Pay off mortgage or invest extra funds

[jwgreene]

I confess I haven't read all of the posts, but there may be a way to pay off the mortgage at least a little sooner without increasing your monthly payment:

www.shredmymortgage.com

www.truthinequity.com

Full disclosure: I am about to embark on this strategy myself for student loan repayment. I have not personally done this yet but the math adds up FOR ME, maybe not you...

[Zaphod]

jwgreene wrote:

I confess I haven’t read all of the posts, but there may be a way to pay off the mortgage at least a little sooner without increasing your monthly payment:

http://www.shredmymortgage.com

http://www.truthinequity.com

Full disclosure: I am about to embark on this strategy myself for student loan repayment. I have not personally done this yet but the math adds up FOR ME, maybe not you…

Click to expand...

Please tell me how these are not scams, and if not why you need these cheesy infomercial companies.

[jwgreene]

I don't think it's a scam--bear in mind I'm doing this but have no data other than my pre-commitment math--because this is something you can completely do yourself without using the linked websites. In fact it seems pretty easy enough that I don't see the value in using them and plan on doing it myself anyway.

 

And I'm not saying this is not without risks. For me the risks seem low enough to commit to this.

 

Basically you use a line of credit as a checking account and leverage your income to pay lower interest and more principal over time, accelerating your mortgage payoff without paying extra on the mortgage itself.

 

I'm doing it to pay off my wife's student loans and compared to just overpaying the loans every month using the debt snowball method, we can pay off $150k in loans about 8 months sooner and pay about half the interest.

 

I'm happy discuss it more if anyone is interested. I can probably let you know more in the next few months after I see how the math plays out in reality.

[Zaphod]

Who is giving a line of credit lower than your tax adjusted mortgage rate? For student loans, maybe you could find it. What are these rates? Yes, we'd love to hear the basics. There has to be an angle where they profit on the spread, so conditions seem appropriate.

All I really need to know is who is offering the credit (and what are their requirements), at what rates and terms, etc...Its extremely interesting. Unsure what leveraging your income is as well.

[jwgreene]

Okay, I'll try my best at explaining it so please forgive me if I am being unclear.

For one, it doesn't matter what the interest rate is so much as it matters how much money you actually pay in interest. I'd rather have a loan at 50% APR on a $1 loan (50 cents per year) than a 0.01% loan on $100k ($10 per year). So the interest rate is only one piece; it is the average daily balance on the loan that is a very important second.

You asked what leveraging your income means, and I think it would be most helpful to give a more realistic example with numbers. Before I get into the example, I want to explain to anyone who may not know the difference between a line of credit and a traditional loan. With a traditional loan, you take the money and then have an agreed upon interest rate, and the loan is amortized into a fixed monthly payment. Some goes to interest (maybe most, depending on how big the loan and how early you are in the amortization schedule) and the rest to principal. Once you make the payment, you can't get that money back.

With a line of credit, you can take money out of the line of credit to use for expenses (like paying your credit card bill). Interest is also charged on the average daily balance of the loan, and you generally do have a minimum monthly payment, but unlike the traditional loan, you can take money back out of the line again when/if you need to. The ability to put money in and take money out at will is what makes a line of credit so powerful for high income professionals who also have a lot of debt to pay off such as a mortgage, or in my case, student loans.

There are two types of lines of credit that I'm aware of: a home-equity LOC (HELOC) and a personal LOC (PLOC). The former is secured and typically a lower interest rate; the latter is unsecured and typically a higher interest rate. Currently, most HELOCs I've seen are around 5%. Mine has an introductory rate of 2.74% for the first year.

Okay, on to the example, let's say person A has a traditional loan of $100,000. Mortgage, student loans whatever. The loan is at 5% APR. He makes $10,000 per month, expenses are $5,000. He has an emergency fund, so the rest of his income goes to the loan every month,  regardless of the term of the loan. He will have that loan paid off in 21 months and pay $4,632 in interest.

Person B transfers the same loan to a HELOC, also at 5% APR. He gets paid on the 1st. He puts the entire $10,000 paycheck into the line of credit. Now the interest being accumulated is on $90,000 instead of the full $100,000. During the month, he puts his expenses all on a credit card which payment is due on the 30th. On that day, the daily balance bumps back up to $95000. To make the math easier, let's say essentially for the entire month the average daily balance was $90,000 (ignoring the fact that on the last 1-2 days of the month the daily balance was higher due to the credit card payment). Then on the 1st he gets paid again. So, same loan amount, same expenses. In this example, person B will also pay his loan off in 21 months, but will pay only $3751 in interest, saving $881 in interest over less than two years. Not much difference in this scenario, but person B doesn't necessarily need that emergency fund because if an emergency does come up he can actually just borrow the money out of the line of credit, leaving him free to invest most or all of the emergency fund.

Let's try this on something more mortgage like. It get's more complicated but more powerful. Warning: you need to know how to create amortization schedules to double check my work.

Let's make these two physicians put $100k down on a $400k home, making $200k with a take home of around $11k monthly after taxes. Expenses are $8000 monthly (including mortgage). Physician A has a traditional 30 year mortgage, meaning his monthly payment is $1610.46. He makes no advance payments. At the end of 30 years, he will pay $279,767 in interest, or 93.3% of the total mortgage value. That interest rates seems pretty crappy now, doesn’t it?

Physician B gets the same house and same mortgage terms. However, he gets a $40,000 HELOC (90% loan to value, which is what most banks will give up to) immediately after purchase. He puts all that down on the mortgage principal. Now the mortgage is $260,000. He has advanced his mortgage amortization by 91 months (7.6 years), saving $106,764 in interest. If he makes $11k monthly with $8k expenses, he can get the HELOC paid down in 14 months, costing $662 in interest. Then he dumps the HELOC $40k back into the mortgage again, saving 61 months (5 years) and $60,317 in interest. He builds the HELOC back up, again costing 14 months and $662 in interest, and does that until the mortgage is paid off. The end result: home paid for in ~80 months. HELOC costs: ~$4,634. Mortgage costs: ~$49,593. Savings: ~$230,000 in interest. (I could be off by a couple thousand or a couple months…new to these calculations).

Now, what happens if you are Physician C and don’t use the HELOC and just pay all your extra income on the mortgage? You pay the mortgage off in 130 months, paying $88,887 in interest. So “leveraging” your income can become quite powerful, saving ~50 months and ~$34,000.

I have attached my spreadsheet I used to come up with the mortgage example. It’s probably hard to follow, and I apologize, but it’s hard to keep the math neat. I can clean things up if requested and answer more questions if requested.

If you read through all that, I thank you because it took a long time to come up with!

[Zaphod]

You should probably go back and read through the examples and discourse through the rest of this thread as lots of reasons why this is a generally bad idea are mentioned, and most people will not think of them off the top of their head.

For the record, I invest over paying down extra principal (besides very small nominal amounts) every time, in this environment with these low rates (after tax if we're talking mortgages) its a no brainer. The 1610/mo payment at year 30 in perpetual 1.5% inflation is worth 2510 (aka todays dollars are worth more than tomorrows and paying it today is more expensive). People always seem to forget this part, as well as the tax deduction you would be saving yourself by spreading it out, and causing more tax payment by paying it down early, etc...Dont confuse nominal and real.

I'll assume we're talking about student loans as this kind of scheme for a mortgage is based on a misunderstanding of finance and net present value of money, inflation, hedging and the like. Also, who actually keeps their home for 30 years? You, me, some people? Possibly, but on average people sell after 8 years. 100% agree the money is gone if paid down. You can still get a heloc even if the principal was going to mortgage itself and still have liquid funds, lots of trouble for little real benefit in a mortgage.

For student loans, you should really refinance first. Then, I have no issues with using a heloc (10y really low and I've seen great rates lately) as its a good way to take a non dischargeable non deductible debt and make it deductible and easier to discharge as well. Thats just a smart debt swap, and something I'll likely utilize in the future.

Dont get me wrong, I'll play the interest rate spread game (eg, dont pay qtrly taxes but do invest them for a spread), churn credit cards for rewards travel, even swap 0% balances for a bit, etc...so I love the game. This one just doesnt make a lot of sense, and relies on unrealistic terms (owning for 30 years, etc...) and discounts benefits (tax deductions) to arrive at some better number to make you feel better. Again, for a mortgage, too much work no tangible benefit. A mortgage is a currency short/inflation hedge, learn it/use it. Student loans, using a heloc could come in handy and gives your debt better attributes, but no need for all the rest of it, Heloc debt is also deductible.

[jwgreene]

Okay, I've read through all the post. And I'm trying to keep up with everything but admit I don't understand everything yet. I'm only 8 months into financial education and still in the negative net worth phase...

 

I too have read the statistic of the average duration of owning a home is 8 years. On a 30 year amortization, by year 8 in the above example you've only put $42,441 extra equity into the home when you sell. You've put $112,163 toward interest, even if that interest is tax deductible it's significant. If you could pay the home off in < 8 years as in the above example, you could sell it and buy another house likely outright. That "feels" like a good thing to me, even if your strategy works objectively better (but I don't see it yet).

I used the FV function and was surprised to see that if you took the extra $3,000 in the above example and invested it at 10% interest over 30 years, the total amount would be $493,000, versus in my example focusing on the house payment for 8 years and then investing the mortgage amount plus $3,000 into a similar investment would yield only $328,000. So my way I'm out $165,000. So I see that point. Compounding is pretty amazing.

However, I guess my final thought would be that if you can pay the house off in 8 years, you could then increase your HELOC to $200,000 if you wanted to and invest it all. Over 22 years at 10%, that would yield $1.6 million and cost you $30,000 in interest while paying off the HELOC over another 77 months.

I know that 10% is probably way too optimistic but it still seems like paying the home off sooner and taking a HELOC on the home of whatever amount your comfortable with and investing it wisely is not a terrible idea.

At this stage in my life, with my negative net worth and limited financial knowledge, I value the security of owning a home outright I guess.

[YYjames]

Didn't read any posts except OPs question

What I do: I invest instead of paying mortgage. Why pay a cheap interest mortgage? when I can make 6+% return on my money.

[Zaphod]

jwgreene wrote:

Okay, I’ve read through all the post. And I’m trying to keep up with everything but admit I don’t understand everything yet. I’m only 8 months into financial education and still in the negative net worth phase…

 

I too have read the statistic of the average duration of owning a home is 8 years. On a 30 year amortization, by year 8 in the above example you’ve only put $42,441 extra equity into the home when you sell. You’ve put $112,163 toward interest, even if that interest is tax deductible it’s significant. If you could pay the home off in < 8 years as in the above example, you could sell it and buy another house likely outright. That “feels” like a good thing to me, even if your strategy works objectively better (but I don’t see it yet).

I used the FV function and was surprised to see that if you took the extra $3,000 in the above example and invested it at 10% interest over 30 years, the total amount would be $493,000, versus in my example focusing on the house payment for 8 years and then investing the mortgage amount plus $3,000 into a similar investment would yield only $328,000. So my way I’m out $165,000. So I see that point. Compounding is pretty amazing.

However, I guess my final thought would be that if you can pay the house off in 8 years, you could then increase your HELOC to $200,000 if you wanted to and invest it all. Over 22 years at 10%, that would yield $1.6 million and cost you $30,000 in interest while paying off the HELOC over another 77 months.

I know that 10% is probably way too optimistic but it still seems like paying the home off sooner and taking a HELOC on the home of whatever amount your comfortable with and investing it wisely is not a terrible idea.

At this stage in my life, with my negative net worth and limited financial knowledge, I value the security of owning a home outright I guess.

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Paying down your mortgage extra reduces your liquidity in your day to day life which reduces your security, I know your answer is always heloc, which is great...but its an extra step and only at 80% value (unsure of many places that do 90% value at good rates). So your doing extra work by transferring and getting less out. If you were planning to invest it, just skip that step and do it at full value. Almost all of your answers come down to "feels". You have to remove that from your decision making process unless you cant sleep at night. I find the major reason for this is a misunderstanding of how it works. Also you have to think about it from a legal options and tax standpoint, you lose a lot of flexibility moving from a mortgage to a heloc that Im sure the pushers of these programs do not tell you about. Youre basically reducing your options legally and from a liquidity standpoint for very little gain.

Say you pay off your house, and then sell. There is no guarantee of what price you'll get for it, it may be less than you put in (and very well may be considering transaction costs), and all youre essentially doing is putting it in one pot and then pulling it back out into another except you added a hefty fee for the privilege. This strategy nearly guarantees you a loss compared to just paying regularly. Remember, you make more profit if you put less capital into it in the first place right? Two scenarios @ 8 years later:

A: 100k house paid off. Sell for 120, 20k profit (before realtor fees), 100k locked up (lost opportunity cost) from time you paid off until check clears. Total you have ~120k, and feel really great about it all.

B: 100k house, regular pay, 0% down. Sells for 120. Your principal left is 84628, so profit before costs is ~5k, ~35k after check clears and you didnt even have any extra principal locked away and invested the extra 833 a month for an astounding 6.5% CAGR, netting you another 105K for a total of 140k after 8 years.

Simplify your ledger into two basic categories, income and liabilities. Its over complicating things and confusing it by labeling it "interest" or "principal" and not just cash flow or profit, etc...Whatever scenario leaves you with more money and better net worth with the least amount of steps is the best. By all means pay the lowest rates possible, but dont oversimplify to where you shoot yourself in the foot.

Net worth gets better whether you pay down a debt or put the money in savings, it is category agnostic in this regard. You can either make it to zero and then positive net worth by paying down your debts, or accumulating appreciating assets. Debts are usually simple interest and for defined periods, investments like stocks, etc...and compound interest and can be trans generational in timespan. You have to really, really want it to pay down debt before accumulating assets instead. Imo, this is mostly a social thing and something you're made to feel like is supposed to be the way, and honorable, but makes no sense in our scenarios (reliable high income, etc..). As soon as you get a better understanding of finance, and a longer term view, you will likely reverse your present positions (just based off where you stand and how youre approaching it).

I was once like you and planned to throw every extra red cent at debt (due to ginormous negative net worth, still there just less ginormous) and learn all about finance to never let that happen again. But...in the process of learning about finance figured out my prior debt based ideals made no real world sense. Think about it, then do exactly whats best for you and your family. Sometimes I see people get super austerity like and often it comes from an emotional place and not one of understanding so I am just throwing that out there.

[YYjames]

Very well put Zaphod.

I would absolutely agree and add that physicians by nature are risk averse and would pay down debt

I am with you. I leverage debt.

Great post.

[Zaphod]

YYjames wrote:

Very well put Zaphod.

I would absolutely agree and add that physicians by nature are risk averse and would pay down debt

I am with you. I leverage debt.

Great post.

Click to expand...

Agree. As humans we are wired to over react and place too much emphasis on low risk events and not put enough on real risks, part of why we see the problems in health we do. The trick is to educate yourself about it and whats most likely. Doctors are even more so as unfortunately due to training our natural confirmation bias is actually increased as a way to come to the most likely conclusion. Its bad when this spills into the rest of your life, makes it harder to be rational.

The other thing people forget is that you only have so much tax protected and hard to reach savings space, at some point it will be in a taxable and accessible space its not lost forever like if you paid something down extra would be. If you all the sudden wanted less debt or to rearrange your balance sheet, you could at a moments notice. My mortgage and retirement funds are at one bank. It would literally take my about 30s to transfer my taxable account to my checking and then pay off my mortgage, 5 clicks and its done. You have flexibility and can change your mind.

You cannot later on starting from the other way. You cant all the sudden start to feel secure about earning well and living like a resident to decide youre not that concerned about paying down your debts ultra fast and want to build a nice nest egg...nope that money is gone forever and doesnt change your monthly cash flow a dime (unless you paid it off).

[PhysicianOnFIRE]

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Agree. As humans we are wired to over react and place too much emphasis on low risk events and not put enough on real risks, part of why we see the problems in health we do. The trick is to educate yourself about it and whats most likely. Doctors are even more so as unfortunately due to training our natural confirmation bias is actually increased as a way to come to the most likely conclusion. Its bad when this spills into the rest of your life, makes it harder to be rational.

 

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Very true.  I like to tell anxious patients that statistically they are much safer under anesthesia than they were in the car ride to the hospital, even though I'm sure they are (or were driven by) an excellent driver.

Of course, as you say, we're not wired to think that way, which is why John Madden takes the bus instead of flying.  And why I reach for the versed when my explanation falls on deaf ears  

[StarTrekDoc]

We're in the same boat :  mid-40s and ability to pay off our mortgage now from our taxable account but holding off

30yr Mortgage 4% -  $500,000  yr 3 of 30

Taxable account $500,000  -- Living in California.

 

Definitely understand the benefit of Home ownership and knowing a guaranteed savings yearly, but a few things that keep us from paying off.

1.  California -- earthquakes/fires; 100% equity in the home is a large risk even with all the insurance.  I'd like to keep eggs spread out since house is 1.4M worth.

2.  Locked in low interest rate:  historically lowest and will probably rise into the future where the 500,000 in taxable accounts will flex upwards even in safe bond/muni bond market -- could simply do California bonds and do at least break even.   With earnings ongoing, no reason to pull FIRE trigger unless needed.

Will we sleep any sounder if we paid off the mortgage instead?  Probably not with the California risk in itself.  

 

 

[adventure]

You might also consider what effect (if any) eliminating debt would have on your debt to income ratio, if you were to pursue other loans. (mortgages, business, etc).

Having flexibility is worth something.

[G]

Some people buy fancy cars, I pay off my debt.  A luxury purchase!  To be fair, when I have extra cash flow secondary to no monthly mortgage payment, I'll probably just buy more expensive scotch.