Completely inappropriate question about financial matter

Thank you Dorothy. I have to chew on this for a while. I look at the $500K, as not "with the bank", but a transfer from one of your assets (cash/bonds), to another (property). You then have 100% of the equity. As for benefits, you now have the money that used to go toward the monthly mortgage payment+insurance+other lender required impounds, to invest/donate/play with every month. I think you can still reap the benefits of tax free investment, but do it by putting in $1,000 - $2,000 a month, instead of $400k up front. Again, I trust your numbers, but I have to mull it over. I wish you well.

Quote: Ayecarumba

Thank you Dorothy. I have to chew on this for a while. I look at the $500K, as not "with the bank", but a transfer from one of your assets (cash/bonds), to another (property). You then have 100% of the equity.

Yes, with no mortgage, you have an equity investment in your property. With a mortgage, you have an investment on margin which has a lot more upside/downside potential relative to the investment. Around here (Kansas), it has been essentially flat for the last year.

--Dorothy

Quote: DorothyGale

Around here (Kansas)

If you're buying California munis and you live in Kansas the income will still be taxable on a state level (assuming Kansas has state income tax, which I'm not sure of). I'm sure your advisors thought of this, but most likely you're just pulling our legs when talking about your location. ;-)

Final ... $417k, 3.825%, 0 points, 15 years fixed. Signed the docs ...

Many thanks,

--Dorothy

That is a good rate! May I ask where you got it? I'm thinking of refinancing myself.

Despite the good rate, by the way, my vote would have been to pay down the mortgage. I see that Treasury Rates are currently 3.59% for 10 years, and 3.74% for 20. If you can't do better with something else, pay down what you owe. That is what I did with my first house.

Quote: Wizard

That is a good rate! May I ask where you got it? I'm thinking of refinancing myself.

I walked in and out of several banks asking about their rates. Then I went to my bank, Wells Fargo, and asked. They gave me a slightly higher rate than the best I had found elsewhere. I showed them what I could get, and they immediately matched the best rate I found.

Interesting that you would pay down the mortgage. As an actuary, you may know something I don't ... maybe ... then again, didn't I find out about you and that curtain thingy?

Isn't interest income on treasuries subject to federal taxes, reducing the effective yield to under 3%? That's why I buy tax free munis ...

--Dorothy

Thanks for the information.

I have no special knowledge about investments at all. I'm an expert at calculating annuities, but that is about it.

Someone correct me if I'm wrong, but I know that captial gains and interest are subject to taxes, favoring paying down mortgage debt. However, interest on home mortgages is tax deductable, favoring investing elsewhere. I know that long term captial gains rates are low compared to income tax rates. However, if we forget that, wouldn't that knife cut equally both ways. For example, you have a 500K mortgage and 500K in cash. Assume an interest rate of i, on both investments and the morgage. Assume a tax rate of t. By paying off the mortgage you lose a deduction of 500,000*i*t. By investing the money you pay taxes of 500,000*i*t. This also assumes you are already itemizing. In reality, I'm sure it would depend a lot on your personal situation.

Quote: Wizard

Assume an interest rate of i, on both investments and the morgage. Assume a tax rate of t. By paying off the mortgage you lose a deduction of 500,000*i*t. By investing the money you pay taxes of 500,000*i*t. This also assumes you are already itemizing. In reality, I'm sure it would depend a lot on your personal situation.

That's the right idea, for sure. But the tax rates are not equal, and the interest rates are not necessarily equal either. Assume i is the interest on the mortgage and t is the tax paid on ordinary income. Assume I is the interest earned on market investments and T is the tax paid on those investments. You want (I-(I*T))-(i*t) to be as large as possible. Or, in words, you succeed when net-new-interest-earned exceeds net-old-interest-avoided.

Quote: Wizard

That is a good rate!

That is an excellent rate! Assuming you aren't paying 3 points at closing to get it.

There is just about nothing better that a person can do financially for themselves than re-financing at a substantially lower rate. Of course it is a big Pain in the Ass too. Just as well it's not recommended unless the difference is at least 1%, I believe [does anyone know?].

I once saw an old Edward G. Robinson movie where he played a nefarious loan shark. One of his despicable practices was to charge "interest in advance". The next day I went to close on my house and paid "points" in the process. The irony did not escape me that the two practices are identical, one being deplorable, the other honorable. Orwell was right, just change the language, eh?

Quote: DorothyGale

I currently own a home worth about $XXX. I carry a mortgage on it at 5.25% for about $YYY, which is much less than $XXX(the rest is equity). I have the cash to pay it off.

Is it better to own the house outright or to have a mortgage -- essentially borrowing money from a bank -- for other investments?

The choices I have are ...
1.) Stay as-is.
2.) Refinance entire amount for 30 years at 4.25%.
3.) Pay some cash and refinance for a lesser amount, for 15 years at 4%.
4.) Pay it off.

What should this little Kansas gal do?

Hi Dorothy, this is my recommendation. It depends on your level of risk:

1.) Risk Adverse - pay it off outright. Why worry about not having the equity sometime in the future, and why continue to pay interest period, assuming you don't need the interest tax deduction?

2.) Give Me Risk Baby - Refinance, this depends on how much cash you have to pay upfront (we would need to do some present/future value calculations). PV of 4.25% over 30yrs (+deductions) vs. PV of upfront payment + 15yrs at 4% (+deductions). I suspect the latter is better in most cases, but this depends on your level of deductions and the upfront payment. ***And***, since you have equity to payoff the entire loan, invest that money in the stock market. *****Disclosure: investments in the stock market do not guarantee returns and are subject to losses that can be greater than the invested amount. Seek advice and educate yourself before investing.*****

3.) Somewhere in Between - Do the refinancing, and look for a conservative investment with your spare cash. And even then, diversify that conservative investment among several conservative investments. Invest in securities that yield a % greater than the mortgage interest payment. There are a number of high quality bonds yielding 4%, preferreds yielding 7%, and stocks yielding 3-18%. *****Disclosure: any conservative investments is still subject to market risk and no returns are guaranteed. Losses can be greater than the invested amount. Seek advice and educate yourself before investing.*****

I would recommmend also consulting a reputable financial advisor on this matter. As an ex-wall streeter, there are plenty of crooks out there. If you are interested in some consulting services, I'd be more than happy to lend a hand, but I think the advice this forum has given is pretty straightforward and almost comprehensive.

Quote: odiousgambit

That is an excellent rate! Assuming you aren't paying 3 points at closing to get it.

3.875 and 0 points ... it's free money ... in fact, as I pointed out above, it is cash-flow positive to take the loan with brain-dead investing.

I think there is a question here for the "Ask the Wizard" column, just not sure what it is.

--Dorothy

Quote: DorothyGale

These are the basics. The complication arises because of amortization. The numbers below are not static over the life of the loan.

If I take that $400k loan, then I am paying $2950 each month to the bank.

Out of the $2950, $1625 goes to principle, which is an equity line item, leaving $1325 in interest.

Out of the $1325 in interest, which is tax deductible (I am in the 33% bracket), I get $442 back in taxes. That leaves a payment of $883.

Now, I have that $400k to invest as a result of taking the mortgage. Say I get 3% tax free in state municipal bonds. That's an annual income of $12000 from the $400k, or about $1000 per month in income.

I now MAKE $117 per month in profit by taking the loan.

The key point is how much I can make in tax free municipal bonds. At 2% I am losing, at 3% I am winning. I buy shares of FCTFX which has paid over 3.5% for as long as I remember.

FCTFX CHART

Now, if I pay off the loan, then that same $400k is with the bank and I don't get any benefits from investing it, or tax breaks, or equity increase.

--Dorothy

Here is a different angle:
Suppose, you pay off the mortgage, and continue investing the same $2950 monthly at 3%. After twelve months, you will have $35890.83.
On the other hand, keep the mortgage, earn $117 a month + $1625 in equity, adds up to $20904 in a year.
Seems like about $15k/year advantage to paying off (assuming tax free investment, but taking taxes into account makes it even more favorable - you'll only have $490.83 in income in the first scenario vs. 12K in the second one).