Retirement Savings vs Paying Down Home

[Wister5]

Hello -

I would love some advice. My husband is approx. 15 years away from retirement (not looking to retire earlier) and we are on track to reach our "number" when we get there. In fact, we are currently saving 23% of my husband's gross salary toward retirement. (401K, Backdoor Roth, Mutual Funds.)

College for the kids is on-track to be fully-funded (at least undergrad. Hoping we will be able to help with graduate school if needed.) We have an Emergency Fund of almost 6 months put aside/available - and my husband's job situation is very stable.

Here is my question: Should we drop our retirement savings down to 20% and use the additional 3% to

1. pay down the house?

2. invest it into a "pay down the house" mutual fund and then make a lump-sum payment at some point? Or

3. continue saving toward retirement?

I should add that we currently owe $360k on the house at 3.5% interest. We have no additional debt.

Thanks you in advance for sharing your opinions! Oh...and is there something I have not considered?

[Zaphod]

You should do whatever fits your specific plan the best since all are great choices.

I would continue saving towards retirement, whether thats in a taxable which you think of as "mortgage-paydown" or whatever. This not only is the most correct by the math and will leave you with the most money in the end, it also gives you the most options today as you will have another source of funds in case of emergency.

Your house is insured, inflation even low inflation, will erode the cost of your mortgage over time anyway, and you'll have more funds on hand without being solely at risk should something happen to the house.

[TheHappyPhilosopher]

Mathematically it is almost always advantageous to keep a mortgage at 3.5% and invest the difference over a long time horizon. In my mind there are only two advantages to paying down the mortgage.

1. In some states a primary residence acts as asset protection. Everyone will value this differently. This only applies if the money is being investing in an account with no asset protection (ie: nonqualified). If it is the choice between mortgage and 401k I would say no advantage.

2. Paying off the house in full lowers monthly cash flow needs. This is important in the case of an emergency where you have no income. For this reason I am either going to keep my mortgage as long as I can, or pay it off in a lump sum all at once. There is really no advantage to paying down parts at a time as you still have the obligation to pay the mortgage. I would rather have a 500k mortgage and 500k in additional savings that 250k mortgage and only 250k in additional savings. The person with the 500k mortgage has more options if either an emergency or investment opportunity arises.

[DMFA]

You're between a pillow and a soft place.

How many years left on the mortgage?  How much cumulative interest left to pay on that amortization schedule, taking into account tax deduction?  If you're in 33% bracket, your effective interest rate is 2.345%.  About half of that is how much you'll "earn" from paying it early since that principal is amortizing over time, which is probably less than inflation since the Fed "wants" inflation to be around 2%.  That generally argues against paying mortgage early.  On the other hand, since you would do very well not to carry any debt into retirement, if you have a longer term on that debt then you would benefit from eliminating it sooner.

Either way, you sound like you're in a very good place, and barring catastrophe it seems as though you should cruise into retirement.  Cheers

[Dr. Mom]

All your choices are good choices. Personally I would not limit tax advantaged retirement savings to pay off the house at 15 years from retirement.  If you are maxing out tax deferred and are onto taxable investing, I would split the difference between investing and mortgage pay down as long as your liquidity needs are met.

[StarTrekDoc]

Good question and source of many debates on this forum on 'best course'.   As Zaphod said -- do what allows you to sleep best at night since all are good choices to the end goal.

We do #2:  We have a separate "house mortgage" taxable account in Fidelity that's designated at any given moment to push over to the mortgage balance.  It's weighted heavier to muni bonds for stability (which still outperforms the interest mortgage straight up) along with a conservative stock balance.

We do it for another reason -- earthquakes.  I don't want to own $1.4M all by ourselves on a single property; gladly would have BOA share the risk on this.

[FIREshrink]

You want to maximize your wealth? Odds favor investing (assuming you are a tax-efficient, low-cost, passive index investor).

You like the feeling of being debt free? Pay off your mortgage. Likely your terminal wealth will be somewhat lower, but odds are also that it won't matter.

FWIW, we invest rather than pay off the mortgage. Our rate is 3.625% and is scheduled to be paid off when I turn 72.

[Wister5]

Thank you to all who have weighed in thus far.  I have a follow-up question:

 

Should we be factoring  profit-sharing contribution into his "gross salary" for calculations?  For example...should we consider his "gross" to be:

 

Base salary + Bonus + Profit sharing contribution to 401K (which is currently 14% of his Base + Bonus) = 20% goal

-OR-

Base salary + Bonus = 20% goal (and then the 14% profit sharing contribution is used to reach that 20% goal)

Am I making sense??

I am thinking in circles over here....

 

[Zaphod]

TheHappyPhilosopher wrote:

Mathematically it is almost always advantageous to keep a mortgage at 3.5% and invest the difference over a long time horizon. In my mind there are only two advantages to paying down the mortgage.

1. In some states a primary residence acts as asset protection. Everyone will value this differently. This only applies if the money is being investing in an account with no asset protection (ie: nonqualified). If it is the choice between mortgage and 401k I would say no advantage.

2. Paying off the house in full lowers monthly cash flow needs. This is important in the case of an emergency where you have no income. For this reason I am either going to keep my mortgage as long as I can, or pay it off in a lump sum all at once. There is really no advantage to paying down parts at a time as you still have the obligation to pay the mortgage. I would rather have a 500k mortgage and 500k in additional savings that 250k mortgage and only 250k in additional savings. The person with the 500k mortgage has more options if either an emergency or investment opportunity arises.

Click to expand...

#2 is a good point. There is no increase in liquidity or cash flow until the last drop is gone, in fact its the opposite and so many people gloss over this and its very important.

As far as paying lump sum, there is a similar interesting wrinkle. Mind you, I am not actually arguing in favor of any one way or the other, though I know how it likely comes off my screen to yours, I really just find all these things very interesting. Okay, anyways...Say you owe 300k and are going to pay it off lump sum to avoid 2k/month for the next whatever time frame is left. Yes! Super awesome. However, I just dont get the logic of it all since you didnt really do anything other than switch monies from one pocket to the other. I mean nothing actually happened. You just divided up savings money 300/2k/month and prepaid. Now to get back to that level in your savings (as is said desire of many espousing such a strategy) you put the now free cash flow of 2k/month into savings. TL;DR, you already have liquidity, the money in savings and you could just as easily draw from it, its the same basic transaction. Thats why its good to take a 10,00ft view of it I believe.

The only thing is you have reversed the weightings of benefits as far as taxes, inflation, risk, and interest are concerned. lets not forget transaction costs which are essentially a tax against any "savings" you get from paying down a mortgage. You cannot tap that equity or savings ever again without some kind of transaction cost. You went from tax advantaged, inflation assisted, and simple to compound like the worse set of trade offs. For risks I mean those like @startrekdoc discuss as well as housing and regional economic busts as well. Some equity is a safeguard in those situations but full equity may be even more risk. Interesting stuff.

[TheHappyPhilosopher]

I'm not sure I completely understand, but I will throw some more of my thoughts out there.

 

I see paying off the house as kind of like an annuity. You pay a lump sum and basically get a monthly stipend back in the form of not having to pay a mortgage. You are trading market risk for a lower rate of fixed return (even though those terms may not be entirely accurate).

 

Every financial decision has risk (volatility, inflation, liquidity, etc), the decision to pay off the house trades some risks for others and should probably be viewed in totality. For instance I would never pay off a house I thought I was not going to live in for many years or was tied to a job that was tenuous.

 

As a side note, I saw three close friends/family members go down in flames due to liquidity issues, cash flow and mortgage problems this last economic crisis, so I am a bit evangelical about not paying down the mortgage unless it can be eliminated completely!

[Zaphod]

TheHappyPhilosopher wrote:

I’m not sure I completely understand, but I will throw some more of my thoughts out there.

 

I see paying off the house as kind of like an annuity. You pay a lump sum and basically get a monthly stipend back in the form of not having to pay a mortgage. You are trading market risk for a lower rate of fixed return (even though those terms may not be entirely accurate).

 

Every financial decision has risk (volatility, inflation, liquidity, etc), the decision to pay off the house trades some risks for others and should probably be viewed in totality. For instance I would never pay off a house I thought I was not going to live in for many years or was tied to a job that was tenuous.

 

As a side note, I saw three close friends/family members go down in flames due to liquidity issues, cash flow and mortgage problems this last economic crisis, so I am a bit evangelical about not paying down the mortgage unless it can be eliminated completely!

Click to expand...

I basically mean if you have a lump sum, you already have an annuity in the form of dividing that lump sum up monthly. Paying off the mortgage to receive it is simply a redundant and unnecessary step is really all im trying to say. I just cant see the difference except that people feel like its a thing to do.

I totally agree with the last part, I mean Id rather foreclose if one had to than some other options due to liquidity issues.