OT: If you had a million dollars...

[Qube]

OT: If you had a million dollars...

Now this is hypothetical and please I need some real answers :)

Assuming you had a million dollars and a mortgage at 4.5% ($220,000). Would it be more beneficial and practical to take the million and invest, getting better return than 4.5%, or to pay off the mortgage fully, with three month penalty?

The reason I ask is because of all those factors like compounding interest and sorts... it doesn't seem to be an easy and cut answer.

Yes, this is hypothetical ;)

[mikell]

Can't say - what do you mean "three month penalty"? Is that a pre-payment penalty equal to 3 monthly installments? So, what was the original term and what is the remaining term on the loan? Penalties suck.
If you are in the top tax bracket, the deduction for home mortgage interest has to be figured, and that can mean real bucks.
Besides, jumbo CD rates are now over 4.5%, so investing the $ in safe investments seems to make better sense than paying off a mortgage.
That's my quick and dirty take.

[diamond777]

pay off the mortgage and invest the 780k

[Martin in Bellevue]

In the US, that mortgage interest is deductible, making the interest earned elsewhere more attractive.

How much is the early payoff penalty, which I thought to be illegal?

There's also the liquidity issue? Is the current income reliable? Will reserves be needed in the short term? If you can get, say 6% from a bond structure, is the return worth having that amount tied up? Sometimes, that can be preferred, as long as short term liquidity is met. Don't forget to maintain a cash reserve that you're comfortable holding.

[Jay 535i]

The first thing I would do is talk to a financial advisor, because he can answer your question with knowledge rather than intuition.

That aside, my intuition tells me that $1m, wisely invested, should generate a liveable income indefinitely. It doesn't make sense to spend a big chunk of the principal straight off the bat.

[calmloki]

Lately I've been fighting my natural inclination to pay off debt as fast as possible. My home loan is at 5.5% (interest is deductible). I have an amount greater than the home loan earning 6.1% (taxable) in multiple 6 and 12 month accounts at the same credit union. Crazy times! Multiple accounts so if I did need or want to pull it early I could pull only close to the amount necessary. Another credit union had a 7% short term interest account available, so some money is stashed w/ them. Bear in mind that you are only insured to $100,000 per SSN per institution. In inflationary times like these (think 3.6% claimed and I believe it is greater) debt is good. It's like watching the debt decrease by the amount of inflation for free. Of course, your savings are doing the same thing, but I'm thinking hold cash, wait for opportunity, and be ready to invest. Shoot - if you have a Costco card Chase will pay you 4.55% in a money market checking account right now.

[Qube]

The first thing I would do is talk to a financial advisor, because he can answer your question with knowledge rather than intuition.

That aside, my intuition tells me that $1m, wisely invested, should generate a liveable income indefinitely. It doesn't make sense to spend a big chunk of the principal straight off the bat.

That's what I'm thinking. Not that I have a million dollars mind you, but that's my first thought... like the other comments as well.

[mholbrook]

There is nothing quite like having your home paid off and having in the neighborhood of $700k if "go to hell" money invested. If you are like me, in my late 50's, it means that I can live quite nicely on my pension income, interest, and my 15 hour/week part time job.

Thanks to California and those crazy home prices, we bailed and took just over 1/2 of the equity and bought a brand new 2600 sqft home in Meridian, Idaho last year. The Idaho home has already gone up over $100k and the new houses in our sub are all over $500k. If they sell, we are gold again!

Pay off the mortgage.

[Scott H]

In the US, the interest paid on a home loan is tax deductible so that eases the effective interest rate on the home loan. Paying off your current home is way too subjective to anayize without all the facts. It's a condo right? How long do you plan on being there? What is your current loan term? 5,7,10 year ARM? 15 or 30 year standard? How much is your current home appreciating?

Maintaining some sort of mortgage is beneficial for both credit rating AND tax deductions in the US. If it were my home, and I planned on being there until I grew out of it, I would refinance to a 15 year mortgage with no prepayment penalties. The 15 year term allows you to pay down principal at a faster rate but still leaves you cash to put work earning higher interest rates. The no prepayment penalty allows you an out if you decide to pay down the principal at any time without negative impact.

You are in a vastly different age group, income stream, cost of living, and real estate scheme than Mike is, and probably cannot count on r/e appreciation to beat out other investments the same way you might have in the past 5-8 years.

Let me also add that using it to pay for karting and E34 shipping would be counterproductive :D




In the US, that mortgage interest is deductible, making the interest earned elsewhere more attractive.

How much is the early payoff penalty, which I thought to be illegal?

There's also the liquidity issue? Is the current income reliable? Will reserves be needed in the short term? If you can get, say 6% from a bond structure, is the return worth having that amount tied up? Sometimes, that can be preferred, as long as short term liquidity is met. Don't forget to maintain a cash reserve that you're comfortable holding.

[Qube]

In the US, the interest paid on a home loan is tax deductible so that eases the effective interest rate on the home loan. Paying off your current home is way too subjective to anayize without all the facts. It's a condo right? How long do you plan on being there? What is your current loan term? 5,7,10 year ARM? 15 or 30 year standard? How much is your current home appreciating?

Maintaining some sort of mortgage is beneficial for both credit rating AND tax deductions in the US. If it were my home, and I planned on being there until I grew out of it, I would refinance to a 15 year mortgage with no prepayment penalties. The 15 year term allows you to pay down principal at a faster rate but still leaves you cash to put work earning higher interest rates. The no prepayment penalty allows you an out if you decide to pay down the principal at any time without negative impact.

You are in a vastly different real estate scheme than Mike is, and probably cannot count on r/e appreciation to beat out other investments the same way you might have in the past 5-8 years.

Thanks for your input. I don't count on any appreciation given that it's a condo unit... even if it's in a very prime location. All your comments have given me a jump point for when I finally make that first million. Of course, at that time a financial advisor should be in tow.

One thing is for sure... even when I have a million, I won't sell my e34. Sure, she may be a partner to a z4, but never gone ;)

[dynamic_e]

My 2 cents, Martin hit it on the head.

Money in your home is NOT
1) Liquid
2) Safe
3) Earning a rate of return.

I would rather take out a 5 or 10 year intrest only mortgage and invest or save the money elsewhere. 4.5% compound intrest will beat 4.5% straight intrest(on a mortgage) any day of the week. Your house will always go up and down in value based on supply and demand, not your mortgage, so why tye up money in a plce that is not working for you?

In essence, by paying extra in principle you are saying, "here, mr banker, take my money. I dont trust myself to invest it and earn a rate of return, but i'll let you take my money and profit from it. And what I need my money from my house, i'll go back to you and apply/beg to get access to my equity."

I speak publicly about this stuff all the time, and often find we are looking at the way we pursue our mortgages the wrong way here in America.


Anyhow, off my soapbox for now.

[Scott H]

and the fact that supply is beginning to far outreach demand in many hot markets, you don't think that gaining equity in your home through payment of principal is wise, and that betting on appreciation to supply that equity is a better choise? I find that particularly risky, especially given that it can be difficult for a beginner to create returns on investments that will exceed 1) interest + principal cash outlays they are making on their mortgage + 2) inflation rates + 3) the DJIA, Nasdaq 100, Russell Index, etc.

The other thing to take in to account is that paying off your mortgage will provide equity to roll in to the next home at some point. That being when you want to move out of condo/townhome and in to single family, or when you outgrow your current single family and move in to larger single family. The equity in your current home, attained partially by paying down principal, allows is much easier to roll in to your next purchase, as opposed to triggering taxable transaction to liquidate positions you have taken in investments which would ultimately reduce your effective rate or returns.

Finally, interest only mortgages are VERY hot and widely available b/c of the real estate market's recent history. A lender's risk was relatively low knowing that they would be able to foreclose on a defaulted mortgage and recover their principal. That may not be as much the case in the coming years if the r/e market stagnates (which it appears to have started doing). Interest rates will be higher and home appreciation will be lower relatively speaking. At that point, your investment choices better be VERY wise or VERY lucky to overcome the hurdle rate (assumed to be the rising interest rate of a mortgage).

Finally finally, interest only mortgages require an overall smaller monthly cash outlay. This allows the buyer to borrow more money. I have seen many young, undisciplined people max out a 5 or 7 year interest only loan and purchase a 600k-700k home on $125k/yr salary. If you ask me, this is DAMN risky. If one loses a job, or the r/e market slows, or any other major life event occurs, it could be very very hard to turn this house back in to the cash needed to downsize and get in to a more appropriate financial position. With young, undisciplined buyers, this is very risky. Maybe for slightly older, more established people this is a better choice.

Just another set of my $0.02



My 2 cents, Martin hit it on the head.

Money in your home is NOT
1) Liquid
2) Safe
3) Earning a rate of return.

I would rather take out a 5 or 10 year intrest only mortgage and invest or save the money elsewhere. 4.5% compound intrest will beat 4.5% straight intrest(on a mortgage) any day of the week. Your house will always go up and down in value based on supply and demand, not your mortgage, so why tye up money in a plce that is not working for you?

In essence, by paying extra in principle you are saying, "here, mr banker, take my money. I dont trust myself to invest it and earn a rate of return, but i'll let you take my money and profit from it. And what I need my money from my house, i'll go back to you and apply/beg to get access to my equity."

I speak publicly about this stuff all the time, and often find we are looking at the way we pursue our mortgages the wrong way here in America.


Anyhow, off my soapbox for now.

[Tiger]

Deductible mortgage interest and the interest income you are getting will wipe out itself in incoime taxes... Scott H is, I believe, tax expert here... Let's say you got $666,666 after tax from $1,000,000 lumpsum payment... Yes, the gov't get your tax money before it pays out to you...

With $666,666 earning at 6%... which is the highest 3 years CD you can get now... your annual interest will be about $40,000. Let us say that your salary is about $50,000... so your tax bracket has jumped from 15% to 25% if married and filing jointly... from 25% to 28% if single... So in tax matter, I don't see that much of a difference whether you paid house off or not.

In investment matter, it would make a whole lotta difference... let's say you didn't pay off the house and you earn 6% interest on CD alone... that gives you about $40,000 interest every year. If you paid off your house, you have $441,666 and your interest income would be only $26,500. That's $13,500 difference! It would take you 10 years to earn your $220,000 as compared to a little over 5 years to earn $220,000.

If you are savvy investor, there are different scenarios... you would put it in IRA, either one and other tax shelters via different but well balanced portfolios of I-Bond, TIPSond, mutual fund and CD. If you are young, then I'd put half in IRA and other tax shelters and rest in normal taxable investments as above. Don't forget GOLD too!

The motto is this... earn as much as you can and pay the taxes. I don't care what how much tax I gotta pay as long my investment is growing fast enough. If you want to avoid paying the taxes, then your return will be as skimpy as you are not paying the taxes plus you can't really use those money freely as you would think... so many red tapes.

If you invest in stocks, mutual funds of all sorts, then your investment return would likely be higher. Same deal... just pay the damn taxes... although lower now at 15% I believe... and let the money keep piling up. The interest/profit return rate would compound itself every year and growing faster every year in the J curve effect that you won't believe. However, if you spend all the money you earned via investment, you won't get anywhere.

So, the question is whether to pay off the mortgage or not? NO! Spend on what you earn and once in a while splurge a tiny bit to make it fun... but never deplete those investment!

Now you can go learn more about this stuff... You make on what you know... Ignorance doesn't pay. Period.

[Rustam]

OT: If you had a million dollars...

Now this is hypothetical and please I need some real answers :)

Assuming you had a million dollars and a mortgage at 4.5% ($220,000). Would it be more beneficial and practical to take the million and invest, getting better return than 4.5%, or to pay off the mortgage fully, with three month penalty?

The reason I ask is because of all those factors like compounding interest and sorts... it doesn't seem to be an easy and cut answer.

Yes, this is hypothetical ;)

I would buy an apartment building and use the generated income to pay the mortgage. In my neighborhood 6 family appartment house is able to generate on average $70,000 a year...

And I would still have some money left ~$200-300K ...

Hypothetically.

[Tiger]

Rental is good... however, it is not really totally income. The property tax will take a good 45% of the revenue... The maintenance will eat another 20% or so... thus leaving the rest to income tax... in the end... not so great income. Plus your time involved to maintain and manage the place. And once every so often, you need to renovate... big $$$ if you don't know how to do this yourself.

On the other hand, it does get you a fairly safe investment that will increase in value over time... an excellent investment option yet still not easy money... nothing is easy money.

[BillionPa]

That aside, my intuition tells me that $1m, wisely invested, should generate a liveable income indefinitely

untill gas hits $20 a gallon....

I dont consider life without my E34 liveable.

[calmloki]

Renting residential property we own is what we do. It works as much or as little as you do, as with most jobs. NOT the right thing for everyone. For the first 15 years we worked for it: all profits + money from both jobs + our time and effort went into the properties. Result is that we now have a home mortgage (financed the house 'cause home mortgage interest is cheaper than commercial property interest) and a mortgage on one other house. All else is free and clear. Home free? Not hardly. Yesterday I replaced showerstall walls, fixed a broken doorframe, rekeyed two locks, and showed the same apt. twice (16 miles from home). Today I got a call at 6:30AM from a tenant claiming no water at all in the bathroom but water in the kitchen. Drove in to find zero problems. Pointed out to the son of tenant that he might have called with the news. Got home to a message from a new tenant regarding a frig that had a cold freezer but a warm frig compartment. Drove back to Salem to dissassemble and thaw freezer evap coils and set temp switch to normal rather than instant ice age. 4-6 calls from potential tenants. Works for us, gives us a nice net worth, but tough to quit and take the tax hit. Some might find the whole job a bit irritating...

[Scott H]

Roll up all of your homes and put them towards one or two decent apartment buildings and defer the gain on the sale of the homes.


Renting residential property we own is what we do. Works for us, gives us a nice net worth, but tough to quit and take the tax hit.

[calmloki]

Roll up all of your homes and put them towards one or two decent apartment buildings and defer the gain on the sale of the homes.
Defer the gain - aye there's the rub: at some point you want to get that money out of play and into your wallet. What you suggest was the original game plan - but we have enough to retire on now and I'm not that hungry - we could do a 1.75 mil place pretty easy, but then the profits either go to a managment company or we end up managing a manager. We are vain enough to think that our management is a value added item for the apartments and houses - our vacancy rate is less than 1/2 the local rate and we often rent the same tenant several different places over time. Bad management could wipe us out a lot faster than we built it up. Think we'll probably phase out over the next 5 years or so and move more of our assets into higher risk property loans - nice security, high rate of return, generally short loan periods as the interest is punitive enough to make the borrower eager to refinance. Property makes sense to us - stocks kick my butt.

[tdgard]

I'd certainly pay off the mortgage. All this talk about CDs and "low risk you can make 1-2 percent more a year" is crap. Take the thing that is using up most of your income away and you will not have to invest the rest like a Nancy. Buy more mortgages. The one thing they are not making any more of is land.

We bought the worst house in the best neighborhood--a foreclosure with some problems. In 3 years it has gone up $200k (slightly more than double) with our cost being about 1/10 of that. I did not buy it to live in (but that's a bonus) I bought it as a vehicle to upgrade.

Every day I kick myself for not buying 10 years ago. For those in Atlanta, there are the houses along Deering Rd, which in 96 were going for 45k-60k. Buckhead expanded into the area & they now go for close to 300k--for 800sq ft 2 bed bungalows. Should have bought a half dozen of them. A buddy of mine bought a city block in what was a crack neighborhood in downtown Atlanta 15 years ago for a couple hundred thousand. Recently turned down 6mil. They did not want the buildings--just the dirt under them.

It just seems dumb to me to spend 400k on a 200k mortgage. Sure the interest is deductible, but it's sure not a 1:1 ratio. Plus you then spread that 200k in tax advantages over 30 years. Why ever have it in the first place?

[kyleN20]

finish school, get the job i wanted, let my million make me money, and use the intrest to pay off bills (not sure if this would work) then use the money from my mechanical engineering job to pay for my beer and project e30/m30 turbo.

[calmloki]

I'd certainly pay off the mortgage. All this talk about CDs and "low risk you can make 1-2 percent more a year" is crap. Take the thing that is using up most of your income away and you will not have to invest the rest like a Nancy. Buy more mortgages. The one thing they are not making any more of is land.

We bought the worst house in the best neighborhood--a foreclosure with some problems. In 3 years it has gone up $200k (slightly more than double) with our cost being about 1/10 of that. I did not buy it to live in (but that's a bonus) I bought it as a vehicle to upgrade.

Every day I kick myself for not buying 10 years ago. For those in Atlanta, there are the houses along Deering Rd, which in 96 were going for 45k-60k. Buckhead expanded into the area & they now go for close to 300k--for 800sq ft 2 bed bungalows. Should have bought a half dozen of them. A buddy of mine bought a city block in what was a crack neighborhood in downtown Atlanta 15 years ago for a couple hundred thousand. Recently turned down 6mil. They did not want the buildings--just the dirt under them.

It just seems dumb to me to spend 400k on a 200k mortgage. Sure the interest is deductible, but it's sure not a 1:1 ratio. Plus you then spread that 200k in tax advantages over 30 years. Why ever have it in the first place?

Sigh. First off, as you are aware, once you buy a property all of the property's appreciation accrues to you. This is true whether you have paid for all of the property or 1% of it. The original poster wanted to know if he should pay off his mortgage. In the current climate, when he can easily and with outstanding safety match or better what his mortgage is costing him, it makes no sense to divest himself of $220,000 that he could save to make a big investment. He's already going to make as much on his current property as he ever will, paid for or not.
It's great that property is doing well, but as with tech stocks or anything else, current performance is no guarantee of future performance. For instance: in 1970 I bought an undeveloped block of land in Twin Rocks Oregon, 11 blocks from the beach, for just over $5000. In 1980 I sold it on contract for $14,000. Cool! After paying 10 years worth of interest, property taxes, realtor fees, and closing costs I still made money. My buyer sold the property a year later just the way he bought it for $95,000. He had maybe $4000 of his money invested. Two lessons: real estate value goes in spurts, and use the power of OPM. Other People's Money.
Sally and I are risk averse: we went against all the real estate wisdom and paid everything off as soon as possible. Real estate has been very good to us. Had we been willing to be deeply in debt we could be 3-4 times or more better off.
In the current climate the original poster has nothing to lose by banking his money at an equal or better rate to his mortgage expense but does stand to gain the security of having $220,000 in the bank as a safety cushion and waiting for the perfect investment - as well as a percentage point or two of interest. And BTW - a percentage point or so less on a mortgage or credit card or more on a savings account DOES add up, especially over the odd decade or two. 2% of $220,000 for a year is $4400... Why throw that away if it's free?
Tom Walrod (Live well below your means - a favorite saying)

[Rustam]

untill gas hits $20 a gallon....

I dont consider life without my E34 liveable.

I have a feeling that this will never occur.

[Ross]

Keep the mortgage if the real estate is appreciating at rate greater than your 4.5%, especially if you have amortized an appreciable amount. Invest the mil. in Ross' miracle BMW approved snake oil.

[tdgard]

Additional sigh. Let's crunch straight numbers and stick with 6% to make math easy.

A $200,000 mortgage will cost you $431.676.38 over a 30 year loan. That's $1199.10 a month without any of the other associated BS.

Option A:
Invest $1,000,000 at 6%. You'll get $5,743,491.17 off a compounding interest investment after 30 years. Then subtract the $431,676.38 for the cost of the house. You now have $5,311,814.79.

Option B:
Pay $200,000. Invest $800,000. Add to this $1200 a month which is your saved mortgage payment (I'm assuming you can come up with an additional 90 cents to make this happen--still want math to be easy). You end up with $6,029,505.31.

The initial question was "What would you do?". I stand by my answer. I would rather end up with more money while living with the security of having my home paid off and not worrying about layoffs, downturns in the economy, blah blah blah. You also have the total value of your home vs the value minus the loan amount.

[calmloki]

Additional sigh. Let's crunch straight numbers and stick with 6% to make math easy.

A $200,000 mortgage will cost you $431.676.38 over a 30 year loan. That's $1199.10 a month without any of the other associated BS.

Option A:
Invest $1,000,000 at 6%. You'll get $5,743,491.17 off a compounding interest investment after 30 years. Then subtract the $431,676.38 for the cost of the house. You now have $5,311,814.79.

Option B:
Pay $200,000. Invest $800,000. Add to this $1200 a month which is your saved mortgage payment (I'm assuming you can come up with an additional 90 cents to make this happen--still want math to be easy). You end up with $6,029,505.31.

The initial question was "What would you do?". I stand by my answer. I would rather end up with more money while living with the security of having my home paid off and not worrying about layoffs, downturns in the economy, blah blah blah. You also have the total value of your home vs the value minus the loan amount.

Okee doke - Agreed, original question is "what would you do", thus making any true answer correct. I appreciate your point of view and, as I said, we accelerated all our contracts to payoff with two exceptions, a rental house with a 7 year fixed then ARM @5.75%, and our own home, which we borrowed against at 5.5% fixed for 15 to payoff an 8.5% commercial loan on some apartments. The reason we have not paid those off is that we are earning a higher rate of return than we are paying, while having a major chunk of change in the bank as security/investment capitol.
Over the course of taking out more than a few property loans we've found the points and fees to be onerous: If we use capitol we have bankrolled we don't pay any fees or points on that amount.
Regarding the security of having a paid for house lets take a couple options: A: your house is paid off, you get all crippled up and can't work, the remaining $800,000 is invested in hot real estate except real estate isn't always real liquid and in today's rental market it's not easy to generate a positive cash flow: how you gonna pay taxes food, medical expense, etc.?
B: Same scenario with the no income, crippled, $800,000 trapped in appreciating but untappable real estate, an unpaid for house with a $1200/mo. house payment, and $200,000 in the bank. Hmm. All of a sudden it looks like you can keep your head above water for quite a while by tapping that $200k for the monthly house payment plus all other living expenses.
Money is fungible. If you pay off the house to avoid 4.5% interest then you have tied up that $200k effectively earning 4.5%(the property appreciates and value accrues to you no matter what amount you have invested). If you don't pay off the house, banking the $200k at 6%, then that $200k is earning 1.5% and giving you more freedom to use the cash as you wish.
In your two scenarios, if you use 6% as the cost of the mortgage and 6% as the bank interest you can earn then of course the scenarios come out equal dollar value. Your option B looks bigger because you added an extra $1200/month. The current climate is unique in my experience: Fixed real estate interest LOWER than *short term* savings instruments. I'm only investing in 6-12 month instruments because I expect interest rates on savings to continue to climb and I want my income to climb with them. My debt, however, is fixed at a low rate - strong disincentive to pay them off. Several years ago, when savings paid 2% or so my answer might have been different. My stock picking is dismal enough that I don't go for the "don't pay off your home - invest in the market in stead and make a historic 10% or more" theory that more clever people espouse. I'm Mr. Safety, Mr.Thrifty, Mr. Pile Up The Pennies Over A Long Period. But that's just me.
Good for you buying the worst house in the best neighborhood. Smart.
Tom

[Gayle]

People have already talked about tax savings and alternative investments. I have two things to tell you: Time value of money and leverage.

Time value of money.
With inflation a dollar is not worth as much tomorrow as it is today because it won't buy as much as inflation drives up the price of goods. When you use debt to buy a house, you lock in the payments and get to pay it off with tomorrows dollars that are worth less. Here is an example that will bring this home.

When I started driving a long long time ago, gasoline was $0.25 a gallon. That is not a typo. Now it is over $3.00 but it is still the same percentage of an individual's cost of living. (I know people think it is world politics, but cost the same on a percentage basis then as it does now). Then a dollar bought you 4 gallons of gas. Now it buys you 1/3 of gallon or less. A dollar was worth more then than it is now because it bought you more.

Can you imagine how cheap gasoline would feel if I could still buy it for $0.25 a gallon? That is how cheap your mortage payments feel at the end of 30 years because of the effects of inflation. Your current mortage payments will feel like nothing and in effect will be nothing because you will be paying them off in dollars that are worth less. You can pay off your mortgage now with dollars that are more more now or you can pay it off over time with dollars that are less valuable.

If you think the gas example is ridiculous, here is a different one. I bought a very nice 3 bedroom house in a trendy part of Cleveland in 1979 for $43,000 and sold it in 1986 for $62,000. That was not a period of time wild housing inflation. Do you think the person who bought it would have preferred to pay for it in 1979 dollars (my house payments) or 1986 dollars (his house payments)?

Your income goes up with inflation and your house payments don't so housing costs become a smaller and smaller percentage of income.

Leverage
Let's look at your condo strictly from an investment value. Let's pretend it is a rental instead of your residence. To use easy round numbers, let's say your condo costs $100,000 and you put 20% down or $20,000. Someone who is a financial planner correct me if I have the percent wrong, but I think it is at a 7% return that the value of an investment doubles in 10 years. Real estate has gone up in value at a rate greater than inflation, so an average of 7% is reasonable to expect over 10 years. Ten years from now your $100,000 condo should be worth $200,000. You have a $100,000 gain on an investment of $20,000. That is a 500% return. If you bought the condo for cash and paid the full $100,000 up front, you paid for it with expensive dollars instead of delated tax deductible dollars (argument above) and your return is $100,000 on a $100,000 investment. That is a 100% return. Would your prefer a 500% return on your investment or a 100% return on your investment?

You may be thinking but I had to make house payments. Think of it as renting to yourself. Wouldn't you like to not have your rent go up for 10 years? And would you really want to pre-pay your rent for 10 years or 30 years in you knew that it was going to go down as a percentage of your income?

[calmloki]

People have already talked about tax savings and alternative investments. I have two things to tell you: Time value of money and leverage.

Time value of money.
With inflation a dollar is not worth as much tomorrow as it is today because it won't buy as much as inflation drives up the price of goods. When you use debt to buy a house, you lock in the payments and get to pay it off with tomorrows dollars that are worth less. Here is an example that will bring this home.

When I started driving a long long time ago, gasoline was $0.25 a gallon. That is not a typo. Now it is over $3.00 but it is still the same percentage of an individual's cost of living. (I know people think it is world politics, but cost the same on a percentage basis then as it does now). Then a dollar bought you 4 gallons of gas. Now it buys you 1/3 of gallon or less. A dollar was worth more then than it is now because it bought you more.

Can you imagine how cheap gasoline would feel if I could still buy it for $0.25 a gallon? That is how cheap your mortage payments feel at the end of 30 years because of the effects of inflation. Your current mortage payments will feel like nothing and in effect will be nothing because you will be paying them off in dollars that are worth less. You can pay off your mortgage now with dollars that are more more now or you can pay it off over time with dollars that are less valuable.

If you think the gas example is ridiculous, here is a different one. I bought a very nice 3 bedroom house in a trendy part of Cleveland in 1979 for $43,000 and sold it in 1986 for $62,000. That was not a period of time wild housing inflation. Do you think the person who bought it would have preferred to pay for it in 1979 dollars (my house payments) or 1986 dollars (his house payments)?

Your income goes up with inflation and your house payments don't so housing costs become a smaller and smaller percentage of income.

Leverage
Let's look at your condo strictly from an investment value. Let's pretend it is a rental instead of your residence. To use easy round numbers, let's say your condo costs $100,000 and you put 20% down or $20,000. Someone who is a financial planner correct me if I have the percent wrong, but I think it is at a 7% return that the value of an investment doubles in 10 years. Real estate has gone up in value at a rate greater than inflation, so an average of 7% is reasonable to expect over 10 years. Ten years from now your $100,000 condo should be worth $200,000. You have a $100,000 gain on an investment of $20,000. That is a 500% return. If you bought the condo for cash and paid the full $100,000 up front, you paid for it with expensive dollars instead of delated tax deductible dollars (argument above) and your return is $100,000 on a $100,000 investment. That is a 100% return. Would your prefer a 500% return on your investment or a 100% return on your investment?

You may be thinking but I had to make house payments. Think of it as renting to yourself. Wouldn't you like to not have your rent go up for 10 years? And would you really want to pre-pay your rent for 10 years or 30 years in you knew that it was going to go down as a percentage of your income?

Regarding time value of money, to be fair Gayle, we must admit that if you have an amount equal to the cost of the house debt sitting in savings, the effect of inflation punishes your savings account just as exactly as much as it hammers your debt. 'Course, if you have more debt than cash, you are on the winning side of inflation: at the alleged 3.5% inflation rate that's like having $3500 of every $100,000 paid for you each year by magic!
Oh, and this just in: Capitol One money market account through Costco is now paying 4.72% - up from 4.55, 4.3, 4.1%. $484 free money/year by banking $220,000 with them vs. paying off a fixed 4.5% $220,000 loan.

<http://www.costco.com/Service/FeaturePage.aspx?ProductNo=11074727&cm_mmc=BCEmail_152-_-Services-_-45-_-CapOne_BCEmail_152>

Tom

[Alexlind123]

OT: If you had a million dollars...

Now this is hypothetical and please I need some real answers :)

Assuming you had a million dollars and a mortgage at 4.5% ($220,000). Would it be more beneficial and practical to take the million and invest, getting better return than 4.5%, or to pay off the mortgage fully, with three month penalty?

The reason I ask is because of all those factors like compounding interest and sorts... it doesn't seem to be an easy and cut answer.

Yes, this is hypothetical ;)

Buy a Ferrari Enzo.

[Gayle]

at the alleged 3.5% inflation rate that's like having $3500 of every $100,000 paid for you each year by magic!


And that extra $3500 won't do you any good because it will cost you $103,500 to buy what you could have bought for $100,000 the prior year. You have to earn a return in excess of inflation to come out ahead.

Money market is very tied to inflation expectations. Those money market returns you mention signal inflationary expectations. A few years ago returns were 2% or less. In fact, the rate you quote of 4.72% suggest that next year it may take $104,720 to buy what you could buy for $100,000 last year. And don't forget you have to pay taxes on that $4,720 so you don't get all of it.


Anything with higher returns has more risk than an investment in housing. To come out ahead on the inflation game he would have to put the money in investment in which returns exceed inflation, for example the stock market which entails considerably more risk than housing. Plus we all get stupid when it comes to the stock market and think we can out smart the averages and end up losing money. For most people, housing is a wonderful, no brainer forced savings.

This is the absolute historic low for debt. The rate for my first mortage was 11%. To be able to lock in debt at the low is a no brainer.

I rarely drop credentials, but I have an MBA in finance and I am a CPA. I may be clueless about cars, but I know a little about this subject.

[calmloki]

Gayle - I don't think we are disagreeing:
Me:at the alleged 3.5% inflation rate that's like having $3500 of every $100,000 paid for you each year by magic!

You: And that extra $3500 won't do you any good because it will cost you $103,500 to buy what you could have bought for $100,000 the prior year

I was talking about the effect inflation had on $100,000 *in debt*. The $3500 isn't cash, but a reduction in the effective debt: a $100,000 debt in last year's dollars is equal to $103,500 debt in today's dollars. If one chose to pay off last years debt with today's dollars you are left with $3500 in today dollars (this assumes, of course , that your income has kept pace with inflation).

You:
Money market is very tied to inflation expectations. Those money market returns you mention signal inflationary expectations. A few years ago returns were 2% or less. In fact, the rate you quote of 4.72% suggest that next year it may take $104,720 to buy what you could buy for $100,000 last year.

Quite right - my belief is that the rate of inflation has been grossly underreported - given that two different local credit unions have offered rates of 6.15 and 7% on short term deposits while loaning money out at those rates or below I wouldn't be surprised if inflation isn't closer to 7-8%.

You: This is the absolute historic low for debt. The rate for my first mortage was 11%. To be able to lock in debt at the low is a no brainer.

Damn Skippy! Been buying since 1970 and usually paid over 8.5%, never under till lately. Keeping my powder dry and waiting for the current crop of Johnny-come-latelys to get bitten by buying too much place on interest only ARMs. I expect people to discover owning rental property is work, the store of available apartments to shrink as existing apartments are converted to condos, loan companies to take a beating, money to flood back into the stock market, "For Sale" signs to blossom on the land, and property values to level out over the next 5-8 years. I'll be shopping - or leveraging our money by making property loans.

You: I rarely drop credentials, but I have an MBA in finance and I am a CPA. I may be clueless about cars, but I know a little about this subject.

No arguement from me at all!

Tom