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Don't Prepay Your Mortgage [Consumer Reports]

Posted by dave_donhoff (dwdonhoff@hotmail.com) on
Wed, Mar 12, 08 at 12:41

From www.ConsumerReports.org

YOUR MORTGAGE;
It rarely pays to prepay

http://www.consumerreports.org/cro/money/credit-loan/prepaying-your-mortgage-3-08/overview/prepay-mortgage-ov.htm?resultPageIndex=1&resultIndex=1&searchTerm=mortgage pre-pay

Tiny-ized
http://tiny.cc/DontPrepay

Here is a link that might be useful: YOUR MORTGAGE; It rarely pays to prepay


Follow-Up Postings:

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RE: Don't Prepay Your Mortgage [Consumer Reports]

oops! too late

But I will say--being in a position to wipe it out completely was sure helpful when our income got slashed by 1/3 and never went back up!


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Being liquid enough to wipe it out completely is EXACTLY the place to be in the case of disaster!!!!!

'Nice job'
(Not that you needed the pat on the bak ;~)

Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

We paid off our mortgage as soon as my husband retired as well. He retired at a relatively young age, and what seemed like a very comfortable retirement income sure looks different ten years later. Can you say double the energy dollars? Escalating food prices? Stocks sucking eggs?

Not making a mortgage payment means something called disposable income. LOL.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I am glad I paid off my mortgage 18 months ago. My investments did horrible since. Had I kept my money in stocks, I'd not be able to pay off my mortgage now...


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I realize that many financial advisors advise against pre-paying, but we paid ours off more than a decade ago (ten years into a 10.75%, 30 yr fixed - not bad credit just standard fixed rates in the late 80's) and I'm so glad we did.

Not having to make a mortage payment left us flexible enough to be able to take the risk of starting our own business and live through some lean times as we built it up. Not to mention we saved a huge amount of money in interest.

Having it fully paid off has also made us think long and hard about taking out a HELOC or other loan when we thought about it from time to time. And that saved us from the trap of easy credit. Yes, we would have taken out a loan, and still could I imagine, if we truly needed to access that equity for some unplanned need, but on second thinking it was always such a rubicon to (re)cross we just figured out other ways of getting what we needed (or did without).

When we purchased this property it was at the max we could swing financially, but whenever we had a bit (even if less than $100 bucks in a given month) left over (after savings and IRA contributions) we threw it into the mortgage principal payment. When we got a small investment windfall, and after paying the taxes on it, it pretty much matched the remaining principal so we just killed the thing off in a lump payment.

I am so glad we did! Not having to earn (or deplete savings) to meet a mortgage payment every month is the ulitmate financial security, and freedom.

Molly~


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Wait a second... if prepaying a mortgage is bad, why is paying down principal at all a good thing? If we follow the logic, shouldn't we all be trying to get into interest-only loans?

Seems to me the goal should be to pay off the mortgage at a rate that allows you to keep real estate equity in proportion with other savings and investments. Depending on how well other investments are doing, that can mean prepaying a mortgage from time to time.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Well said, mfbenson.

I'm with Suze Orman that paying off a mortgage is a good move if done in the right way.

We are prepaying our mortgage and can't wait for the days of freedom ahead! We have a large emergency fund and a well funded retirement account- prepaying our mortgage is just one more way to use and invest money. We do it in proportion to other things.

It's all a balancing act.

I can't help but think that the "debt mentality" is what's led to so much of the credit crisis of late.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Ours is paid off. We got no tax break due to interest on our home morgage due to the fact the interest was less then our standard deductions. Our total outlay every month now is less then $300.00 for taxes and insurance on our home. This frees up our money for other things.

There is great peace of mind that comes with a paid for house. It is hard to put a dollar value on that.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

But Dave, I was only in that position to wipe it out because for 12 years, I'd been prepaying it.

I suppose we should have spent those 12 years putting the extra $2,000 into the stock market.

EXCEPT THAT: Right when we'd have needed that money due to disaster striking--gee, guess what, the stock market was crashing! That, after all, was a huge factor in why my DH lost his job and found it hard to get another one.

Stock investments CAN go down in value. The value of not having a must-pay debt like the mortgage NEVER goes down.

And I think it's funny that everyone here either HAS paid off the mortgage early and is very glad, or is TRYING TO do so, and is really looking forward to it.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi mfbenson,

Wait a second... if prepaying a mortgage is bad, why is paying down principal at all a good thing? If we follow the logic, shouldn't we all be trying to get into interest-only loans?

EXACTLY! That's certainly one of the better options.

Seems to me the goal should be to pay off the mortgage at a rate that allows you to keep real estate equity in proportion with other savings and investments.

Yes.... however "in proportion" is still a bit ambiguous. Having your naked real estate equity be equal to all other savings and investments would still probably be very dangerously UNDER-diversified (at least prior to the point of retirement with sufficient passive income.)

More approppriately, naked real estate equity ought to be balanced & treated the same as owning treasury bonds (except without any yield.) Its fairly stodgy, but the value can be lost in the markets (without a yield to compensate the owners.)

When a person reaches the point of shifting completely away from growth and yield investments, THEN it can be a financial consideration to "invest" in naked real estate equity.

Depending on how well other investments are doing, that can mean prepaying a mortgage from time to time.

Sure, as long as the balancing investments are performing strong enough to compensate for the risks assumed in the naked real estate equity. Otherwise, you're better shifting to treasury bonds (which at least provide an interest yield for the market risks,) and only when you can afford to not care about losses of income & value, THEN shifting balances to the real estate equity.


Hi Talley Sue,

But Dave, I was only in that position to wipe it out because for 12 years, I'd been prepaying it.

That's not true, and you acknowledge it in your further statements.

I suppose we should have spent those 12 years putting the extra $2,000 into the stock market.

AND/OR safer investment & savings vehicles that can grow at or near the costs of your safety home leverage, and provide certainty or even guarantees against principal loss (which the stock markets cannot do.)

EXCEPT THAT: Right when we'd have needed that money due to disaster striking--gee, guess what, the stock market was crashing! That, after all, was a huge factor in why my DH lost his job and found it hard to get another one.
Stock investments CAN go down in value. The value of not having a must-pay debt like the mortgage NEVER goes down.

Indeed... powerful arguments in favor of safer vehicles of savings/investments. Naked markets (stocks and real estate) are openly vulnerable to loss of principal... this should never be forgotten.

And I think it's funny that everyone here either HAS paid off the mortgage early and is very glad, or is TRYING TO do so, and is really looking forward to it.

Same with lottery-ticket buyers... and I don't really see the humour in either one.

Gurus like Ormon, Dave Ramsey & other call it a tax on the uneducated. It applies in all cases of financial blindness, unfortunately.

There is a SAFE time to eliminate your home leverage... and no matter how "emotional" it "feels" otherwise, all times earlier than that is just playing with fire.

Logic won't stop people though... this much we all know.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave,

I think most people understand your point.

If you can guide me to an investment that guarantees a significantly higher rate of return than a 6% home mortgage, please let us all know.

But remember, fine print like "past performance is not a guarantee for future performance" is not allowed.

The investment has to guarantee (with collateral) a minimum rate of return bigger than 6%. Do you know of one?
If it falls below 6% APR, even for one month, you as the advisor should be in something like a default and immediately pay me back everything I invested. I assume you have insurance for that.

On second thought, this is probably naive. I am sure you will NEVER, EVER give a performance guarantee for your investment strategies, will you?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Jrldh,

I think most people understand your point.

Actually... after reading the rest of your post, I don't believe that you do.

How much of your real estate-trapped net worth are you willing and able to lose without significantly hurting the quality of security of your retirement?

If you could get an insurance policy against the risks of those losses, would you?

Would you consider it "responsible" to raise a family who rely on your incomw without a minimum life insurance coverage? You know how much your living income protection (life insurance) is worth... that's the premium you pay for it.

If not, would you consider it responsible to build your own retirement nest egg without any protection against unforeseen financial disaster? (I would assume not.) What is that protection worth?

If you can guide me to an investment that guarantees a significantly higher rate of return than a 6% home mortgage, please let us all know.

Why?

What exactly is your definition of "significantly"?

What is your financial security worth, if you could put a number to it? Is it worth more than your living income protection? Less? to what degree either way?

Asset Diversification is "security insurance."

If you end up paying a little bit in return for safety and security, that's the same thing a responsible person does in protection of their living income for their family with life insurance premiums.

If you break-even, *AND* get your security FOR FREE, then its a beautiful thing.

If you happen to make a PROFIT while getting retirement and net-worth security, then heaven is truly smiling on you!

NOWHERE ELSE do you even have the POTENTIAL of having an insurance policy PAY YOU for the rpivilege of protecting you... but in asset diversification, YOU DO!

But remember, fine print like "past performance is not a guarantee for future performance" is not allowed.
The investment has to guarantee (with collateral) a minimum rate of return bigger than 6%.

Why?

What do you mean "with collateral"?

Do you know of one?

I know of several safe-growth diversification methods that guarantee against loss, and offer stable and steady growth that averages well above average mortgage interest rates... sure.

If it falls below 6% APR, even for one month, you as the advisor should be in something like a default and immediately pay me back everything I invested. I assume you have insurance for that.

I have no idea what you are asking here.

On second thought, this is probably naive. I am sure you will NEVER, EVER give a performance guarantee for your investment strategies, will you?

Sure, I will! Fixed and indexed growth accounts guarantee zero losses, and a growth rate roughly matching certain financial indexes.

I hope this solves your burning dilemas ;~)

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"shouldn't we all be trying to get into interest-only loans?

EXACTLY! That's certainly one of the better options."

Boy I am really having trouble wrapping my mind around that answer. But even if I don't agree I want to at least understand what you are getting at. I've got a few stumbling blocks with this concept:

For starters, I think you are seriously overestimating the risk tolerance of people in this forum. Moreover, people tend to place a psychological value on their house: "Its not just a house, its a home", or "its not just shelter, its my sense of safety" and so they will go to great lengths to avert any risk to that house, be it real or imagined - and imagining the bank reposessing the house is getting easier and easier these days.

Lastly, it seems a bit incongruous to me that real estate equity is dangerous: I'd be at much greater risk of becoming upside-down on a mortgage if I only have a little equity rather than a lot of equity.

Maybe I'm all washed up trying to rebut your point... I suspect I haven't even reached the point of understanding it. I'm still sort of stuck with my original thinking that the mortgage is the risk, not the equity.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

One point is guaranteed. Your mortgage company doesn't want you pay off early.

Whether or not you, as an individual homeowner, depends on many factors.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Let me use a common proverb:

"A bird in the hand is worth two in the bush"

Helpful hints:
bird in the hand = paid off mortgage
two in the bush = possible (but not guaranteed) profit from investments

"I have no idea what you are asking here. "

That is disappointing from a financial guru.

I tried to make a (admittedly crude) analogy to the responsibilities of a mortgagor. If the mortgagee invests in my house, I will be in default, if I violate certain points of the contract. In essence, if the lender doesn't get his guaranteed ROI.

I thought you would be able to understand that.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I think it really depends on your situation. If you're paying 10%, then you're going to have a hard time improving on that in an investment. At 5%, you have a much better shot. Unless the stock market goes down the toilet, of course.

There's also the question of where you are in the mortgage. If you have 29 years to go, it doesn't make much sense to prepay, as the time value of that money invested overrides the tiny dent $500 bucks might make in the debt.

Perhaps the point of the article is that one shouldn't take financial gurus' pronouncements as gospel. Just because Suze says prepay doesn't mean you should. Maybe you should pay off your cc debt or put money into an IRA.

One piece of guru advice that i've learned to utterly reject is the old saw to buy a used car instead of new. I'll never do that again.
1. A car w/ only 20,000 miles or so is priced only a couple thousand bucks less than new. Why shouldn't I get that brand-new performance, to say nothing of the full 3-year warranty?
2. A car that's significantly cheaper than new is also old and has a lot of mileage. Therefor it's more likely to be a piece of junk. Been there, done that, learned my lesson. That $5000 car actually costs more like $8000 once you put in a new tranny and gas line (or whatever). And that's just the first year.

In short, conventional wisdom isn't always wise.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Mfbenson,

For starters, I think you are seriously overestimating the risk tolerance of people in this forum. Moreover, people tend to place a psychological value on their house: "Its not just a house, its a home", or "its not just shelter, its my sense of safety" and so they will go to great lengths to avert any risk to that house, be it real or imagined - and imagining the bank reposessing the house is getting easier and easier these days.

OH NO... I realize the apparent aversion to risk here (and of many others as well.)

The issue of serious trouble is revealed in your following sentence;

Lastly, it seems a bit incongruous to me that real estate equity is dangerous: I'd be at much greater risk of becoming upside-down on a mortgage if I only have a little equity rather than a lot of equity.

The equity you retain IN YOUR REAL ESTATE is QUITE vulnerable.

If you have a lot of cash-value equity, but keep it SAFELY SEPERATED from your real estate... then your statement is spot-on; You'll be at far less risk of going upside-down on your mortgage payments (because you simply have not lost the equity, and have it available in liquidity.)

Maybe I'm all washed up trying to rebut your point... I suspect I haven't even reached the point of understanding it. I'm still sort of stuck with my original thinking that the mortgage is the risk, not the equity.

A very dangerous misconception. A mortgage carries ONLY the risk of making its monthly payments. Equity is at full risk of significant market loss, disaster, litigation or siezure ongoingly.

It is much MUCH safer to have CASH than it is to have trapped that cash into the real estate. Having that safety cash offset its own costs of existence (the additional mortgage interest proportion) by earning safe rates of growth often completely equals out the process costs and gives FREE (or near free... and sometimes positive profit) SECURITY INSURANCE.

THAT is the learning point.

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jrldh,

"A bird in the hand is worth two in the bush"
Helpful hints:
bird in the hand = paid off mortgage
two in the bush = possible (but not guaranteed) profit from investments

This in not a conservative statement but one of both greed (of focusing on profits) and fear.

Diversifying your assets is a responsible and effective way of PROTECTING your net worth.
Concentrating your net worth (in real estate equity, for example) is the riskier choice.

I tried to make a (admittedly crude) analogy to the responsibilities of a mortgagor. If the mortgagee invests in my house, I will be in default, if I violate certain points of the contract. In essence, if the lender doesn't get his guaranteed ROI.

Lenders don't get guaranteed ROI (unless there is a prepayment penalty period in place.)

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Hi Housenewbie,

There's also the question of where you are in the mortgage. If you have 29 years to go, it doesn't make much sense to prepay, as the time value of that money invested overrides the tiny dent $500 bucks might make in the debt.

Actually, this perspective completely ignores the risks as well, in favor of focusing strictly on profits/savings.

The most important consideration is the PROTECTION of your net worth.
Having SOME (an intentionally balanced) amount retained in your naked real estate equity is not as dangerous.

When your unleveraged, unprotected real estate equity increases beyond the balance points with the rest of your family balance sheet, you slide deeper & deeper into danger.

Having an interest-only mortgage avoids accidental imbalancing, and allows the individual to re-balance their equity from other buckets ONLY when it makes financial sense for THEM... rather than the forced payoff by the lender.

One piece of guru advice that i've learned to utterly reject is the old saw to buy a used car instead of new. I'll never do that again.
1. A car w/ only 20,000 miles or so is priced only a couple thousand bucks less than new. Why shouldn't I get that brand-new performance, to say nothing of the full 3-year warranty?

One reason is that a 2-3 year "used" car has shed off between a 30-50% "brand new car" price premium, with only a 2-5% "wear & tear" factor.

NOT saying you CAN'T choose to pay the premium if its emotionally worth it to you... but financially taking it a few years off is a huge real savings.

In short, conventional wisdom isn't always wise.

So very very true!!!!

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Did anyone actually read the article Don linked to? Pretty interesting study using computer models to compare prepaying with investing. Investing almost always did better, especially over the long term.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

The one thing the article doesn't address is that it's easier for most people to add the $100 to their mortgage payment rather than take the time to invest it. And if they don't invest, they're more likely to buy a pair of shoes or something.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Probookie,

What you're talking about are people who need to be managed, not people who are responsible self-managers.

Anyone who needs to BE managed and needs control taken OUT of their hands is certainly best off being forced into savings. This can be done with payroll auto-deposit, etc.

Still... inescapable forced savings is better than inescapable forced amortization, in terms of conservative safety.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Harriet, yes I did read the article, and it seemed quite persuasive. Also timely, as I have been wondering whether it makes sense to send extra $ towards the mortgage, vs. investing, especially given that my husband and I now have enough equity not to be upside-down, have an emergency fund, and definitely will not stay in our house long enough to pay off the mortgage (probably no more than 5 more years, maximum, and less than that if we decide we can buy a larger house for less than it would cost to build an addidion). The article corroborated a gut feeling that I've had lately, which is that it might make more financial sense to invest some of the $ that my husband and I have been directing towards repayment of debts. It is a closer question with one of my student loans, as its interest rate is higher than the 5.25% we're paying on the mortgage. And the funny/ironic thing is that I am having this 'invest vs. prepay debt' urge notwithstanding the fact that my 401k balance has declined 12% this quarter (I'm in my early 30s, so most of the $ is in index and target-date funds).

I will be the first to admit that I do not fully understand everything that Dave has said in the posts above (or even half!). But my sense is that, even for people who will stay in their house long enough to pay off the mortgage, investing that same amount of $ used for pre-payments in the type of diversified way Dave suggests should yield enough liquid $ to pay off the mortgage in cash if they were to later determine that for emotional peace of mind they'd rather not have a mortgage.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Robin,

I will be the first to admit that I do not fully understand everything that Dave has said in the posts above (or even half!).

OY... I wince at this, though I am aware it is true for many otehrs as well.

Here is my open plea;
PLEASE *ask* me "what the heck are you actually saying Dave???"

I know that what I am bringing is very factual, dry & counterintuitive... so I have zero hestitation to break it down into different bite-sized bits from various angles.

Just ask. All I request is we all keep it adult in spirit.
(I know some people feel like their sacred cows are being gored... but its not the case. I want all to succeed safely.)

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Some people don't see a home -- at leasto the primary residence -- as an investment.

We're not taking loans against our house to fund cars or vacations (we're "cash only" people) and we're not revolving our retirement around it, either. In fact, we will pay off our mortgage long before we reach retirement.

We do have other investments, we just don't consider our home to be one of them.


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typo!

Sorry! That was supposed to say "at least NOT the primary residence."

Proofread, Lara! Proofread!


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave--

OK here's a question. What is a "fixed and indexed growth account?" Being a lawyer, I had to 'research' that term via web searches, and my best guess is that you might be referring to fixed and/or indexed annuities? I thought you were talking about investments like mutual funds diversified with bonds, until you started discussing guarantees against loss.

(and looking back, I did understand at least half of what you said; it's only the specific responses later in the thread that started to 'lose' me).


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Lara,

We're not taking loans against our house to fund cars or vacations (we're "cash only" people) and we're not revolving our retirement around it, either. In fact, we will pay off our mortgage long before we reach retirement.

As long as you can afford to lose your home value, or the home itself, and NOT incur a significant damaging loss to your financial security, safety and lifestyle, then paying your cash into your real estate equity is not so dangerous.

MOST people are not in your fortunate position however... losing the value of their home (or even just a portion of it) would be devastating to their financial retirement.

============================================================

Hi Robin,

What is a "fixed and indexed growth account?"

Its not a single type, but a class of safe pseudo-investment vehicles.

Taxable fixed & indexed accounts are Structured Notes (available through several Wall Street investment & securities firms.) These parallel and are competitive to the insurance world's annuity products, but offered by the security banking realm. Generally they match annuity (fixed & indexed) features, but without the insurance coverage nor premiums to pay for it.

Tax-deferred would be fixed, or indexed annuities, OR taxable vehicles (as in the Structured Notes, above) within qualified deferrable accounts (such as 401(k)s, IRAs, and the various pension schemes.)

Tax-free would be fixed, or indexed universal life policies with principal guarantees.

NOT exactly a DIY thing (as with practicing law...) but the strategies are valid, hammered-out, and with several of them it is highly likely to not only not come at a net cost, but actually be profitable to place the diversification safety-hedge in place.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

How does carrying a mortgage increase your diversification? Sure it can improve your liquidity, if you save or properly invest the money you would have used to prepay. And if your investments work out, then maybe you end up with a higher net worth. But diversification? If the value of the house plunges, you still owe the balance on the mortgage, unless you are prepared to walk away when your equity is gone. Dave, do you advocate that? So it seems to me that the house represents essentially the same proportion of your net worth, mortgage or not.

Even the Consumer Reports article says "On the other hand, many people find peace of mind in paying off their mortgages and owning their homes outright, especially as they approach retirement. That can make an investment in your mortgage a worthy choice, psychologically if not financially."

No mortgage = no worrying about who services your mortgage now, whether they're applying your payments, whether unfair fees will be added to your balance, whether you might be foreclosed on by mistake. And we know mortgage ownership is so confused these days, that lenders have been able to foreclose without showing proof of ownership.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi SUburbanMD,

How does carrying a mortgage increase your diversification?

You only have a defined amount of positive net worth. If you have a disproportinate amount of that exposed in your real estate equity, you are simply under-diversified.

In order to balance and protect your positive net worth, you would need to SEPERATE it from your real estate. A mortgage allows you to do that.

Make sense?

Sure it can improve your liquidity, if you save or properly invest the money you would have used to prepay. And if your investments work out, then maybe you end up with a higher net worth. But diversification? If the value of the house plunges, you still owe the balance on the mortgage, unless you are prepared to walk away when your equity is gone. Dave, do you advocate that?

People do not walk away from their HOME just because the values plunge. They walk away from their home when they do not have the liquidity to make the payments.

I advocate being more responsible in cash management, and the conservative protection of longterm security and future financial independence. Protecting yoru net worth is crucial in this regard, and real estate (especially the home you live in, which you are LEAST likely to unemotionally sell merely to exit the market) is a very dangerous bucket to hold your safety equity in.

So it seems to me that the house represents essentially the same proportion of your net worth, mortgage or not.

How can it? If you have a home worth $100,000 with no mortgage, and no seperated safe equity, it represents 100% of your net worth.

If you have a home worth $100,000, with $100,000 leverage, and $100,000 distributed amongst safe equity accounts, your real estate represents zero % of your net worth.

A wise balance is prudent. Conservative protection wins financial independence.

Even the Consumer Reports article says "On the other hand, many people find peace of mind in paying off their mortgages and owning their homes outright, especially as they approach retirement. That can make an investment in your mortgage a worthy choice, psychologically if not financially."

EXACTLY as I have ongoingly repeatedly said; Eliminating your home leverage is an EMOTIONAL treat... but never mistake it as a wise FINANCIAL strategy.

No mortgage = no worrying about who services your mortgage now, whether they're applying your payments, whether unfair fees will be added to your balance, whether you might be foreclosed on by mistake.

Yup... but you have to then play blind, deaf & ignorant to the risks of uninsurable and unforeseeable equity loss and cyclical downturns. Many retirees can't afford to lose much (if any) of their real net worth simply because of that one-sided emotional treat.

AS I KEEP REPEATING;
When you can AFFORD to lose some or all of your equity value in the home, or the home itself, THEN AT THAT POINT paying off the mortgage can't really hurt. It can be a nice "reirement luxury" for those who've saved enough not to mind the risks.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Say my house is worth $100,000, it's mortgaged for $100,000, and I have $100,000 in investments. I figure my net worth (total assets minus total liabilities) as $100,000 (house) + $100,000 (investments) - $100,000 (mortgage) = $100,000.

Then let's say my house becomes worthless. I still owe the mortgage. Now I figure my net worth as $0 (house) + $100,000 (investments) - $100,000 (mortgage) = 0. Certainly I'm far better off liquidity-wise than if the house was paid off and I had no investments. Liquidity is what puts food on the table. It isn't smart to be house-poor, and no one here would argue that it is. But having a mortgage didn't insulate my net worth from the house's decline.

Maybe you mean something different by "net worth"?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi SubMD,

Certainly I'm far better off liquidity-wise than if the house was paid off and I had no investments. Liquidity is what puts food on the table.

Exactly!

It isn't smart to be house-poor, and no one here would argue that it is.

Not when you call it "house poor," but MANY have been (and still are) arguing that its financially smart to pay off your mortgage BEFORE you can actually afford to lose the money.

But having a mortgage didn't insulate my net worth from the house's decline.

True, UNLESS you are investing the liquid $100,000 in vehicles that are reverse-correlated to the housing market (Ok... just picking nits here, I'll admit.)

Having cash is the bottom line, because as you say "it puts the food ont he table."

In the LONG run, real estate can be relied on to EVENTUALLY appreciate again. The key is being liquid enough able to survive waiting out the "long run" and/or being in a position where you don't care.

Maybe you mean something different by "net worth"?

Nope, I believe we're on the same page.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"A mortgage carries ONLY the risk of making its monthly payments. Equity is at full risk of significant market loss, disaster, litigation or siezure ongoingly."

Ok, I'm beginning to see your point, but... doesn't the mortgage also have the risk of making its payoff when it is time to sell the house, and thus it too is indirectly affected by market loss, disaster, litigation, or seizure? And furthermore, if I were to put money in non-real estate related investments, wouldn't those also be at risk of market loss, disaster, litigation, or seizure?

It seems to me that instead of looking at those kinds of risks, someone could just ask themselves whether they'd rather have their money tied up in something that is not likely to outperform inflation (their house) or if they would be willing to pay interest at the tax-deducted rate of their mortgage for the freedom to invest in something that might return more profit than the cost of that interest.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I'm really beginning to wonder about consumer reports, lately. Some of their advice seems really weird-we bought the car buying guide and the '07 Hyundai Azera got all good dots for potential trouble spots but then the used car verdict on it was a half black dot. Several of the cars got this! I'm like, what's going on?

Now they're telling you not to pre pay, I'm beginning to feel like there's some magicican behind a screen going "pay no attention to that man behind the curtain!"


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RE: Don't Prepay Your Mortgage [Consumer Reports]

One only has to read this thread and others like it to understand why this country is going down the toilet.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

It's hard to tell if we're on the same page, when you use financial words ("net worth") to mean what you want them to mean, not what everyone else thinks they mean. I also wonder about "leverage". Really leveraging your clients' home equity would be the direct opposite of prudence, and I doubt you're doing it.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi mfbenson,

Ok, I'm beginning to see your point, but... doesn't the mortgage also have the risk of making its payoff when it is time to sell the house, and thus it too is indirectly affected by market loss, disaster, litigation, or seizure?

Not if you've conservatively managed the equity you seperated from the real estate in the first place. It resides in its safe-haven to be accessed to payoff the leverage.

And furthermore, if I were to put money in non-real estate related investments, wouldn't those also be at risk of market loss, disaster, litigation, or seizure?

If you don't manage the equity conservatively, and wantonly "invest" in loss-vulnerable securities, or disaster-vulnerable business or the like, ABSOLUTELY!

The prudent choice, naturally, is to rebalance your equity to MORE SECURE vehicles than the real estate equity. Moving from one risky account to the same level of risk in another account would be fruitless.

It seems to me that instead of looking at those kinds of risks, someone could just ask themselves whether they'd rather have their money tied up in something that is not likely to outperform inflation (their house) or if they would be willing to pay interest at the tax-deducted rate of their mortgage for the freedom to invest in something that might return more profit than the cost of that interest.

Again, that is the "upside seeking" side of the conversation... but it is only half (at most) of the importance of the topic. Loss-avoidance is not only more critical in the real world, it is also closest to heart (so they say) of most folks who participate here.

The key is in the opnening of the eyes to "the lion over the hill" that everyone ignores, hoping that home equity is safe & secure and can't be lost in a heartbeat.

====================================================================== =

Hi Springer,

One only has to read this thread and others like it to understand why this country is going down the toilet.

More appropriate would be to say the country's home equity (as well as its toilet) is;
- swept away in the tornado & down the river,
- dropping like a rock as the neighbors declare foreclosure & bankruptcy,
- liened & lost in courtrooms from divorce, business litigation & nuisance suits,
- lost for lack of funds due to sickness, unemployment, family drama, and elsewise.

====================================================================== =

It's hard to tell if we're on the same page, when you use financial words ("net worth") to mean what you want them to mean, not what everyone else thinks they mean.

I can't control what "other people think" but I can offer knowledge.

Net worth is the total of the cash-sellable value of everything you own, minus the cash-payoff value of everything you owe.

I also wonder about "leverage".

Leverage is debt married to a functional or appreciating asset.

Really leveraging your clients' home equity would be the direct opposite of prudence, and I doubt you're doing it.

Leveraging home equity can be extremely prudent, protective and conservative.
It can sometimes also by profitable, but that is usually less important than conserving cash & wealth.

My purpose for my clients in the "maintenance & defense" financial stage of life is to;
A) Make sure they are never cash-starved to the point of not being able to weather a cycle,
B) Make sure they are protected from losses of market, litigation, uninsured disaster and personal disasters.
C) Make sure they are comfortable with their protected status.

I hope to be able to say I am succeeding at that ;~)

For my clients in "Growth & accumulation" financial life stage, we take a different appropriate tack.
Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave~
So what would be your advice to those in the "growth and accumulation" phase? My husband and I are both 28, investing fairly significantly in our 401k's, "own" a home and have no credit card debt. Where should we be putting our extra money? Thanks for your insight.

I once sat down and figured out that with $200 extra principle per month I could have the loan repayed 12 years early (it's a relatively modest mortgage payment). Unfortunately, I didn't look at the future value of the series of extra payments. Maybe I'll take another look at how I allocate my resources.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Bri29,

So what would be your advice to those in the "growth and accumulation" phase? My husband and I are both 28, investing fairly significantly in our 401k's, "own" a home and have no credit card debt. Where should we be putting our extra money? Thanks for your insight.

There are so many possible answers to this question, yet if I randomly toss out "possible" answers they're likely to be wrongly targeted to your specifics, creating a broad-swept dismissal of the better overall strategy of proper balancing.

There is also a "breakthrough" level point in the tri-balance of income, tax-rate, and expectable returns... below that point, and you are likely better off simply accumulating your monthly payments into a seperated appropriate-fit growth account from this point forward.

Break-through ABOVE that point, and all of a sudden it actually makes financial (mathematically and defensively) sense to remove as much of your accumulated equity from the real estate as possible, thereby raising your monthly payments (to offset the fact you've run out of qualified retirement account deposit allowance,) and take the lump-sum equity cashvalue and plunk it entirely into a specially-designed tax-sheltered compounding longterm growth vehicle.

A larger lump sum earning a compounding rate of return will outrun the accumulated costs of mortgage interest on the same balance of funds. "Dribbling in" dollars into the growth accounts fails in comparison.

In short; the responsible answer really requires detailing out more of your current status, as well as your emotional/financial DNA.

I once sat down and figured out that with $200 extra principle per month I could have the loan repayed 12 years early (it's a relatively modest mortgage payment). Unfortunately, I didn't look at the future value of the series of extra payments. Maybe I'll take another look at how I allocate my resources.

It is wise to do so. It will certainly open your eyes, at minimum on the "lost growth" side of the equation.
When you're done considering that, *ALWAYS* keep in mind the financial protective issues of seperating your equity from your home.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Dave~
Thanks for the info, I'm still trying to assimilate it all and figure out how I should tweak my plans. I guess my primary reason for putting down extra principle is emotional: I hate debt. My parents have owned their home outright for as long as I can remember, and this just became something that I thought I had to do as soon as possible! Silly though it may be, owing $100k on the house makes me jumpy. I think at this point I'd be better off beefing up my emergency fund, retirement plan and investments rather than tying that money up in the house.

I don't know if I'm ready to pull the equity out of the house and invest the lump sum in some other fashion, but it is certainly something to consider! Thanks again for your advice.

Best,
Bri


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave,

Thanks for taking the time to explain this. I so get your point. I have very little to gain by paying 200$/month for couple months but every thing to lose if I happen to be short of 200$ to pay the mortgage for couple month. Liquidity is necessary to weather bad times. When we bought this house, we can put down 70% (and paid off in like 10 years) or put down the minimum 20% and paid off in 30years or so. We chose the later. We figure out that if we put all our money in the house and Dh happens to lose his job, we'd be forced to sell the house at current market value (which is pretty bad). However, if we have cash to keep up the payment we can hold out and wait until the market improves.

I guess we probably never pay off this house. DH joked that by the time we paid off this house we would be ready to be wheeled into the nursing home. :-)


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Bri,

I guess my primary reason for putting down extra principle is emotional: I hate debt.

COMPLETELY understandable.... *and* entirely irrational ;~)

Consider that *some* debt is actually GOOD debt (also definable as "leverage.") Leverage allows you ownership rights of your home prior to you having accumulated enough cash to buy it outright (and thereby letting you employ the power of time in your favor.)

Leverage can allow you to receive education that can provide the power of greater income on a steeper growth path, before you have actually accumulated the cash to pay for that education (and thereby letting you employ the power of time in your favor.)

Leverage is debt (or commitments) that gives you more in return (in safety, as well as in growth) than it costs you.

My parents have owned their home outright for as long as I can remember, and this just became something that I thought I had to do as soon as possible! Silly though it may be, owing $100k on the house makes me jumpy.

Very few people are well educated in defensive, conservative finances (and that does NOT make them "dumb"... simply unaware, and doing the best they can with the amount of knowledge they've actually had.)

Stretching from "the familiar" into the unfamiliar new knowledge always requires emotional development as well. "New" (to you) is almost never comfortable at first.

I think at this point I'd be better off beefing up my emergency fund, retirement plan and investments rather than tying that money up in the house.

I concur.

I don't know if I'm ready to pull the equity out of the house and invest the lump sum in some other fashion, but it is certainly something to consider! Thanks again for your advice.

=================================================================

Hi Bellaflora,

Thanks for taking the time to explain this. I so get your point.

To BOTH of you (nee, ALL of you,) You are absolutely welcome!!!

I have very little to gain by paying 200$/month for couple months but every thing to lose if I happen to be short of 200$ to pay the mortgage for couple month. Liquidity is necessary to weather bad times. When we bought this house, we can put down 70% (and paid off in like 10 years) or put down the minimum 20% and paid off in 30years or so. We chose the later. We figure out that if we put all our money in the house and Dh happens to lose his job, we'd be forced to sell the house at current market value (which is pretty bad). However, if we have cash to keep up the payment we can hold out and wait until the market improves.

In my best grumbly Yoda voice;
So wise, you are!!!

I guess we probably never pay off this house. DH joked that by the time we paid off this house we would be ready to be wheeled into the nursing home. :-)

A home is a place for keeping your family... not for keeping your money.

If you have an equivalent amount of money equal to your mortgage safely set aside, working in a compounding return for you... you are "the same as mortgage free" (only safer, and better.)

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Thanks again Dave. I guess I should have squeezed in some business electives while I was getting my undergrad degree. May have helped me figure out how to make my money work for me more effectively! I'll definitely be doing some reading in the coming weeks.

Bri


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RE: Don't Prepay Your Mortgage [Consumer Reports]

So here's a hypothetical:

Say our house was worth $500,000, we owed $200k, and we refinanced to a $400k mortgage, pulling $200k cash out. Our monthly P&I payments with a 6% interest rate would then be about $2400. Over 30 years, total interest paid would be about $464k.

If we invested the $200k and added $1000 per month for 30 years with an average rate of return of 8%, minus taxes the result would be (according to one calculator I found):

Compounded interest return $1,259,822.61
Simple interest return $787,440.00
Total invested capital $560,000.00
Investment final total $2,607,262.61

Plus, we would either own the house free and clear or would have sold it at some point and kept any equity earned at that time.

(After 10 years, we would owe $323k on the house and would have $562k in cash. And so on.)

So it seems that one WOULD come out ahead ... or at least would have plenty of cash on hand if needed.

Is that what you're saying, Don, or am I misunderstanding or oversimplifying?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I think I can understand what you're saying but for me getting rid of that mortgage was the best thing. No more debt. I love the peace of mind it brings, being able to pull up into my driveway and know that I own my house lock stock and barrel. Of course I have no intentions of moving on up anymore because I'm at "a place" now that I'm comfortable with. If only I could make those utility bills and taxes disappear


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RE: Don't Prepay Your Mortgage [Consumer Reports]

The way things are going with the financial markets at the moment just doesn't make me confident in investing money.

If find it irresponsible to paint a picture where paying off debt that is secured by collateral that, if gone, would severely disrupt one's life, is a bad choice in an environment where popular investment vehicles are dropping off a cliff, so to speak.

Don, are you stuck in the late 90s or what?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Re Harriet's hypothetical: At a time when 30-year fixed-rate mortgages are 6%, where would you find a *safe* investment paying 8% for 30 years? Why would anyone lend money for mortgages at 6% if they could get a safe 8% return elsewhere? A valid question anytime, and all the more so nowadays, when rates on truly safe investments have been driven lower by the market turmoil.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

harriet

You said "If we invested the $200k and added $1000 per month for 30 years . . ."

If I follow you correctly, you're proposing to refinance a 200K mortgage to 400K. That will obviously mean a much higher mortgage payment and leave you with less disposable income. Where is that "extra $1000" supposed to come from? If you have that much left over to invest with the higher mortgage payment, surely you would have had EVEN MORE to invest if you didn't refinance, no? Instead, by assuming additional investment with the higher mortgage payment, which is certainly counter-intuitive, you have unjustifiably exaggerated the favorable effect of the refinance.

To make a fair comparison between the two scenarios, you should figure out the difference between the two mortgage payments and assume you would invest all of that difference for the 30 years it takes to pay off the smaller mortgage. You should also not muddy the waters by assuming any additional investments. In other words, you would be comparing the difference between the 200k lump sum investment you make by refinancing and the monthly sum you could invest by keeping the lower payment with the original and smaller mortgage.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

How does this "don't pay off mortgage" relate or compare to todays questionable job security versus the "old days" of around say 15-20 years ago where many people went to work for a company and stayed with it until retirement. Didn't matter whether they were an on the floor factory worker or someone in the office. That type of employment seems to be going the way of the do-do bird.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"The way things are going with the financial markets at the moment just doesn't make me confident in investing money."

But that is exactly what you are doing by paying off your mortgage. Home equity *is* an investment, and Don's point is that it can be just as risky as other investments.

"Why would anyone lend money for mortgages at 6% if they could get a safe 8% return elsewhere?"

By that reasoning there should never be any lending less than about 13% - the long term history of small-cap stocks.

"How does this "don't pay off mortgage" relate or compare to todays questionable job security"

You're missing the point - he's saying have the money available to pay off the mortgage if need be, just don't actually do it until you have to.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

jrldh

I also find it a peculiar time for Dave to be flogging this particular horse considering what's going on with both the stock market and house prices. If present trends continue for some time, then one could wind up with both a big loss in the investment portfolio and a house that's worth less than the mortgage balance.

Add to that a move forced by job relocation or loss, etc, and you're looking at financial disaster.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"If present trends continue for some time, then one could wind up with both a big loss in the investment portfolio and a house that's worth less than the mortgage balance.

Add to that a move forced by job relocation or loss, etc, and you're looking at financial disaster."

Ok, but if you pre-pay the mortgage you wouldn't have much in the investment portfolio in the first place, and you could still lose the house or its equity.

Plus, I don't think anyone is seriously advocating dropping a big chunk of change into the markets right now - but there are still good rates available on annuities, and CD's and even certain kinds of life insurance policies that will avoid market risk and still pay enough to beat the tax-adjusted cost of carrying a mortgage. If you structure these investments property you can maintain enough liquidity to access the funds to be able to sell the house if need be, but in the meantime you have the money working for you.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

mfbenson, taking out a mortgage on your home doesn't insulate you from any loss in its value. Even Dave admitted this above, Fri, Mar 14, 08 at 23:23. So I'm not even sure what is meant by "home equity is an investment". No matter how much or little equity you have, any gain or loss in the home's value is yours. Of course, mortgaging the house does give you the option of walking away from the loan and the house if it drops in value. Some people would find this morally repugnant, especially if you went into the deal with the intention of possibly doing it.

The long-term history of small-cap stocks, 13% or whatever it is, is *not* a safe return. That's what they mean by "past performance is no guarantee of future results".


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Mortgage and Homestead Protection

I believe that a mortgage on your house reduces the amount of your "homestead protection" in case of bankruptcy. Could Dave or some other knowledgeable person comment on this?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"Ok, but if you pre-pay the mortgage you wouldn't have much in the investment portfolio in the first place, and you could still lose the house or its equity."

But you would definitely have more equity in the house than if you didn't prepay it. That makes it more likely that you would be able to sell it for enough to cover the mortgage balance. That would put you in a lot better position than if your depleted investments wouldn't cover it. You'd be forced to liquidate them and you still would be left with a shortage -- you'd have no house, no investments and a debt you'd have to pay off.

I also challenge your assertion that there are currently safe investments at rates high enough to cover the tax-adjusted costs of a mortgage. I've looked at current CD and annuity rates and I sure don't see anything that's liquid enough and carries a high enough rate to accomplish this for most homeowners with mortgages.

But maybe I'm overlooking something and you could point me in the right direction?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I started out in this thread by arguing with Dave, now here I am sticking up for him...

"mfbenson, taking out a mortgage on your home doesn't insulate you from any loss in its value."

Yeah, and paying down the mortgage doesn't either. The point isn't to make your house value immune to a bad market, its to put your money to work for you in the best way available.

"The long-term history of small-cap stocks, 13% or whatever it is, is *not* a safe return."

If by safe you mean risk-free, you're right. But if you are just trying to outperform the tax-adjusted cost of a mortgage, over a long enough time period, its a relatively smart bet. There are ways to outperform the tax-adjusted cost of a mortgage without taking on nearly that much risk though.

"Of course, mortgaging the house does give you the option of walking away from the loan and the house if it drops in value."

Technically you could do that even if you owned the house free and clear.

"I believe that a mortgage on your house reduces the amount of your "homestead protection" in case of bankruptcy."

As far as I know that varies from state to state.


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have to change the subject line just to get a post to work

"That would put you in a lot better position than if your depleted investments wouldn't cover it."

If your depleted investments wouldn't cover it, you would have either been investing in something so risky that it may as well be the crap tables in Vegas, or it was such a small amount of money that using it towards the mortgage wouldn't have much much difference anyway. The point is to put the money in something still on the safe side but better performing than home equity.

"But maybe I'm overlooking something and you could point me in the right direction? "

Short answer, universal life, somewhat less short answer, single-payment annuities are paying between 4% and 4.7%, are worth 5% to 5.9% if tax deferred, whereas a mortgage at a competitive rate of 5.8% is costing 4.35% after taxes (less if you're above the 25% bracket). Ok, now the caveats: You might have to pay surrender charges on whatever portion of an annuity or insurance policy you liquidate to cover a sudden financial emergency, so this strategy isn't for everyone, but if you feel such an emergency is not likely I think its worth investigating. Plus there can be an extra bite tax-wise if it was a tax-deferred annuity.

All that said, I am not 100% against occasionally pre-paying on a mortgage, but my thinking is that it would only be done to keep the home equity in proprotion to other investments, whereas the type of "investor" that Dave is most worried about is the person that wants to pay off the house free and clear before even beginning to save in other investments. Even the consumer reports article says it "rarely" pays to pre-pay. "Rarely" is not "never".


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I actually agree with Dave that pre-paying your mortgage isn't the most financially savvy thing to do over the long term. But I think it's harder to convince people of that in a time of both declining house and stock prices.

Let's say you take Dave's advice and stop putting that extra money into your house, but instead start investing it in, let's say, a good stock index fund The stock market goes down for five years and lo and behold, you have to sell your house. Adding together your depleted investment fund and the (smaller) equity you have in your house is never going to add up to as much as you would have if you continued to prepay your mortgage.

An even worse scenario is if the value of your house also declines in that five years, and who knows at this point whether that might not happen? Once again, adding your depleted investment fund together with the smaller equity in your house is going to result in less funds available to pay off your mortgage than if you'd continued to prepay. You seem to think that one somehow cancels out the other.

As I said, if there are sufficiently safe and sufficiently liquid investments available right now at high enough rates to cover the tax-adjusted costs of a mortgage for the average homeowner, I'd sure like to know about them.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"But that is exactly what you are doing by paying off your mortgage. Home equity *is* an investment, and Don's point is that it can be just as risky as other investments. "

Except that I live in my home, something that I can't in my stocks (or other investments).
I don't care, if my home value falls 50% because I won't sell anyways.

However, if my other investments fall drastically (which happens. just read today's news) and I didn't pay off my mortgage and lose my job, I would feel like a real idiot.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"Except that I live in my home, something that I can't in my stocks (or other investments)."

You receive the shelter value of your house whether it is mortgaged or not. Moot point.

"I don't care, if my home value falls 50% because I won't sell anyways."

Sometimes there's no choice. You could lose your house under Emminent Domain, possibly even at the new 50% value if it had already fallen that far.

"However, if my other investments fall drastically"

If that is even a possibility you chose investments that were by far too aggressive, which is also an idiot move.

"and I didn't pay off my mortgage and lose my job,"

And as long as the remaining value of the liquid investments is enough to cover mortgage payments until you get work again you'd make it. And paying off the mortgage isn't even the option for most people anyway - a more common scenario is what to do with an extra $10K or $20K - pre-pay a mortgage balance of $200K, or invest it? If you still have any mortgage balance, then you have monthly payments due.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Harriethomeowner,

(After 10 years, we would owe $323k on the house and would have $562k in cash. And so on.)
So it seems that one WOULD come out ahead ... or at least would have plenty of cash on hand if needed.
Is that what you're saying, Don, or am I misunderstanding or oversimplifying?

You are definitely getting the concept... although (for understanding purposes) you're perhaps oversimplifying a bit... or more accurately over-assuming certain givens. HOWEVER the principal is clear, and you are understanding that principal accurately.

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Hi pkguy,

No more debt. I love the peace of mind it brings, being able to pull up into my driveway and know that I own my house lock stock and barrel.

This is an emotionally-based decision, which cannot be judged as "wrong" by anyone not in your shoes.

Financially, as long as you are in the position where your future security and lifestyle will not suffer by the loss of the home, or the loss of the value of the home, then you ought to be fine.

=================================================

Hi jrldh,

The way things are going with the financial markets at the moment just doesn't make me confident in investing money.

This is an emotionally-based decision, which cannot be judged as "wrong" by anyone not in your shoes.

Financially, as long as you are in the position where your future security and lifestyle will not suffer by the loss of the home, or the loss of the value of the home, then you ought to be fine.

If find it irresponsible to paint a picture where paying off debt that is secured by collateral that, if gone, would severely disrupt one's life, is a bad choice in an environment where popular investment vehicles are dropping off a cliff, so to speak. Don, are you stuck in the late 90s or what?

HARDLY! LOL!

Nobody's been accusing my equity-diversification suggestions as being "popular investment vehicles" here... ;~)

I stand by my position;
Depleting your cash to remove your protective leverage (that can otherwise be offset by growth accounts) prior to being able to afford the losses of liquidity is a financially foolish gamble that you'll never be in the position needing that liquidity.

=================================================

Hi SubMD,

At a time when 30-year fixed-rate mortgages are 6%, where would you find a *safe* investment paying 8% for 30 years?

As just ONE example, at least one Indexed Universal Life contract I am familiar with offered by Old Mutual has averaged 9.7% annual credits, net of the required life coverage premium deducted, and GUARANTEES not only never a loss of principal, but a positive 1% minimum if the index is anything less than 1% (including net loss years in the stock markets.)

That's just one hard example... there are others, but the return is the least of importance over conservation of overall net worth and liquidity.

=================================================

Hi pkguy,

How does this "don't pay off mortgage" relate or compare to todays questionable job security versus the "old days" of around say 15-20 years ago where many people went to work for a company and stayed with it until retirement. Didn't matter whether they were an on the floor factory worker or someone in the office. That type of employment seems to be going the way of the do-do bird.

The issue is NOT "don't pay off your mortgage" but rather to accumulate your security SEPERATED from your real estate until you can SAFELY afford the risks of eliminating the mortgage.

A very significant diference.

It is AS MUCH or even MORE appropriate NOW that boomers are living longer, and need the extended security of a real cash position... and ESPECIALLY since retirement cashflow is now the boomer's defined-contribution responsibility, rather than the defined-benefit pensions of the past (or did I flipflop the descriptions? I'm on the fly here... so please adjust, I trust you understand the point.)

=================================================

Hi jrldh,

I also find it a peculiar time for Dave to be flogging this particular horse considering what's going on with both the stock market and house prices.

RRRREEEEALLLYY!!?!??????????? When *IS* it most appropriate to talk about avoiding risks? AFTER the horses have left the barn?

If present trends continue for some time, then one could wind up with both a big loss in the investment portfolio and a house that's worth less than the mortgage balance.

ONLY if you're taking safety equity and throwing it into loss-vulnerable securities.

Add to that a move forced by job relocation or loss, etc, and you're looking at financial disaster.

ALL the more reason to be liquid seperate from your real estate. Lose your job, and you wont' even QUALIFY for another mortgage, let alone be able to afford the transaction costs and turntimes.

=================================================

MFBenson,

I started out in this thread by arguing with Dave, now here I am sticking up for him...

It is REALLY encouraging to see "the light go on!" Your understanding is becoming solid, as evidenced by your responses in this thread.

=================================================

HERE'S THE THING;

It *IS* possible to guarantee zero equity loss with certain indexed growth accounts (in universal life (tax-free,) indexed annuities (tax-deferred,) or exchange-traded structured notes (taxable.)

Each of these ALSO offer varying degrees of upside, varying side-benefits, and varying cost structures.

SEVERAL easily outperform after-tax mortgage costs on a mid-to-long range average basis.

Those that do not outperform, but under-perform on average can be looked at as the cost of conservative security... the "insurance premium against losing money."

Some people (almost like a religion) are against risk management via insurance or pooled-risk avoidance structures. You can't teach something to somebody who has no willingness to learn.

For those that DO wish to learn, read carefully, eat the meat and toss away the bones.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Thank you to Dave and anyone else here who has contributed good info to this thread.

American are not accustomed to talking about personal money openly. Even among family and close friends. I hope younger people will become more educated about finances.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"You receive the shelter value of your house whether it is mortgaged or not. Moot point."

Not a moot point. You don't understand, apparently.
If it is mortgaged and I can't pay the mortgage anymore I lose my shelter.
If I don't have a mortgage but own the house, this problem simply doesn't exist. So it is by far not a moot point. To the contrary, it is the essence of the "safety" vs. "investment" argument.

And no, obscure things like foreclosure because of property tax delinquencies and eminent domain don't count much. Because what's the chance of that happening.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Thanks Dave..
I think defined benefits (pensions) are pretty fast disappearing in favor of the defined contributions since the expectations are that lifetime employment with one company is fast disappearing as well. At my employer, since retired now, we had to make a decision about 8 years ago which of the two we wanted our pensions allotted. I went with DB being so close to the finish line.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

SubMD asked "At a time when 30-year fixed-rate mortgages are 6%, where would you find a *safe* investment paying 8% for 30 years?"

and Dave answered:

As just ONE example, at least one Indexed Universal Life contract I am familiar with offered by Old Mutual has averaged 9.7% annual credits, net of the required life coverage premium deducted, and GUARANTEES not only never a loss of principal, but a positive 1% minimum if the index is anything less than 1% (including net loss years in the stock markets.)""

While it's true that Old Mutual is allowed to advertise that its MasterChoice insurance product has averaged 9.7% annual credits, it should be noted the 9.7% is averaged over the 25-year period between 1982 and 2006, whereas MasterChoice was introduced to the market in Oct of '03. The credits are indexed to the S&P 500 and reflect that index's ups and downs. For the same time '82-'06 time period, the S&P index's average rate of return with dividends was 13.25%.

On the downside, a MasterChoice policy holder would have received only the minimum 1.00% credits in six of those 25 years and would have received less than 2% in 2007. The returns are capped on the topside. That means that no matter how well the S%P preforms in a great year, your credits are topped at 15% -- the cap used to be 17%, but Old Mutual cut that back to 15% in April of last year.

The MasterChoice policy isn't as risky an investment as an S&P index fund. It also won't make you nearly as much money over the long term. That makes sense because, as most people know, investments that have the promise of greater returns carry more risk.

But no one should think that MasterChoice or and other insurance policy that's tied to a stock market index is risk free. It does NOT represent a "safe" investment in the sense that most people understand it. Yes, it's true that your principal will return 1% in a bad year. But 1% is a whole lot less than the tax-adjusted interest rate of your mortgage. And that's what MasterChoice would have returned to its policy holders for three years in 2001-2003 had in been in existence. During the period 2001-2007, its average yearly credit would have been about 5.9%. But don't forget that the compounded rate of return would be about 1% lower, or 4.9% and we have to use the compounded rate because that's how your mortgage interest is calculated. From that, you have to subtract the cost of the premium. And there's going to be a surrender charge i you cancel the policy before it matures and the extra costs of any riders you purchase and so on.

Now to be fair, it's an insurance policy and you do get a death benefit. Part of the premium pays for this feature and that's why the rate of return is lower than the index it's based on.

The bottom line is that a product like this carries much more short-term risk than "safe" investments like CDs, money market funds and Treasury bonds. Long term it will almost certainly make you more money than any of those investments, but not nearly as much as if you'd invested in a good index fund and bought cheap term life insurance instead.

It's up to everyone to decide how much they want to leverage their mortgage investment and how much risk they're comfortable with. But make sure you understand what the actual risk is of any investment vehicle you're thinking of buying, Above all, don't take the agent's words at face value because, as we all know, s/he's not an objective source of information.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"If it is mortgaged and I can't pay the mortgage anymore I lose my shelter. "

The only way that could happen is if you lose your income and *all* of the money in your savings and other investments. If money becomes *that* tight, you aren't going to be able to pay the property tax bill or the utility bills, and you'd lose the house anyway.

"tax delinquencies and eminent domain don't count much. Because what's the chance of that happening."

Its a lot higher than the odds of the value of a universal life policy or a tax-favored annuity going to zero.

Paying off a mortgage early is not necessarily a bad move, its just that there are generally better places to put the money first.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi FF,

Nicely explained on the OM MasterChoice program. The individual yearly returns are meaningless (versus individual yearly mortgage costs) as long as we are talking about longterm strategies, and the safe returns on the leverage.

Guarantees against losses on the downside are matched by maximum credit levels at the topside, naturally.

However,
The bottom line is that a product like this carries much more short-term risk than "safe" investments like CDs, money market funds and Treasury bonds.

This ignores TAX risks, and INFLATION risks, which as any retiree will explain to you, becomes evermore burdonsome when your work-a-day career-life is drawing near the golden years.

If you have some religious problem with the growth aspects of Indexed Universal Life, and buy into the securities-salespeople's fear hoopla about Fixed & Indexed Annuities, your NEXT best "safe" vehicle would be the taxable exchange-traded structured Notes you can get from several large Wall Street houses.

VERY LASTLY... if you find yourself in no option but a fully-taxable, non-compounding CD, at least go with a structured Indexed CD, and get the upside credit benefits matched to the large-scale securities markets while eating the internal costs of the government depository insurance.

Cheers,
Dave Donhoff
Strategic Equity & Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Thanks for your kind comment, Dave.

Actually, we intend to put some of our money into annuities when the time comes, which won't be too long. I'm certainly willing to trade some return for security in retirement. We'll still keep some funds in the markets and have a certain segment in money markets, CDs or the like.

As for ETNs, I understand the IRS has yet to rule on their tax treatment. I wouldn't take a serious position in them at this point because the risk of a big hit should the ruling be unfavorable is too great.

No matter how you slice it, it still comes out the same way. You can diversify your own investments, you can hire an FP to do it, or you can purchased hybrid products like yours, but you're always going to be in the position of balancing risk against return, inflation ans taxes notwithstanding. That's just the nature of the investment animal.

Insurance companies have long been packaging up term insurance in combination with investments. First (at least as far as I know) there was "whole life." Then "universal life" became popular. Now, we see even further hybridized products like "equity indexed universal life" policies.

They are always sold as "safe" investments that will give you a good rate of return. They're structured so that most people don't understand how they work. They carry high premiums, which lowers your net return. They have agents who make good commissions when they sell them.

What they DON'T do is change the risk/return balance. Equity index policies aren't as safe as regular universal life, as one would expect because they carry a higher rate of return. For the same level of return they are not any "safer" than structuring your portfolio yourself or paying a professional to do it for you if you don't feel up to the job.

That's why they don't interest me. But I'm sure they suit some people, and that's fine as long as policyholders understand the balance between risk and return in the product they've bought.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Interesting times to revisit this question:

Two years ago I paid off my mortgage. $160k - modest but typical for DFW.
House is worth $205k (was $200k when I bought - no bubble here)

Let's compare:

Scenario 1: Had I kept my mortgage and invested with a return that tracks the DJI:

Had I invested my $160k, this would now be worth $141.5k. In the 24 months, I'd paid $23k PI on my 6% mortgage:
$141.5k
-$23k
-----------
= $118.5k

So my $160k shrank to $118.5k

Today the house is worth $205k. The balance on the loan would be $156k, which results in an equity of:

$205k
-$156k
-----------
= $49k

So the $160k + house turned into $118.5k + $49k = $167.5k


But I paid off the mortgage two years ago. That saved me 24 PI payments, totalling $23k. The house is worth $205k.

So the $160k + house turned into $23k + $205k = $228k

Which means paying off the mortgage was $60.5k better! Even with tax benefits, which at a max were $7k over two years, it is still $53k better!

Bonus: I don't lose sleep over what's going on at Wallstreet this week!


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RE: Don't Prepay Your Mortgage [Consumer Reports]

jrldh,

Paying off early didn't save you 24 PI payments. It only saved you the I (interest). You just paid the P (principle) sooner than you needed to.

However, I envy you that paid-off state of mind.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I love not having a mortgage. Many people don't get any tax saving from interest payments. There is wonderful peace of mind having a paid for house, too. My total house outlay is $300 a month for taxes and insurance.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi jrldh,

Congrats on your feelings of safety and good sleep! You are certainly fortunate that your real estate equity has not yet been under pressure like so many others, and that's a blessing to appreciate!

Of course, as with ANY 'naked asset' that you own in full exposure "past performance is no guarantee of future results." Your unleveraged equity is now at full exposure to not just the market, but potentially all other uninsured risk elements as well. These are what are known as S.L.A.P. risks;
Softening market values,
Litigation exposure,
Acts of God (and we've certainly seen these recently,)
Personal catastrophe (inlaws, exes, and/or medical economic disasters.)

You look at "Scenario 1" as shifting your at-risk real estate equity into at-risk securities equity (DJI.)
This wouldn't have been a very well planned equity re-employment, as you would have simply traded full expore risks in real estate assets into full exposure risks in the stock markets.

Let's look at a better "Scenario 2";
You had shifted your $160,000 into an S&P-indexed tax-free universal life account which offers dollar-for-dollar upside when the stock move up, "catches" any upsides as a "high water mark" on an annual basis, and keeps a "no loss guarantee" floor so that if/when the stock markets drop your equity doesn't lose a dime.

These cash accumulation accounts are averaging 9.6% annual positive credits because of their "upward ratcheting" design, and the average annual cost over their account life is about 1% of balance, so your average net annual "return" is 8%-ish... however, that 8% return is income tax free, as well as being sheltered from the financial industry and real estate market storms.

Your $160,000 leverage cost you a rate of 6% pre-tax, and (assuming an 18% marginal tax bracket) 4.9% after tax (6% multiplied by (1.0 - 0.18)). That $160,000, more safely employed, would have earned you a pre-tax rate of 8%, which is the taxable equivalent of 9.8%, using the same marginal income tax bracket assumptions (8% divided by (1.0 - 0.18%)).

Your 2 year equity balance would have been;
Yr 1: $160,000 * 1.08% = $172,800
Yr 2: $172,800 * 1.08% = $186,624
TOTAL GAIN = $26,624

Your 2 year after-tax cost of leverage would have been;
Yr 1: $160,000 * 0.049% = $7,840
Yr 2: $160,000 * 0.049% = $7,840
TOTAL COST = $15,680

NET 2 YEAR GAIN, TAX FREE = $10,944

For many folks, this is a NICE retirement supplement, and knowing that their equity is finally protected from market and "SLAP" risks help them sleep far better at night as well.

FURTHER, since the gains are income tax free, they do NOT trigger taxation on Social Security income (as do distributions from qualified tax-deferred accounts like IRAs, 401(k), and 403(b)s...)

SO... what you don't know CAN cost you... and what you DO know can protect (and even grow) your financial freedom.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Are you talking about life insurance like mentioned in the link below?

Phew, good that the socialist government of the USA bails out insurers like AIG then!!

Here is a link that might be useful: Equity Index


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi jrldh,

No, you linked to an article about a salesman pushing indexed annuities with longterm maturities (longer than 7 years) to 90 year old seniors.

Accumulation accounts in universal life contracts are markedly different.

A) You're not even ALLOWED to bury the full amount of the planned account value into it all at once, the maximum you can contribute is a but over 20% of your desired amount per year... so it is impossible for anyone to get "fast-pitched" into it (which explains why the stock jockeys hate it and the annuity hustlers avoid it, leaving pretty much only Financial Planners who operate for the long run of their clients,)

B) 100% of any pre-deposited cash values above the basic insurance premium is fully withdrawable WITHOUT any surrender penalty... so a client using an indexed universal life contract account would never face the nightmare the senior got in that article you brought,

C) Cash-value life accumulation contracts differ from annuities in FIFO tax treatment, as opposed to LIFO for annuities. This means that the already-taxed original-deposit principal funds (the money that went "first in") can be considered "first money out" whenever drawn, so that the client will have access to them tax free (since they had already been taxed before deposit,)

D) Universal Life accumulation accounts allow for zero interest rate loans of the growth (profits) credited to the life account... and that means that after a client has eventually drawn down the original deposits that they had employed into the account over the years, they can simply "borrow" the remaining profits from themselves at no interest costs, and no income tax burden... rather than "withdrawing" the funds and having to pay income taxes on them. The "loan to self" never has to be repaid until the account owner passes, and the coverage pays the difference to the owner's estate,

E) Because the owner gets access to their spendable living cash tax free, it also DOES NOT trigger the income tax burdens on their social security benefits.

AND... to top it all off (sure to make you smile,) NONE of this is emburdoned to the taxpayer through Uncle Sugar! No socialism mandate, no government corruption, no "class warfare," and no indebting of our grandchildren's grandchildren at all!

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

So Dave, how common is it, really, for people who are appropriate insured (title, homeowners, umbrella) to actually lose large amounts or all of their equity?

In theory, DH and I lost equity when the bubble burst and the inflated market value of our home dropped about $40K to a more reasonable level. But that reasonable level is still more than twice our purchase price.

We've seen comparable drops in our 401k accounts, which are diversified across many mutual funds. Those are not immune either. And safer investment vehicles generally have lower returns. (And yes, we have them, too, plus a one-year emergency fund).

We are quite happy to be in year 4 of a 15-year refi with a mortgsge principal less than my salary.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Mary,

So Dave, how common is it, really, for people who are appropriate insured (title, homeowners, umbrella) to actually lose large amounts or all of their equity?

Its difficult if not impossible to insure against EVERY risk with traditional insurance products (including umbrella coverage policies.) I suppose that if we *ONLY* look at the few folks who get extensive coverage for legal risks from within the family, and sufficient disability risks for ALL family members (so that a loved one's required attention by an otherwise insured principal earner doesn't also enburdon the family's income requirements,) then I would imagine that the downsides are fairly low.

How common is it, really, for people to take on THAT much coverage, and cross-coverage, when "everyone seems healthy" and nothing appears to be at risk, on the surface? (Answer; extremely uncommon.)

In theory, DH and I lost equity when the bubble burst and the inflated market value of our home dropped about $40K to a more reasonable level. But that reasonable level is still more than twice our purchase price.

How much had you lost by not only not having that $40,000 protected, but also not having it growing for your retirement safety? IOW, the opportunity costs you paid for that "peace of mind" and letting the drawdown happen unaccounted for?

We've seen comparable drops in our 401k accounts, which are diversified across many mutual funds. Those are not immune either. And safer investment vehicles generally have lower returns. (And yes, we have them, too, plus a one-year emergency fund).

Good. Everybody is wise to determine how much of their net worth they are comfortable having at risk of loss, and putting that much into aggressive "investments" that can actually lose money... and putting the amount they cannot afford to lose into more conservative principal-protected growth accounts for safety & security.

OH, and by the way... when the "investment" accounts with the unlimited upsides are taking it in the shorts, like they are today... suddenly the "boring 5%-8% principal guaranteed" accounts seem not so terrible, no?

When all the equities are in the red, and you just want to no longer lose money because you don't have enough earning years left... "zero is your hero!"

We are quite happy to be in year 4 of a 15-year refi with a mortgsge principal less than my salary.

Congrats on your happiness! Again, if that's a risk you're comfortable with here's hoping the equity risks payoff nicely for you in the end with no surprises!

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

But Dave, again, I ask how common is it for people to really lose most or all of their equity? Sure, it's uncommong for people to have coverage against every possible risk. But how often to they really suffer a loss due to a lack of that much coverage? How often do they really lose their equity other than due to market fluctuation?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Mary,

But Dave, again, I ask how common is it for people to really lose most or all of their equity?

Stop and think about that for a second... and think about the number of homes that are wiped off the face of the Earth each year simply by natural disasters.

What portion of those lose most, or all, of their real estate equity? I don't have the statistics, but its quite significant to say the least.

The Southern states with the hurricanes are simply the most obvious recently, but aren't the only areas vulnerable to uninsured (and uninsurable) losses from plain ol' natural disasters....

And natural disasters are simply the EASIEST to understand & identify with. In reality the other SLAP risks are just as prevalent and damaging to equity values.

Sure, it's uncommong for people to have coverage against every possible risk. But how often to they really suffer a loss due to a lack of that much coverage?

How often???? It only takes once!

How often do they really lose their equity other than due to market fluctuation?

Market fluctuations are never permanent... people only really lose their equity value from market drops when they are also trapped due to unforeseen timing or poor planning into selling before the inevitable recovery.

I would venture that the MAJORITY of permanent equity loss, other than sales timing entrapment during a down cycle, comes from uninsured health-related and economic/employment issues that could have been avoided with greater liquidity and seperation of equity from the real estate itself.

CHeers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave -
Aren't you a mortgage broker?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

You know, I am a regular on a couple of the other boards on this site, but not here. Although I like to lurk on this board, I grow weary of it often because of this constant push. Dave's constant single-issue posts are a bit off-putting to me. If diversification is the goal, then how about spreading your wings a bit, my man?

But seriously, I understand the problem of retirees being house-wealthy and cash poor. But there is a balance to be had that can include investments AND a paid-off home. First, a move to a geographical area with lower property costs and tax burdens and the (usually) associated much lesser volatility in the housing market. Second, adequate long-term care insurance and term life to protect the remaining spouse's financial security. Third, a reasonably priced home so that investment and morgtgage paydown is simultaneously achievable. These are simple things that can be done and that don't require "leveraging" one's retirement shelter.

I understand the math. I get it. I really do. But keep in mind that some people consider their homes dwellings rather than investments to be leveraged.

You are dismissive of the decision to pay off a home early as being an "emotional" personal decision. But isn't any "investing" of any kind emotional and personal to a degree? Of course it is. Different individuals have different risk tolerances, different goals, different time lines. Investing is not one size fits all. Unfortunately your advice is.

I think I was particularly troubled by your assessment that most folks are not adequately insured for all potential risk. Your solution for these folks who are unsophisticated in the ways of risk assessment? Don't pay off your house and trust the market and annuities.

I, for one, never underestimate the value of unencumbered shelter.

Jakabedy
Security Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I have an interest only loan that is 10x higher than my initial mortgage was 30 years ago & I'm within one year of retirement. There were reasons for it, purchase of other property that I paid cash for & the expectation of receiving an inheritance from my parent's estate to use to pay off my mortgage. Parent's property did not sell & I am left holding a loan with considerable interest.

Both my husband & I work with good salaries, however, I take sole responsibility for my financial future and do not consider his income. Now, I am making very hefty payments on the principle to shrink the interest payments to a level I feel comfortable with. Payroll deductions for thrift contributions (currently 9%), Series I savings bonds and other savings should prove relatively safe. 6 months ago I switched my work thrift from stocks to bonds and also withdrew some major cash to purchase raw land. That land will be placed in a state stewardship program to cut the tax burden and provide an inheritance for my sons.

Financial security is highly personal-unless there is enough discipline to button down expenses/and or increase income in time of economic pressure, risk should not be assumed. I find it highly ironic that so many people are in extreme circumstances today in spite of what all the experts say. So, pre-pay a mortgage? If it means more cash flow without increased risk and a better standard of living, why not?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Gardenspice,

Aren't you a mortgage broker?

We are licensed to originate mortgage loans as a brokerage, among other financial licenses, yes.

======================

Jakabedy,

You are opinionated, and everyone deserves their chance to expresse their opinion...
HOWEVER,
Have you bothered to actually sit down and READ my posts? (It certainly doesn't not appear that you have.)

I am CONSTANTLY talking about diversification....
My posts are virtually NEVER "single issue"...

I've NEVER been "dismissive" of anyone making emotional decisions, AS LONG AS THEY DON'T DECEIVE THEMSELVES WITH JUSTIFICATION THAT THEY ARE OBJECTIVE, FINANCIALLY CONSERVATIVE DECISIONS (seriously... have you decided to respond without reading ANY of what I actually write???)

You were "particularly troubled" by my pointing out most folks are underinsured... then you PROJECT solutions upon ME that I have never espoused!

STOP STOP STOP!!! Go back and R-E-A-D!

(I'm always fascinated by the oh-s0-righteous who take ME to task... and go ricocheting off into the ethosphere at angles nobody could have ever imagined....

Reminds me of the old SNL skit with Gilda Radner... going off about "Violins in Isreal"... LOL!!!)

========================

Hi Mulchmamma,

So, pre-pay a mortgage? If it means more cash flow without increased risk and a better standard of living, why not?

EXACTLY right!!!! Its simply sad and amazing that so few people stop to actually "do the math" and determine WHEN it is finally appropriate to eliminate the leverage, and all it provides.

Have an awesome weekend!
Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

"AND... to top it all off (sure to make you smile,) NONE of this is emburdoned to the taxpayer through Uncle Sugar! "

Is this a benefit or a disadvantage?

Because if I had put my life savings in a life insurance policy that I cannot access for many years without penalty, I'd have sleepless nights reading how banks fail, insurance companies are at the brink of failure etc.

This investment vehicle that you suggest isn't even FDIC insured! So if this life insurance you pitch actually does fail (quite likely, if you read the news nowadays), I'd have NOTHING. ZIP. NADA. - except my mortgage on my house.

As it is, I have plenty of CASH (oh, the horror), own my house free and clear, have no debt and if I should lose my job (a real possibility, given how things are going), I am soooo glad, I am not indebted to anyone and will be able to live in my house without the risk of eviction for several years just on savings alone (btw. I'm in my mid 30s and really glad I didn't fall for this leverage nonsense - judging by the pale looks in the panicked faces of my coworkers who don't own anything besides investment "papers" that fall 10% each day).


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RE: Don't Prepay Your Mortgage [Consumer Reports]

>>think about the number of homes that are wiped off the face of the Earth each year simply by natural disasters. What portion of those lose most, or all, of their real estate equity? I don't have the statistics, but its quite significant to say the least. <<

It would only be true if they had no homeowners insurance or the insurance, for whatever reason/Acts of God, did not pay out.

Homeowners whose properties were damaged in the 1989 Loma Prieta earthquake, centered in Santa Cruz, all rebuilt or sold their properties, in which case the new homeowners rebuilt. Current price for a 2bd house recently sold was reported on Zillow as $799K. I can assure you that in 1989 that home would not have cost more than $200K, and most probably less than that. Our 2 bd Oakland hills home was purchased for $180K in 1989 at the very top of the market, just before values fell (lucky us, LOL).

Insurance does not pay everything, but the value of the property is in the land. Out here some 75-80% of the value is land-only, which is why there are so many tear-downs in older neighborhoods like ours.

During the 1991 Oakland hills firestorm, many homes were completely destroyed. All of them were rebuilt (and most of them a lot larger than before, not surprisingly). One of our friends had been burned out for the SECOND time - they lost their first house in the 1982 hills' fires! Each time they said they had to come up with about 15-20% to rebuild the house to equal their previous dwelling. Despite their being burned out twice, they had received such considerable appreciation between the two fires, in the end they said they had not really lost any money.

Lots that were not immediately rebuilt, were sold to other owners who would rebuild. They just aren't making any more land around the SF Bay Area [grin], so buildable lots are always valuable.

So I don't agree with you that considerable equity is lost. In an earthquake or fire, I would expect to have to come up 15-25% to rebuild to our satisfaction, but the remainder would be covered by our homeowners and earthquake insurance policies.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi jrldh,

if I had put my life savings in a life insurance policy that I cannot access for many years without penalty, I'd have sleepless nights reading how banks fail, insurance companies are at the brink of failure etc.

So then only use cash-value accounts where you are NOT restricted from accessing all, or the majority, of your cash value,

This investment vehicle that you suggest isn't even FDIC insured!

To quote you;
Is this a benefit or a disadvantage?

Life policies are insured for much more than the $100,000 minimum the FDIC policy covers (often 5 times the FDIC limits) and have the identical perfect record (nobody in the U.S. has lost their cash-value principal from a life insurance company failure in the history of the industry.)

So... which "insurance policy" would provide sounder sleep when talking about life savings protections?

So if this life insurance you pitch actually does fail (quite likely, if you read the news nowadays), I'd have NOTHING. ZIP. NADA. - except my mortgage on my house.

Wrong, entirely. See above.

As it is, I have plenty of CASH (oh, the horror), own my house free and clear, have no debt and if I should lose my job (a real possibility, given how things are going), I am soooo glad, I am not indebted to anyone and will be able to live in my house without the risk of eviction for several years just on savings alone (btw. I'm in my mid 30s and really glad I didn't fall for this leverage nonsense - judging by the pale looks in the panicked faces of my coworkers who don't own anything besides investment "papers" that fall 10% each day).

Depending on how you define "Plenty of cash" that is the key to it all... and perfectly in alignment with everything I advise from the top down.

You'd have to squint and ignore my content really hard not to have realized that by now. Cash is king... and giving it up to eliminate beneficial leverage before you can actually afford to is simply dangerous to your financial safety. That's all there really is to it.

=============================================

Hi Jkom,

You're right in regards to equity... but you missed the point about liquidity (which I may have been lax in specifying above.)

If you have a "free & clear" home that is well insured, and it is wiped out by a combination of cross-insured events (like hurricane victims who were cross-covered by flood insurance and also wind/rain damage insurance... who then fought amongst each other in courts all the while holding back your home value benefits...)

VERSUS... the neighbor with all (or most) of their home equity seperated into a principal-guaranteed growth savings account...

The person with their equity rebalanced into safer non-vulnerable accounts is clearly in a far better position for their immediate family's security and their life continuity.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I see this has risen up again. Gotta say I'm feeling mighty fine right now that I paid off my mortgage in 15 years rather than taking cash out and investing add'l funds in the market. Math may not add up in the long run and it may be "emotional" but it's a great feeling at the moment.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Dave,

I admit I didn't read every post in this thread as so many started to seem repetitive.

But I do have one question anyway; if you've already adressed it above, please let me know and I'll go read more thoroughly.

Suppose you own a home, with a mortgage for most of the value of the home. And because you haven't prepaid the mortgage, you've saved quite a bit of money and invested it and it's doing ok and is safe. And you have the house insured, of course. But something, not covered by insurance, happens to the house, destroying it. This, I think, is one of the reasons you say it is good to have the mortgage and the savings elsewhere. Am I right or mistaken about this?
If I am right, then my question is - don't you still have to make your mortgage payments until the mortgage is paid off? And if so, are you really that much better off? I guess I can see that you would be. If you had $100K in savings and only had to make a $2K a month payment on the mortgage on the destroyed house, then you'd be able to continue living (renting maybe) off your income, assumming you still had a job at the time (your place of business wasn't destroyed by the same event that destroyed the house). What are your thoughts on the various options here?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Thetews,

Suppose you own a home, with a mortgage for most of the value of the home. And because you haven't prepaid the mortgage, you've saved quite a bit of money and invested it and it's doing ok and is safe. And you have the house insured, of course. But something, not covered by insurance, happens to the house, destroying it. This, I think, is one of the reasons you say it is good to have the mortgage and the savings elsewhere. Am I right or mistaken about this?

Yes, partially right anyways. The more important benefit is that you are left in full control and access of your equity value in immediately (or fairly rapidly) accessable funds.

Even when you are fully insured against the disaster that wipes out your home, getting access to your insurance benefits can take a long time (and sometimes involve legal processes in defense of your benefit demands.)

If I am right, then my question is - don't you still have to make your mortgage payments until the mortgage is paid off? And if so, are you really that much better off? I guess I can see that you would be. If you had $100K in savings and only had to make a $2K a month payment on the mortgage on the destroyed house, then you'd be able to continue living (renting maybe) off your income, assumming you still had a job at the time (your place of business wasn't destroyed by the same event that destroyed the house). What are your thoughts on the various options here?

You've thought through and self-answered your own question perfectly!

Cash is king... and when all else fails, you can survive through the tough spots on cash-in-hand... but "interest saved" by giving away that cash back as early payoffs to the mortgage bank (even if it emotionally felt great at the time) won't even buy your kids a sandwich when everything is unaccessible.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

I haven't read the whole thread. But--

Did anyone mention how suspicious it is that the Consumer Reports article compared paying down the mortgage to investing in the S&P 500 from *1986 to 1996*?!? Peculiar years to choose, don't you think? Instead of, say, the most recent ten years, which is what the Wall Street Journal called "The Lost Decade" back in March 2008, when Consumer Reports published this article? Nominal 10 year S&P returns are at negative 18% as of today!


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Uh Humm, where is D.Donhoff, Fannie Mae & Freddie Mac now..2 of the 3 are under house arrest.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Woodinvirginia,

Uh Humm, where is D.Donhoff, Fannie Mae & Freddie Mac now..2 of the 3 are under house arrest.

I'm right here, same as before... and the financial truth stands unchanged.

Thanks for asking!
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dan:

I read from the very top of this thread when I stumbled upon it via a Google search on 'Prepay vs Refi'. Very emotionally charged this thread; must have spent a good 2-3 hours trying to understand the postings. I was totally against your argument (angry even) in the beginning but eventually came around to understanding what you are trying to explainthe basic economic concept of maximizing your utility.

We are currently in the 7th year of a 30-year fixed mortgage at 5.75%. Eventhough we could have originally afford a 15 year mortgage, we choose to have the leverage of lowered monthly payments so that we can 1) invest the additional money or 2) be financially stable should one of us looses a job. Through budget tightening, we now have an extra $400 a month to invest. I took about a 50% hit on my various investments last year (401k, VUL, IRA) and this quarter does not look to promising either so I am somewhat skeptical on when the market might rebound. With this skepticism in mind and the fact that I hate my mortgage company for what they did to us post-Hurricane Ike, we are thinking that the additional $400 monthly towards the mortgage might be a better way to go for now. We like to think of it as our very own personal refinancing plan. Same results but no ridiculous closing fees and the flexibility to resort back to a lowered payment should one of us looses a job. With interest rates so low, we even thought about refinancing the other way to get another 30-year mortgage at 4.50% but still adding all the extra money towards the principle. Fees and recouping time steered us away.

Questions for owning the house outright: Why is house rich, cash poor so bad? As long as you can pay for your property tax and minimal utilities, you still have a roof over you head right? Granted standards of living might be lowered, but it beats living in the streets. You can always sell it and rent an apartment. Likewise for the imminent domain argument; some kind of compensation will be available for you. As for Act of God, insurance should compensate; or worse case scenario, you can pitch a tent on YOUR land.

Questions for carrying a mortgage and leveraging for as long as possible: As morally repugnant as a previous user put it, you still can walk away from your mortgage should you be upside down and keep all your liquidity, right? The only things you would loose are your equity and credit (and dignity). Just chalk up the interest as rent paid for your time at the house (OR you can try to take advantage of the current Administration bailout policies J LOL). Seriously, should you walk, can the bank go after your liquidity in this situation? Im not familiar with bankruptcy and foreclosure rules and their ramifications. I always thought that walking away is one of the leverage I have for a prolonged mortgage. Also, an assumption that I always have is that all debts under my name would go with me to the grave should I die and my wife gets to keep the liquidity. Am I correct or does my wife have to shoulder the financial burden (life insurance aside) eventhough her name is not on any of the debts?


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Tom,
(JUST jabbing ya! Everyone calls me Dan, Don... whatever... ;~)

I read from the very top of this thread when I stumbled upon it via a Google search on 'Prepay vs Refi'.

Google is sweet, no?

Very emotionally charged this thread; must have spent a good 2-3 hours trying to understand the postings. I was totally against your argument (angry even) in the beginning but eventually came around to understanding what you are trying to explainthe basic economic concept of maximizing your utility.

I *LOVE* seeing that kind of epiphany happening!!!

We are currently in the 7th year of a 30-year fixed mortgage at 5.75%.

Side Note; REALIZE that the year # is meaningless except for how it affects the weight of your amortization burdens. The further you go, the heavier the weight on your payments against your liquidity.

You can *ALWAYS* stroke a check, at any moment, to eliminate as much of your leverage as you can afford. Of course... trying to do so BEFORE you can actually aford it (like the people who constantly shave away their safety cash with extra monthly principal surrender payments) is simply dangerous & cash-foolish.

Even though we could have originally afford a 15 year mortgage, we choose to have the leverage of lowered monthly payments so that we can 1) invest the additional money or 2) be financially stable should one of us looses a job. Through budget tightening, we now have an extra $400 a month to invest.

That is both smart, and responsible!

I took about a 50% hit on my various investments last year (401k, VUL, IRA) and this quarter does not look to promising either so I am somewhat skeptical on when the market might rebound.

OUCH! I would strongly suggest getting OUT of investments that are still open to downside losses, if you cannot aford to lose your principal. Your 401(k)* and traditional IRA (especially after the market collapses) can be rolled on a tax-efficient basis into a ROTH IRA (or similar) and then engaged in fixed-indexed instruments (income or growth annuities) that catch any annual upsides to the stock markets, lock in the gains against any future losses, and guarantee your principal against any stock market downsides.

That VUL can be tax-free 1035 exchanged to a fixed-indexed universal contract that will provide the same (or better) upsides, with guarantees against any losses to the downsides.

NOW is DEFINITELY the time to stop the losses and get in a position to take advantage of volatility (riding the up-waves, and then locking int the gains with guarantees against downside losses on the down-waves.)

With this skepticism in mind and the fact that I hate my mortgage company for what they did to us post-Hurricane Ike, we are thinking that the additional $400 monthly towards the mortgage might be a better way to go for now. We like to think of it as our very own personal refinancing plan. Same results but no ridiculous closing fees and the flexibility to resort back to a lowered payment should one of us looses a job. With interest rates so low, we even thought about refinancing the other way to get another 30-year mortgage at 4.50% but still adding all the extra money towards the principle. Fees and recouping time steered us away.

I'd suggest you were either miscalculating, or analyzing from a misperception. Depending on the size of your home value, re-balancing your leverage from 5.75% to 5% or lower, and moving as much of your real estate equity OUT of the house and into tax-free principal-guaranteed growth vehicles with stock-index upside (at a 8-10% average) versus yoru tax-deductible sub-5% cost of leverage... its really far safer, conservative, and more responsible.

Questions for owning the house outright: Why is house rich, cash poor so bad?

Because "you can't eat real estate equity."

As long as you can pay for your property tax and minimal utilities, you still have a roof over you head right?

Doesn't really matter if you can't afford the rest of the common costs of survival during duress.

Granted standards of living might be lowered, but it beats living in the streets. You can always sell it and rent an apartment.

Hate to be an involuntary, desperate seller in the current real estate markets... and that's what you are suggesting as the "safety-upside" to your plan.

Likewise for the imminent domain argument; some kind of compensation will be available for you.

"Some kind" of compensation? Google "Kelo emminent domain" and see how reliable our government is in that regard. Do you really prefer to leave your family's financial security & safety in the hands of the courts? (And do you really think that in times of desperation you can wait it out & fund the litigation required?)

As for Act of God, insurance should compensate;

Tell that to the H. Katrina people... the ones who got stiffed while various insurance companies played games of "chicken" through the court systems to see whether the damages to be covered were caused by wind-driven rain, or wind-driven floods (yeah... like it mattered!) And the entire time NO checks were issued...

Tell that to the California earthquake victims who's homes were destroyed by the indirect consequences, and not by the earthquakes themselves.

Insurance is the "contractual rental of other people's safety reserves." It can never effectively cover the safety you can give yourself by using your OWN reserves instead of someone else's (at their own rules of engagement.)

or worse case scenario, you can pitch a tent on YOUR land.

And feed yourself with what? Using what sewage systems? Getting water, heat & power where?

Cash reserves means you can take your family to safety, WHEREVER that may actually be.

Questions for carrying a mortgage and leveraging for as long as possible: As morally repugnant as a previous user put it, you still can walk away from your mortgage should you be upside down and keep all your liquidity, right?

The answer is; It depends on your state's laws. Some states say purchase money loans are non-recourse, but refinance loans are not (i.e. California,) while other states say that purchase loans ARE recourse, and equity refinancing is not (i.e. Texas.) Homestead laws are various among different states as well.

CASH is the ultimate law... "the golden rule" remember.

The only things you would loose are your equity and credit (and dignity). Just chalk up the interest as rent paid for your time at the house (OR you can try to take advantage of the current Administration bailout policies J LOL). Seriously, should you walk, can the bank go after your liquidity in this situation? Im not familiar with bankruptcy and foreclosure rules and their ramifications. I always thought that walking away is one of the leverage I have for a prolonged mortgage.

See above.

Also, an assumption that I always have is that all debts under my name would go with me to the grave should I die and my wife gets to keep the liquidity. Am I correct or does my wife have to shoulder the financial burden (life insurance aside) eventhough her name is not on any of the debts?

It depends on how you have planned & structured your estate. NOT to be taken lightly... a seperate conversation than cash/liquidity... but super-critical nonetheless.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Touch! LOL. Sorry about the name, Dave :-). Did I mention I've spent 2-3 hours reading this thread? Thanks for your thorough reply. I can be verbose (sometimes) and I really appreciate you taking time to answer some of my concerns. Hopefully, you can elaborate a little further on the points below.

[That VUL can be tax-free 1035 exchanged to a fixed-indexed universal contract that will provide the same (or better) upsides, with guarantees against any losses to the downsides.]

Since my 401k is with a previous employer, the VUL is where most of my investment monies go into on a monthly basis. Im not familiar with the fixed-indexed universal contract. What is it? Does it provide for the life insurance aspect? Any fees associated with the switch?

[I'd suggest you were either miscalculating, or analyzing from a misperception. Depending on the size of your home value, re-balancing your leverage from 5.75% to 5% or lower, and moving as much of your real estate equity OUT of the house and into tax-free principal-guaranteed growth vehicles with stock-index upside (at a 8-10% average) versus yoru tax-deductible sub-5% cost of leverage... its really far safer, conservative, and more responsible.]
So you are suggesting that I re-up with another 30-year fixed mortgage? I have about $12,000 in equity on the house. How would I remove that equity from the house OR did you mean equity going forward should I refinance? I believe the refinance rate quoted me is 4.375% with $6,500 closing. I hate closing costs and the fact I have to stay another 3 years in my house in order to recoup. I guess I could use the extra cash along with my $400 surplus each month to invest in tax-free principal-guaranteed growth vehicles. What are some examples?

[while other states say that purchase loans ARE recourse, and equity refinancing is not (i.e. Texas.)]

Okay if my screen name hasnt given me away, what does recourse mean for Texans? Not that I would just up and walk out of the mortgage, but if real estate prices continue to tumble and I become upside-down, can I walk? Should I walk? Can I keep the cash I have in these other liquid investments? Or will the mortgage company try to go after them?

Ps. I was being facetious with the roof-over-you-head-at-all-cost questions :-b Just wanted to stir the pot a little since its been closed to a year now since the thread started.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Tony,

Since my 401k is with a previous employer,

If you're no longer employed where that 401(k) had been provided, you are allowed to roll it out to an IRA. FURTHER, if your holdings have taken a hit to value, you may be able to use the carried-forward loss to cancel out the taxation of rolling straight out to a ROTH IRA (which is preferrable if you prefer to have it grow tax free rather than tax-deferred.) This is *NOT* a DIY thing though... you need a knowledgable financial planner &/or IRA specialist to handle this in a way you don't accidentally incur IRS penalties on yourself.

Since my 401k is with a previous employer, the VUL is where most of my investment monies go into on a monthly basis. Im not familiar with the fixed-indexed universal contract. What is it?

The financial growth accounts in the insurance world come in two categories; Fixed and Variable. However, UNLIKE mortgages... the terms are NOT self-explanatory.

In the insurance world, these are defined as follows;

Variable = earns money by being completely integrated with the stock and mutual fund markets, with full exposure to all the potential upsides, and full exposures to all potential losses. Further, because "variable" programs involve the trading of stocks/mutual funds directly in your seperate account, there are usually significant "management fees" charged to pay for the stock market jockeys who try to beat the markets.

Fixed = earns money by an "assigned credit" just as a CD or savings account at a bank would be. Fixed accounts can (and do) provide written guarantees of principal... a protection against any loss of money... fully backed by all the reserves held by that company.

Within the "Fixed" side of the insurance world, there are "Indexed" accounts. These accounts come with a guarantee protecting against loss of money on the downside, however the "credit" that is applied as your earnings is determined by tracking the rate of growth of one of the broad market indexes. The most common is the S&P 500, but the DOW, the NASDAQ, and the Russell5000 are also often available as a selection.

Fixed-Indexed accounts have no "management fees" the way that Variable accounts do. Instead, the provider offers a guarantee of no loss (so, no return less than zero,) and also puts a "cap" on the possible upside (i.e. if the index goes up 20%, and the cap is 15%, you are credited only as high as the 15% cap.) Due to the market positions taken, the insurance company itself probably only sees a return of maybe 17% as their own "cap" even when the market goes to the moon... but that 2% "haircut" is one ofthe ways they "make" their management fees, over time.

Does it provide for the life insurance aspect?

There are fixed-index annuities (appropriate for your rollout from the 401(k) to a ROTH IRA, for example.) These annuities have built in insurance features, but the benefit dollar amounts are generally just the balance of the funds put into the account.

There are also fixed-index universal life policies (the perfect replacement for the VUL accounts.) These can be structured with as little as $50,000 in death benefit, up to as high as your personal situation qualifies for (in some cases many millions of dollars in death benefits.)

Any fees associated with the switch?

There are two ways to go about using such program strategies;

A) No Load products... which have no internal "loads" or administrative fees & commissions. Of course, there is no free lunch unfortunately, and no-load products are only available through fee-only planners (so there you have fairly significant up front fees associated.)

B) Traditional products (or "normal load" though nobody calls them that.) Traditional universal life (and/or any other traditional insurance products) have ZERO up front fees to the client... but instead have either annual administrative fees, and/or a "surrender period" (similar to a prepay restriction for mortgages) during which you agree to leave your funds alone so that the company can have them make enough for BOTH of you so that the company's portion of the profits cover the transaction costs they paid to get it all set up in the first place.

So you are suggesting that I re-up with another 30-year fixed mortgage?

The answer is a big pregnant "maybe."

I have about $12,000 in equity on the house. How would I remove that equity from the house

Being that you are in Texas, you might not be allowed to, even if you wanted to. Texan legislators determined that Texans are not to be trusted with the final 20% of the equity in their primary residence (their homestead,) and wrote an ironclad restriction into the Texas Constitution itself prohibiting Texans from doing so.

OR did you mean equity going forward should I refinance? I believe the refinance rate quoted me is 4.375% with $6,500 closing. I hate closing costs and the fact I have to stay another 3 years in my house in order to recoup.

If you're not 90% confident, or better, that you'll have no reason to again refinance (let alone actually sell your home) for 3-5 years... you're likely better off leaving everything alone anyway.

The most prudent financial structuring (leverage versus asset classes) should always be done for a 5+ year perspective, in my opinion.

I guess I could use the extra cash along with my $400 surplus each month to invest in tax-free principal-guaranteed growth vehicles. What are some examples?

EXACTLY... see the explanations above ;~)

Cheers,
Dave Donhoff
Leverage Planner


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Follow up on Tony's last question

Tony,

Forgot your last Q, sorry;

Okay if my screen name hasnt given me away, what does recourse mean for Texans?

"Recourse" means being able to "get back at you" or "get revenge" or "get recompensation" (depending on your perspective.)

"Full recourse" in the lending world means that if you borrow $100,000, and only pay back $70,000 (for example,) the lender can sue for judgment of the remaining $30,000, and if they win can pursue you to pay that judgment.

"Non-recourse" means that the lender cannot pursue you for any amount other than what the collateral will get for them at re-sale.

SPECIFICALLY, in regards to Texans, it is a somewhat complex conversation... depends on whether the financing in question was for the purchase or equity re-access, and whether it was on a declared (or default) homestead property or not. If in doubt, best to ask a Texas real estate attorney.

Not that I would just up and walk out of the mortgage, but if real estate prices continue to tumble and I become upside-down, can I walk? Should I walk? Can I keep the cash I have in these other liquid investments? Or will the mortgage company try to go after them?

If in doubt, best to ask a Texas real estate attorney.

Cheers,
Dave


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi everyone,

I have tried to read through all of these posts and make sense of all of it, though I have a very limited understanding of finances. I'm hoping someone can give me a bit of info/advice .

Here is my situation:
- I am 34
- single
- currently renting an apartment in Los Angeles
- looking to purchase a house in Los Angeles
- have as stable of a job as one can have in this economy
- have enough saved to buy a house in my less preferred areas and enough to almost buy a house in other areas that I would prefer
- I am not very good with finances though have been very fortunate to have a good job and have lived somewhat thrifty for many years
- I am somewhat risk adverse after losing around $12k in the stock market back in 2000-2001
- I would like to buy a house sometime in the next year when I think prices get closer to what I anticipate to be the bottom
- all of my savings are currently divided between multiple savings accounts in banks, obviously not earning much interest, though it is FDIC insured

With all of that said:

1. I am wondering how to figure out how much $ to put down on a house or whether to try to almost buy one outright? Being risk adverse in this uncertain economy, my options really are FDIC backed banks or something similar, or putting it into a house. If looking at this decision based on potential interest earned in the bank vs. the amount paid to a lender for a loan, it would seem to me that the 2% being compounded in the savings account is less than the 5-6% I will be paying for the loan, right, making more sense to buy the house then earn less in savings interest. The plan would be to put a large amount down though keep a large amount in the bank for emergencies.

2. How do I calculate how much $ I will save by deducting interest from my taxes? I do not know which tax bracket I fall in, though I earned around $115,000 last year.

3. I am also a bit concerned after reading all the doom-and-gloom stories about our economy and the future value of the dollar. I do not really understand much about economics, though I am hearing some forecasting that at the rate our debt to other nations is growing, the value of the dollar will plummet in a few years. Is there any likelihood of this really happening? If so? I am guessing it will mean all of the $ I have worked so hard to save over the years will not be worth as much and it might make sense to put more of it into a house now? Can anyone comment on this?

4. I am also concerned about bank failures, even with FDIC insurance. I have been told that FDIC insurance guarantees you will get your money back, though they do not guarantee to pay it back all at the same time and they can do it over many years. Is this true?

Thank you for any info/input!!!!!


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Stanw,

1. I am wondering how to figure out how much $ to put down on a house or whether to try to almost buy one outright? Being risk adverse in this uncertain economy, my options really are FDIC backed banks or something similar, or putting it into a house.

The most conservative position is always to keep as much cash as required to cover all contingencies. If you run the numbers, the amount of any additional cash you might bury into a down payment would have otherwise carried you through many months (or even years) of safety by covering interest costs if you had to do so without a job, or in the face of unforeseen loss or desperation.

Always remember;
EVERYONE should eliminate their mortgage, but ONLY after they can actually aFford the risks of doing so (i.e. when they can aford to write a single check, and still have enough cash and working capital left over for a relatively low-risk lifestyle from that point onward.)

Even if you have 100% of the cash necessary to buy a house today, and even if we are at a market bottom in Los Angeles... unless you ALSO have enough remaining cash left over AFTER the purchase to cover all uninsured, unforeseen contingencies, AND enough income-producing assets to cover your lifestyle should you be unable to work.... a mortgage is your best cash protection.

If looking at this decision based on potential interest earned in the bank vs. the amount paid to a lender for a loan, it would seem to me that the 2% being compounded in the savings account is less than the 5-6% I will be paying for the loan, right, making more sense to buy the house then earn less in savings interest.

You can grow your funds in equally insured, compounding universal insurance accounts, tax-FREE, with guaranteed fixed rates of 5%, with options of selecting fixed-indexed credits that match the upside of any annual stock market index increases, but protect against any loss of your principal in stock market decreases (an "upward-only" ratcheting of your funds, annually.) NET/NET (even after the costs of the actual term insurance coverage) that outperforms at-risk market funds (and blows the doors off the 2% savings & CD strategies.)

That beats the pants off traditional banking products, and has the equally perfect record compared with FDIC insurance (nobody has ever lost their principal deposits in FDIC or private industry insured fixed or indexed accounts.)

The plan would be to put a large amount down though keep a large amount in the bank for emergencies.

Covering for emergencies is smart.... optimizing your safe growth plans is smartest.

2. How do I calculate how much $ I will save by deducting interest from my taxes? I do not know which tax bracket I fall in, though I earned around $115,000 last year.

How to calculate marginal tax rate

2008/2009 Tax Bracket Thresholds

THEN... use this formula;
(Face Interest Rate) multiplied by (1 - Marginal Tax Rate) = After-Tax Mortgage Interest Rate


3. I am also a bit concerned after reading all the doom-and-gloom stories about our economy and the future value of the dollar. I do not really understand much about economics, though I am hearing some forecasting that at the rate our debt to other nations is growing, the value of the dollar will plummet in a few years. Is there any likelihood of this really happening? If so?

FIRST OF ALL... recognize that ALL things occur in cycles... some are larger/longer cycles, some are shorter (even much shorter.) After some 12-15 years of raging long-run bull markets (with the 2000/2001 stock collapse being immediately replaced by a real estate orgy,) we are now in a downward cycle... it is 100% normal, non-surprising, expectable... and completely survivable for those who live responsibly and don't freak out.

NEXT.... YES!!!! Impending inflation (the collapse of the value of a cash-dollar held personally) is *ALREADY* occuring, and picking up steam. Most of the most savvy market analysts are predicting double digit inflation beginning as early as next year, and some are calling for the potential of inflation in the U.S. into the 20%s and even 30%s within the coming 3-10 years.

Virtually NOBODY is calling for no (or even just "low") inflation going forward from the mid to long term.

I am guessing it will mean all of the $ I have worked so hard to save over the years will not be worth as much and it might make sense to put more of it into a house now? Can anyone comment on this?

Not "into a house" as in "down payment" because if you do you will lose out on one of the hugest ways to protect yourself AGAINST inflation.

If you see what is coming, you want to do this;
A) Borrow dollars at TODAY'S dollar value, locking in the specific number of dollars (example, $100,000 in 2009 dollar value,)
B) Pay interest for it at less than the rate of real inflation (real inflation = double digits, real after-tax interest = sub-5%,)
C) Pay back the actual loan principal itself in FUTURE depreciated-value dollars (example; after 20 years the 2029 dollar will be worth significantly less than HALF the value of 2009 dollars... so paying off a loan of $100,000 borrowed in 2009 dollars... but using $100,000 of dollars received in 2029 is the equivalent of having HALF of your loan PAID FOR YOU BY THE CAUSE OF THE INFLATION ITSELF!)

Inflation is caused by the injection of imaginary money (money not backed by anything) into the economy by one or several governments, OR by private industry extending credit (which is also "imaginary money.)

1) Credit offerings have collapsed FAR below the norm... and this is also only a temporary cycle,
2) Governments all over the world (ESPECIALLY the U.S. government) is running the imaginary-money printing presses and flooding the markets with imaginary buying power at a rate never before seen in human economic history.

If you borrow (safely, responsibly,) at todays dollars... the government and the return of the credit industries will pay off a massive amount of your future debt, merely from the effect of inflation.

4. I am also concerned about bank failures, even with FDIC insurance. I have been told that FDIC insurance guarantees you will get your money back, though they do not guarantee to pay it back all at the same time and they can do it over many years. Is this true?

If never heard of the FDIC stringing out bank-failure beneficiaries... but in all of the economic U.S. history, no FDIC-insured bank depositor has ever not been made whole, and no state-fund insurance-covered cash contract holder had ever not been made whole.

Nobody can guarantee that the private reserve insurance nor the federal reserve insurance schemes will remain perfectly safe and reliable in the future... but they both have perfect track records looking in the past.

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi Dave,

Thanks for taking your time to respond!!! I'm going to go through your response in detail and I might have some follow-up questions if you do not mind :-)


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Stanw,
You are welcome (of course!) and no worries about follow-on questions. Bring 'em on... if they get too detailed we can always go "off boards."

Cheers,
Dave Donhoff
Leverage Planner


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Dave,
Assuming that inflation does kick in big time like everyone is expecting, does this necessarily mean that interest rates will climb accordingly? has there been a precedence where inflation was high and rates low? Thanks.


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RE: Don't Prepay Your Mortgage [Consumer Reports]

Hi NCRG,


Assuming that inflation does kick in big time like everyone is expecting, does this necessarily mean that interest rates will climb accordingly?

The answers are "it depends" and "not always, nor necessarily."

As I consider the question, we then have to dive deeper to establish the distinction of "WHICH rates?"

Interest rates for borrowing are a tail that wags behind the dog of interest credits guaranteed to buyers/investor of bonds. Different classes and types of bonds have different maturity dates. The duration (life-span) of the bond gives the buyer of the bond a degree of certainty of return against anticipated uncertainties.

Inflation is only ONE (albeit a huge one) factor that can affect the crediting or returns-earning on an investor's dollar. When a bond buyer anticipates that the value of their cash-currency will be degraded (i.e. inflation) to some degree of anticipation over a period of time, the bonds with that time duration will have to have a 'premium' interest credit over alternative duration bonds in order to "win" the investor's purchase.

SOME would argue that the current pricing of longterm bonds actually reflects the general market's foresight of LOW inflation... but this could only be true if the bond pricing was determined in a vacuum with no input EXCEPT anticipated inflation. Instead, bonds are being hammered for lack of confidence in the issuers (including the U.S. treasury.)

True sentiments about impending inflation can be deduced from the market's valuation of non-issuer hard assets (i.e gold, silver, durable commodities.) These fail to generate any yield (they just sit there, they don't spit out earnings, interest or dividends,) but they aren't affected by political policy; they can't be created out of thin air thereby diluting the value of all previous assets.

has there been a precedence where inflation was high and rates low?

Absolutely... but I can only say that so blatantly because you left the variables so ambiguous.

There are often times when immediate inflation is sky-high (think about when housing prices were doubling every 3-5 years in certain markets,) yet both the national long term interest rates, and even the local long term bond interest rates were DROPPING.

The reverse can occur as well... look at the current deflation of real estate... yet, because of the withdrawal of availability (qualification-ability) of mortgage credit, if you wanted to borrow the equivalent amount of money today over 80% of your home value, compared to 2004, you would have to pay a much higher blended rate of interest.

Why? In 2004 mortgage rates were a bit higher than today... but if you owned a $100,000 home you could use it to collateralize $100,000 of working leverage at, say, a total cost of 7%.

TODAY, (all income, credit, etc) equal) you might be able to borrow the 1st $80,000 at 5%... but the last $20,000 would have to be acquired on an unsecured basis at probably 12-25% interest rates... bringing your blended costs of interest on the same comparative dollar to more than 7%... DESPITE the deflation of the markets.

FURTHER... when talking "inflation/deflation" (as you may have already surmised,) we have to distinguish WHICH MARKETS we are talking about.

CURRENTLY we are seeing a strong INFLATION in consumer food goods. Milk, bread, eggs, and my wife's favorite aphrodisiac (chocolate) are on the rise.
We're seeing mid-term DEFLATION in fuel prices (after a nightmarish overnight spike of INFLATION.)
We're seeing a long-term DEFLATION in real estate prices.
Some markets are seeing inflation in rents, some are seeing deflation.

SO... you asked a simple, innocent enough question. Have I mucked it all up sufficiently with details? ;~)

Cheers,
Dave Donhoff
Leverage Planner


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