Skip to main content
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 3
1. They carry a mortgage on their homes even though they can afford to pay it off. Keep your money working for you. Every dollar paid to the bank is one less that you have to invest. Your house will grow in value no matter what.

I had just started taxable investments when I purchased my primary residence, a condo. I also thought hard and long on what to do: pull out the money from my taxable investments and pay cash, or leave my investments in place and get a 80% mortgage.

I decided to stay invested and take out a mortgage.

I was already benefitting from itemizing, so additional deductions would reduce my taxes at my marginal tax rate, and I am still a good distance away from the phase-out amount. So, after itemizing the interest payments at both the state and federal levels, my 7.375% mortgage looks more like 4.83% after tax deduction. On the other hand, taxable investments, assuming long-term annulized return of 10%, would be between 6.55% (ordinary income tax rates) and 7.35% (long-term capital gains rates).

To assign real numbers to the above percentages, I could pay cash and then the condo would appreciate at whatever rate it will appreciate at (currently about 7%). Or I could take out a $66,800 mortgage, pay $4905 in interest for one year, but with reduced state and federal taxes to the tune of $1691, or a net after-deduction interest payment of $3214. If I project 10% annualized return from investments, the projected earnings from that $66,800 would be $6680, with between $1769 and $2303 in taxes (hopefully closer to the lower tax number for long-term capital gains rates, but with managed funds some of the gains will be short term), so the after-tax projected returns would be between $4911 and $4337. The net result is that I would probably be ahead by between $1697 and $1123. Of course, some years the market will produce better results, and some years will produce lower results. I didn't expect negative returns from the market, but that is just part of the short-term noise in a 30-year plan. 8)

It gets better: the amount of money going to interest goes down each year, and, because I am reinvesting distributions instead of skimming off profits for spending, the investment balance and thus the returns will usually grow each year.

Alternatively, I could have used the $66,800 to pay off the condo in full. The condo would still appreciate at whatever rate it would appreciate at.

I also consdiered that I have a decent job and I don't need the returns from my investments at this time so it looks like I can remain invested and meet normal living expenses from my 403(b)-reduced wages and even then still have enough to max out my 403(b), Roth IRA, and still add a little each month to my taxable investments. I also have a 6-month emergency fund spread out in a money market fund, CDs, and now I-Bonds. Also, if I don't liquidate my Oregon PERS before I retire, even if I don't work for a Oregon PERS contributing employer another day in my life, my pension would give me a pay raise, so if I still have my mortgage when I retire, I would still be able to afford my mortgage payments.

I also like the liquidity of stock funds: if I need the money, I can sell a specific number of shares or a specific dollar amount and have the money within three business days (though if the market is down I might end up selling at a loss) and liquidate just enough to meet my needs, but as someone commented, to get equity out of my residence I either have to get a home equity loan (which may be impossible if my income had stopped) or sell my place (which could take weeks or months, have high transaction costs, and it is either sell none of it or sell the entire place).

I have seen the argument of taking out as much mortgage as one qualifies for and investing as much as possible, but that strikes me as being too leveraged--if one needs the return of investments to meet mortgage payments and the market is down (as is the case for the last 10 months), the investments would hit a duble whammy: low value plus selling low.

On the other hand, my housing expenses are reasonable and living conditions quite acceptable, and I anticipate being here for many, many years. My after-tax-deduction costs for living here are just $50/mo or so more expensive than the apartment I rented for a decade, but I think it is worth it, and I am building up equity at $54/mo. Basically, I view my mortgage as a replacement for my rent, only now I have more say on what I can do to the walls and floor of my residence.

Now different people are in different situations, have different tax profiles, have different comfort levels with various types of debt, so what I am comfortable with won't necessarily be good for someone else.
Print the post  

Announcements

When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.