I’m overweight in stocks, by most people’s standards, so I’m looking to reallocate some money, and also exploring some “safer” investment options for future investment contributions. In this post, I’m going to explore the idea of paying down the principle of my mortgage as a low risk option for future investments. Almost all of my stock holdings would be sold at a profit at the time of writing, so the idea of selling them and incurring capital gains taxes to pay down my mortgage isn’t all that appealing. That could change if the market goes down in 2017 and I can offset those gains with capital losses, but for now I’ll keep the lens on future investment capital.
In my current situation, I owe a little over $360,000 on a house with a value of roughly $775,000. In 2013 I took out a 30 year fixed rate mortgage at 3.75%, the current monthly payment is almost $2600, including taxes. About $700 a month goes towards principal, with $1,150 going towards interest, and the rest is set aside for escrow/taxes. Add in the fact that I’m in the 33% tax bracket, that makes my effective interest rate 2.5% after the tax credit.
Most people will tell you that it’s downright silly to make investments with an expected return of 2.5%. Then there’s the competitor in me that thinks, “hell yeah I can beat that, probably triple it without even trying too hard”. Add on the power of inflation that is working in my favor if I don’t pay it off. Let me explain, as inflation rises, each dollar has less purchasing power that it did in the past. Let’s say inflation is steady at 3.0% over the next 20 years, which is actually lower that the actual 3.29% it’s averaged over the last 100 years. In 2027, that $2600 payment that I would be making will have the purchasing power that $1937 does today. Extend that out another 10 years, and in 2037 if will shrink to $1440, almost half what it is today.
So, paying off my principle isn’t looking so hot yet, is it? One other factor that I don’t think I’ve ever heard anyone talk about is the lack of flexibility one gets when putting cash into paying down their principal. My monthly payment isn’t reduced as my balance goes down. If I make a lump sum payment of $100,000 tomorrow, next month’s payment is still going to be $2600, as are all the rest after that. The other point to consider is that if I all of sudden lose my job, that $100,000 is gone, it’s out of my hands forever. What if the stock market loses 75% and there are deals of a lifetime to be had, or say the perfect business opportunity comes along and I need $100,00? I could potentially refinance or get a HELOC, but there’s no guarantee that is possible and even if successful, would likely comes with a higher interest rate.
Some options would be to set up a separate account and invest the $100,000 into some safe investments like government bonds or set up a fixed rate annuity. Chances are I could earn more than 2.5% right and end up net positive right? It’s highly likely that I could even invest in something like an S&P 500 ETF and still come out ahead even if the market had a catastrophic meltdown by the time my loan is due in 2043. Seems like I’m on to something here.
But wait, let’s explore the other side of the argument. There’s something to be said for the piece of mind that comes with a guaranteed return on investment. While 2.5% is not an ambitious goal, it’s guaran-freakin-teed baby! No stress, no worry about it ever going down. Market crashes, guaranteed 2.5%. Market soars, don’t need to worry about whether or not it’s time to pull out. It’s done, over, no mind space needed, go stress about something else, plenty of options out there.
Let’s explore one other avenue that I don’t think gets enough air time. As long as I’m still working, I should be able to make that $2600 payment without any problem. However, I don’t want to work for 26 more years, not even close to that long! So if I put the early retirement/ 4% withdrawal lens on that $2600 monthly payment, I will need to have $780,000 in investments ($780,000 X .04 = $2600). There is no flexibility with that either. If the markets go way down, I can’t just pay less, I will still need to have $780,000 allocated to paying off that $2600.
I don’t know that I’ve ever met or heard of anyone who wishes that hadn’t paid off their house sooner than they did. While it may not be the most logical economic choice, the idea of owning my house outright is amazing. I must say that the idea of carrying almost $400,000 in debt is overwhelming at times, so much so, that I try to just avoid thinking about it sometimes. While I’m pretty sure there are other more logical money moves, there is a part of me that thinks, how much flexibility would I have with another $2600 to work with a month?
I’ll keep you posted on what path I take.