Prepaying Mortgage vs. Investing

T

TimHume_IHB

New member
<p>Consumer Reports analyzed when it is better to spend $100 on prepaying your mortgage or to invest that $100 in an S&P 500 Index mutual fund. Basically, they came to the conclusion that it is usually better to invest in the mutual fund, moreso the longer you keep the loan.</p>

<p><a onclick="return top.js.OpenExtLink(window,event,this)" target="_blank" href="http://www.consumerreports.org/cro/money/credit-loan/prepaying-your-mortgage-3-08/overview/prepay-mortgage-ov.htm">http://www.consumerreports.org<wbr></wbr>:80/cro/money/credit-loan<wbr></wbr>/prepaying-your-mortgage-3-08<wbr></wbr>/overview/prepay-mortgage-ov<wbr></wbr>.htm</a></p>

<p>What do you think?</p>
 
I agree with the concept. I'd rather pour more money into my wife's 403(b) over the next 10-15 years and not pay any principle down during that time. That's why I am a fan of interest-only loan products. I'll probably shift toward making big principal payments during the last 10-15 years of my loan though just in case...
 
I'm paying off my 2nd mortgage, which sits at 9.5%. I'll keep the 6% 1st in place and invest the rest once the 2nd is taken care of.
 
<p>It's really simple: </p>

<p>1.) Move your investments to higher rates of return </p>

<p>2.) Move your debts to lower interest rates </p>

<p>Unless you are guaranteed to earn a rate of interest above your rate of debt, you should ALWAYS pay down your debt. I always laugh when I see people with 50k in a savings account and yet they owe 40k in credit card debt, all above 10% in interest. You can still save in a 401k because it's prior to taxes, but before you save a dime of your net income, you should start paying off your debt. Start with the highest interest rate debt and move down. Once you are free from debt, you can start to maximize your savings.</p>

<p>It's a vicious cycle, debt is, but it is great when you pay it down. The more you pay down, the lower your payments are, and thereby decreasing your need for additional use of it.</p>
 
IMO, paying down debt is always better. When you invest, you take market risk, and you may not see the rate of return you were hoping for. When you pay down debt, you know exactly what rate of return you are getting -- the interest rate you are paying. It is very rare to find an investment consistently yielding a higher rate of return than what you are paying in debt. In fact, if such an investment existed, it would quickly be bid up in price to the point where the yield was lower than competing debt. Although, I do agree with ipoplaya if you are investing in a tax-favored account because the compounding effect without the taxes taken out over the long term is better than paying down debt.
 
<p>T!m - Here are some other comments on this topic:</p>

<p><a href="http://forums.irvinehousingblog.com/discussion/348/mortgage-or-cash/#Item_17">http://forums.irvinehousingblog.com/discussion/348/mortgage-or-cash/#Item_17</a></p>
 
<p>Depends on your personality too. We just wanted our house free and clear, so we could live somewhere, and not be kicked out. Even a small payment could get you into trouble, if you got under really bad circumstances.</p>

<p>Get to know yourself. $100 paid off on a mtg is 100 bucks that you are not going to be tempted to spend on junk. Especially now that HELOCS are going away.</p>
 
<p>I think the interesting thing in the article is that is tries to look at the unknowns and come up with something we can know or at least make an educated guess at. I think it is pretty clear that it is better to pay off a 10% interest debt than to invest in a 5% interest investment. However, when it comes to investing in stocks/mutual funds, the interest rate is unknown and variable.</p>

<p>IR - in general, I agree with you. But, I think it is interesting that their report shows that if you take on that market risk, you almost always win. Now, granted, they haven't looked at every possible scenario, but they looked at many. I think the general rate of return in many Index funds is higher than mortgage rates currently available.</p>
 
<p>If your mortgage is at a reasonable rate, it makes good sense to max your tax deferred / tax favored investments first, then start paying down that principal debt. This is especially true if done early in the retirement savings cycle so the compounding advantage is maximized. </p>

<p>I wish we had been maxing our Roths back when we could still contribute vs. paying the $500/month toward principal on our mortgage. Stupid IPO... I should have done an interest-only 5/1 ARM! </p>
 
I kinda like the idea of having no skin in the game. It gives me something to walk away from when disaster strikes. The walk-away folk are being rewarded with all kinds of special treatment and think I deserve a slice of that pie.
 
<p>Here you go, Eff. Bon apetite!</p>

<p><img alt="" src="http://www.lamppostrealty.com/commercial/images/franchise/apple_pie_slice.jpg" /></p>
 
I think that there is a tangible psychological benefit to paying off debt at an accelerated rate...



I remember my (private) law school loans... aka the luxury car that I'll never drive... instead of taking the 25-30 year payment plan, I discharged that monkey in 5 years, although I may have taken my lunch to work for those years, and been otherwise very frugal. Paying off those loans freed up so much buying/saving/investing power... which allows me to consider a home purchase this year, etc.



Meanwhile, most of my friends have another 20 years...
 
<em>"I think that there is a tangible psychological benefit to paying off debt at an accelerated rate..."</em>





I can attest to that as well. I paid off my the last student loans in one large lump sum. People may argue it was not the best financial decision because the interest rate was relatively low, but having that weight off my shoulders has been more satisfying than anything I would have done with the money I used to pay it off.
 
Yeah, I think another benefit to paying off debt is that it makes me less want to have any other debt. It's like not cheating on a diet or something.
 
Effenheimer wrote: I kinda like the idea of having no skin in the game. It gives me something to walk away from when disaster strikes.



Well, it's not like there are no consequences if you do walk away. If you walk, you'll suffer trashed credit and, possibly, a deficiency judgment or a 1099 from the lender from which the IRS will extract "phantom tax." (Mortgage Forgiveness Debt Relief Act of 2007 provides relief only from purchase loans; if you refinanced, your loan turns into a recourse loan.)



http://www.whitehouse.gov/news/releases/2007/12/20071220-6.html
 
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