Windfall: Pay off house?
12-22-2006, 09:00 PM
#11
Administrator
You pay what? $1200/month? To earn $14400/yr to pay your mortgage interest you'd have to make a net return on your $300K of 4.8%.
After 30 years you have $300,000 and the value of the home.
If you invested the $300K at 12% you'd get $36,000/yr, $14,400 goes to the mortgage and you invest the other $21,600 into your 401K/IRA. At that rate of return you would have about $4 million + the value of your home in 30 years.
On the other hand...
If you pay off the mortgage and invest the remaining $100K and also contribute the $1200/month to your portfolio for 30 years (the length of the mortgage) you will have roughly $980,000 + the full value of your home and that's only investing at 4.8% after tax which sucks but I'm comparing apples to apples.
If you invest it at a more reasonable 12% annual rate of return you've got a few dollars short of $4 million.
In other words you can do either or but a lot depends on how the money is taxed and what sort of tax advantages you can take advantage of (income/tax bracket/etc.) If you are in a high tax bracket you might find the mortgage option better. In a lower bracket then paying off may be better. You definitely need to talk to an accountant to find the strategy which works best. Don't try it on your own. A good tax professional will make hundreds of thousands of dollars of difference.
After 30 years you have $300,000 and the value of the home.
If you invested the $300K at 12% you'd get $36,000/yr, $14,400 goes to the mortgage and you invest the other $21,600 into your 401K/IRA. At that rate of return you would have about $4 million + the value of your home in 30 years.
On the other hand...
If you pay off the mortgage and invest the remaining $100K and also contribute the $1200/month to your portfolio for 30 years (the length of the mortgage) you will have roughly $980,000 + the full value of your home and that's only investing at 4.8% after tax which sucks but I'm comparing apples to apples.
If you invest it at a more reasonable 12% annual rate of return you've got a few dollars short of $4 million.
In other words you can do either or but a lot depends on how the money is taxed and what sort of tax advantages you can take advantage of (income/tax bracket/etc.) If you are in a high tax bracket you might find the mortgage option better. In a lower bracket then paying off may be better. You definitely need to talk to an accountant to find the strategy which works best. Don't try it on your own. A good tax professional will make hundreds of thousands of dollars of difference.
12-22-2006, 10:41 PM
#12
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What is your age? Middle-aged might want to pay off mortgage and other debts to retire early, or switch to less demanding career. Younger person probably better doing a 50/50 investment/debt reduction.
12-23-2006, 06:11 PM
#13
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na.. I wouldn't pay it off.. 6% is a pretty good rate for fixed 30 yr.. a tad over what mine is..
plenty of MF's out there returning pretty good.. I returned over 18% this last year in my 401k ..
remember.. if investing, it's usually compounded..
paying off you are paying on the unpaid balance..
cheers
plenty of MF's out there returning pretty good.. I returned over 18% this last year in my 401k ..
remember.. if investing, it's usually compounded..
paying off you are paying on the unpaid balance..
cheers
12-23-2006, 06:16 PM
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Originally Posted by cthree,Dec 22 2006, 10:00 PM
You pay what? $1200/month? To earn $14400/yr to pay your mortgage interest you'd have to make a net return on your $300K of 4.8%.
After 30 years you have $300,000 and the value of the home.
If you invested the $300K at 12% you'd get $36,000/yr, $14,400 goes to the mortgage and you invest the other $21,600 into your 401K/IRA. At that rate of return you would have about $4 million + the value of your home in 30 years.
On the other hand...
If you pay off the mortgage and invest the remaining $100K and also contribute the $1200/month to your portfolio for 30 years (the length of the mortgage) you will have roughly $980,000 + the full value of your home and that's only investing at 4.8% after tax which sucks but I'm comparing apples to apples.
If you invest it at a more reasonable 12% annual rate of return you've got a few dollars short of $4 million.
In other words you can do either or but a lot depends on how the money is taxed and what sort of tax advantages you can take advantage of (income/tax bracket/etc.) If you are in a high tax bracket you might find the mortgage option better. In a lower bracket then paying off may be better. You definitely need to talk to an accountant to find the strategy which works best. Don't try it on your own. A good tax professional will make hundreds of thousands of dollars of difference.
After 30 years you have $300,000 and the value of the home.
If you invested the $300K at 12% you'd get $36,000/yr, $14,400 goes to the mortgage and you invest the other $21,600 into your 401K/IRA. At that rate of return you would have about $4 million + the value of your home in 30 years.
On the other hand...
If you pay off the mortgage and invest the remaining $100K and also contribute the $1200/month to your portfolio for 30 years (the length of the mortgage) you will have roughly $980,000 + the full value of your home and that's only investing at 4.8% after tax which sucks but I'm comparing apples to apples.
If you invest it at a more reasonable 12% annual rate of return you've got a few dollars short of $4 million.
In other words you can do either or but a lot depends on how the money is taxed and what sort of tax advantages you can take advantage of (income/tax bracket/etc.) If you are in a high tax bracket you might find the mortgage option better. In a lower bracket then paying off may be better. You definitely need to talk to an accountant to find the strategy which works best. Don't try it on your own. A good tax professional will make hundreds of thousands of dollars of difference.
thank you..
12-24-2006, 06:47 PM
#15
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cthree,
Thank you for the comprehensive response! It certainly is quite a bit to think about for future reference.
Thank you for the comprehensive response! It certainly is quite a bit to think about for future reference.
12-25-2006, 09:27 AM
#16
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I would recommend escrowing some money for as long as you plan to be in the house (be it a few years, or the duration of the mortgage) and invest the rest in an IRA (if you have one). I would put the money escrowed into different types of bonds (preferrably treasury), as the risk is negligible, and you will still be making near prime on the money. This will allow you to live in the home with no additional out of pocket expenses (as if you paid it off), while allowing the funds to grow.
You should also take into account the taxation effects of a $300k "windfall". Chances are you will have at least $45,000 taken out for taxes (assuming all LTCG) and possibly as high as $100,000 if it is ordinary income.
Honestly, if I were in the situation, I would either put the house in a trust (Real Estate Investment Trust organized as a Corporation) along with the escrow for mortgage payments. This will allow for preferrential tax treatment with higher income brackets, but it also limits the exposure of personal assets to possible credit claims arising from the home (in case of a possible foreclosure / title dispute).
Just my $.02
John
You should also take into account the taxation effects of a $300k "windfall". Chances are you will have at least $45,000 taken out for taxes (assuming all LTCG) and possibly as high as $100,000 if it is ordinary income.
Honestly, if I were in the situation, I would either put the house in a trust (Real Estate Investment Trust organized as a Corporation) along with the escrow for mortgage payments. This will allow for preferrential tax treatment with higher income brackets, but it also limits the exposure of personal assets to possible credit claims arising from the home (in case of a possible foreclosure / title dispute).
Just my $.02
John
12-26-2006, 04:04 AM
#17
That is a decent interest rate on the mortgage. Erik gave a good response. Most advisors, I believe, would say not to pay off the mortgage, and I'm in that camp. Many peeps have paid off a mortgage, only to find themselves in financial trouble later when they could not get to liquid assets in the event of an emergency.
You should have the highest mortgage you can afford, IMO. But you also need to be sure you have at least six months of debt payments liquid in the event you have no income (losing your job, for example), so that should be your first priority. Your age does make a difference in whether you invest more for income rather than accumulating wealth. Get yourself a good investment advisor and accountant!
You should have the highest mortgage you can afford, IMO. But you also need to be sure you have at least six months of debt payments liquid in the event you have no income (losing your job, for example), so that should be your first priority. Your age does make a difference in whether you invest more for income rather than accumulating wealth. Get yourself a good investment advisor and accountant!
12-26-2006, 08:31 AM
#18
Personally, I'm all for having no debt. If I got a windfall, I would clear all debt, then go from there. Here's the reason why...
If you have no debt, you essentially have no bills (maybe $1500 a month for utilities, phone, cable, taxes on the house, etc, etc). With dual incomes and no debt except minor bills, you are in a prime position to pursue much riskier investment as well as the traditional more stable investments.
As cthree pointed out, having lots of money up front (for investments) is key to developing wealth down the road. However, his investment portfolia assumes a moderate return rate.
How quickly does it change if you double that rate, but start with less money (as in my scenario)? I don't have time to do the math but I'll bet you can catch up in a hurry. Additionally, you have the freedom of not just putting lots of money away but also spending it - it helps to ENJOY yourself while you're alive, you know.
If you find yourself in a bind or happen to lose all the money from investments (don't tell me it can't happen - anyone remember prior stock crashes?), you're still free and clear - no debt, no real worries, and still plenty of financial freedom.
If you have no debt, you essentially have no bills (maybe $1500 a month for utilities, phone, cable, taxes on the house, etc, etc). With dual incomes and no debt except minor bills, you are in a prime position to pursue much riskier investment as well as the traditional more stable investments.
As cthree pointed out, having lots of money up front (for investments) is key to developing wealth down the road. However, his investment portfolia assumes a moderate return rate.
How quickly does it change if you double that rate, but start with less money (as in my scenario)? I don't have time to do the math but I'll bet you can catch up in a hurry. Additionally, you have the freedom of not just putting lots of money away but also spending it - it helps to ENJOY yourself while you're alive, you know.
If you find yourself in a bind or happen to lose all the money from investments (don't tell me it can't happen - anyone remember prior stock crashes?), you're still free and clear - no debt, no real worries, and still plenty of financial freedom.
12-26-2006, 11:16 AM
#19
Administrator
Debt comes in many forms not all of it bad, some of it suicidal. Debt applied toward capital assets (real estate for example) can be good, unsecured high-interest debt (credit cards) is very, very bad.
Liquidity is not really a problem in this case. In either you've got a minimum of $100K in liquid assets should the need for it arise. Also the scenario described assumes that there are no other changes to lifestyle. The mortgage is already being paid and I assume paid without distress and that the person receiving this windfall is employed and remains employed.
Very little changes in terms of earned income or net worth. The difference is in the future value of the investment. Excluding taxation both are more or less equal in that regard. The only significant issues are how much are you able to contribute to tax deferred investments (IRA/401K) and does the ability to take a further tax deduction on the mortgage interest benefit you.
There are many ways to invest. You could for example take that $300K and buy a franchise, a pizza hut or something, or some other sort of business. You could use it to buy a rental property or two. You could trade options and turn it into millions in only a month or lose it all in the same amount of time. It all depends on the person and their life situation, age, knowledge and so forth.
Liquidity is not really a problem in this case. In either you've got a minimum of $100K in liquid assets should the need for it arise. Also the scenario described assumes that there are no other changes to lifestyle. The mortgage is already being paid and I assume paid without distress and that the person receiving this windfall is employed and remains employed.
Very little changes in terms of earned income or net worth. The difference is in the future value of the investment. Excluding taxation both are more or less equal in that regard. The only significant issues are how much are you able to contribute to tax deferred investments (IRA/401K) and does the ability to take a further tax deduction on the mortgage interest benefit you.
There are many ways to invest. You could for example take that $300K and buy a franchise, a pizza hut or something, or some other sort of business. You could use it to buy a rental property or two. You could trade options and turn it into millions in only a month or lose it all in the same amount of time. It all depends on the person and their life situation, age, knowledge and so forth.
12-26-2006, 11:54 AM
#20
Originally Posted by cthree,Dec 26 2006, 02:16 PM
Debt comes in many forms not all of it bad, some of it suicidal. Debt applied toward capital assets (real estate for example) can be good, unsecured high-interest debt (credit cards) is very, very bad.
My point is that eliminating debt provides an awful lot of "security" above and beyond having more "liquid" assets than debt (being massively rich can change that but Corey isn't "massively rich"). You still have debt and stocks and bonds aren't "solid" investments - they can easily fluctuate to the point that you're losing, not gaining, money, plus you're paying penalties if you have to cash them in a hurry.
You can't just "dump" debt. Penalties, refinancing, and rising interest rates could easily eat up some major investment gains if you get in a truly bad situation. Let's face it - an emergency and/or tough period financially is not going to usually give you all the time in the world to shuck unnecessary debt (or even necessary debt, like a house). It's all good until you can't "afford" your debt any more.
That's why I'd pay it off. I may not make as much money through investments as some of you all, but I also won't get in trouble nearly as easily either. I also won't be worrying about bills and such when the inevitable hard times do hit.
My biggest issue is that you're assuming that current conditions will continue. Everything makes sense when you use that premise. It's when conditions change (for the worse) that your premise isn't nearly so valid. Believe me - the conditions will change at some point.