn't very realistic at all... but we can go with zero inflation for simplicity sake... $54,000 being your "financial independence" number...

$54,000 of passive income after a 30% aggregate tax hit is about $77,000 gross required before the government drains it off, in order to have no less of a living lifestyle at retirement.

$77,000 of gross passive income, at a safe rate of return of 5% (being generous here) requires a working capital base of a bit over $1.5MM

Thinking that reducing payments on a mortgage is a benefit requires ignoring the growth-value of those funds at work, and the savings they provide in safety reserves that displace insurance costs.

I would suggest you're no-where near the point where you can afford to kill off your mortgage leverage yet.... or so it appears from the surface.

Luck,
Dave Donhoff
Leverage Planner
dadoes
Original Author
15 years ago
You have some errors. :-)

Reserves of 3.7 times annual expenses, not including IRA/retirement funds as reserve.

Annual expenses (cash-out) for 2008 was $31.5K. Removing $705/month for the mortgage payment drops that to $23.1K.

$3K is not total passive income. That was an estimate of how much may have been used. Looking at the figures again in MS Money, no passive income was needed to meet expenses.
dave_donhoff
15 years ago
Hi Dadoes,

OK then...
Reserves of 3.7 times annual expenses, not including IRA/retirement funds as reserve.

Once again; How much in total reserves?

Annual expenses (cash-out) for 2008 was $31.5K. Removing $705/month for the mortgage payment drops that to $23.1K.

All inclusive... of all insurance premiums, entertainment/vacation, gifts, travel, etc? Assuming this to be the case, will this amount of annual income be sufficient at the point you wish to no longer have to work for income?

What will that number be?

$3K is not total passive income. That was an estimate of how much may have been used. Looking at the figures again in MS Money, no passive income was needed to meet expenses.

Once again; How much did you earn in passive income? (Income that had nothing to do with your personal employment.)

I think the previous post explained the issues quite clearly... but perhaps I am assuming wrongly. What's not being understood?

Cheers,
Dave Donhoff
Leverage Planner
dadoes
Original Author
15 years ago
- As of market close today, $235,500.

- Inclusive of everything except the 2008 IRA contribution. I'm living comfortably. Effects of inflation, I can't predict.

- Passive income $10.8K, incl interest, dividends, capital gains, tax-deferred.
dave_donhoff
15 years ago
OK... now we're cookin' with gas ;~)

- As of market close today, $235,500.

OK... astrong $200k-205k working capital above a year's reserves.

- Inclusive of everything except the 2008 IRA contribution. I'm living comfortably. Effects of inflation, I can't predict.

OK... apparently you're also expecting to comfortably live off of expenses of $31,500-ish (or its post-inflation equivalent) for your retirement as well...

Pre-Tax, at a reasonably expected rate of 30%, all inclusive, that will require a gross passive income of $45,000.
($31,500 divided by the inverse of 30%, or 70%... = $45k.)

- Passive income $10.8K, incl interest, dividends, capital gains, tax-deferred.

OK... so you're currently about $34k-35k of passive income short to hit your financial independence, given your declared variables.

$34k at a relatively generous 4-5% safe rate of return would require working capital of $680,000 - $850,000.
($34k divided, respectively, by 4% and 5%.)

$680k-$850 minus your current $200-205k leaves a shortfall of $480k-$650k

If you draw down your working capital by $50k to kill the leverage, and 'save' the approx. $175/month in interest... that $175/month at 4% compounding would take an additional 5 years to JUST break even & regain where you already are today. If you're going on CDs at 2.65% if will take over 7 years to regain the growth funds you let go of (and that's ignoring income taxes on those CD rates.)

The mathematic laws of compounding growth will have growing capital outperform savings of non-copounding interest at a cross-point in any future considerations. Of course, the greater the disparity in rates of return versus rates of interest the further forward the crossover benefits... but currently mortgage interest rates are equal or BELOW similarly safe rates of return... making it a financial no-brainer to maximize leverage to optimize compounding rates of return (assuming you are responsible & rational.)

The longer you take the more risks of the unforeseen... the FASTER you can reach your "financial independence" point ($680k-$850k earning 4-5% annually) the SAFER the path. Every growth detour you take (like reducing your growth funds by killing leverage) is another day/week/month/year of risk you are assuming.

Hopefully that makes a bit more sense now.

Cheers,
Dave Donhoff
Leverage Planner
dadoes
Original Author
15 years ago
The $31.5K-ish 2008 yearly expense includes $705/month for the mortgage payment. Shouldn't that be eliminated as part of "retirement" income requirements? Or is it insignificant?

Your scenario has all retirement income coming from personal savings/investments. Social Security is headed for (or is it already in?) a crises. One cannot expect to receive any benefit 10 years from now? 20 years? 30? 40?

Only the interest saved is considered for regain? Not the full $705 payment that'd no longer be going out each month?

Value of the home (purchased $245K, current tax appraisal $227K) is also disregarded? Which of course, I know it doesn't have any cash value unless sold ... but downsizing could happen years from now.
dave_donhoff
15 years ago
Hi Dadoes,

I ran a very simplistic Excel analysis... a great deal of complexity was left aside, but leaning toward conservatism in each case.

One mistake I made (I realized as I was lying in bed last night) was that I credited a full annual rate of return EACH MONTH... rather than 1/12th of a return rate each month... so "the regain to whole" was artificially accelerated in my previous example... but probably not by too much.

The $31.5K-ish 2008 yearly expense includes $705/month for the mortgage payment. Shouldn't that be eliminated as part of "retirement" income requirements? Or is it insignificant?

It never went away, the principal portion isn't an expense. You're simply pulling from your working cash to deposit into real estate equity.

You *could* eliminate it from a future projected income budget... but you'd be better off eliminating the principal burden today in order to keep your funds working (if possible) and leave the future carry costs in place.

Your scenario has all retirement income coming from personal savings/investments. Social Security is headed for (or is it already in?) a crises. One cannot expect to receive any benefit 10 years from now? 20 years? 30? 40?

SS benes are fairly insignificant, if they're available to you at that point at all (we'll very likely be seeing means-testing hurdles put in plalce, as well as the stretching forward of qualifying ages.)

Only the interest saved is considered for regain? Not the full $705 payment that'd no longer be going out each month?

Right, only the interest is actual expense.

Value of the home (purchased $245K, current tax appraisal $227K) is also disregarded? Which of course, I know it doesn't have any cash value unless sold ... but downsizing could happen years from now.

The value of the home would reflect the monthly principal portion of the $705... which is why its immaterial. Its not a gain, its simply your money... you took it from one pocket and transferred it to your shoe. Those funds very likely would have more safely and suredly helped you achieve financial freedom had they been seperately compounding in growth accounts.

AGAIN... we're not diving into sharpened details here, nor using analytical models that include variables of increasing tax burdens, inflation, real estate appreication, stock market cycles, health cost concerns, etc. etc. When we "sharpen the pencil" and start getting even more accurate, the truth stands out in even more stark relief.

As a VERY SIMPISTIC rule of thumb...
If you're not a financial hazard to yourself, you are far better off sending every additional dollar above your reserves into growth accounts UNTIL you have reached financial independence BEFORE considering the surrender of your mortgage leverage.

Cheers,
Dave Donhoff
Leverage Planner

Mortgage Payoff Revisited

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