Well, I’ve been going over my goals for 2008 and have been struggling with whether to reduce my debt or save and invest the money I would use to reduce the debt.
Let’s start with the easy stuff. I have some CC debt (about 6k with 0% interest until May). That will be paid off by May, hopefully J. No way I could earn more investing then the CC interest, unless I get in the ground floor to a pyramid scheme.
Now it starts getting harder. I have 2 car loans that are 4% and a medical bill that’s 0%. I also have a 30 year fixed mortgage at 5.5%.
Theoretically, I could save and invest and make more money then I would need to pay out for the cars and the medical, letting those 3 payments end a natural death.
The mortgage has a low interest rate over 30 years, has a tax advantage for the interest paid, and if I put the money into diversified stock funds, I could almost double the return and still take advantage of the tax credit.
Woo Hoo!!! No brainer!!! All aboard the investing express!!!
As I said before, theoretically looks good on paper. The answer has to be more complex then this. So I go to Sir Google and ask him. He returns about a gazillion articles each with a different answer. Ok maybe 2 answers: payoff mortgage and don’t payoff the mortgage, and most article slanted to not pay off the mortgage.
One of the articles was from a financial advisor from either Morgan Stanley or JP Morgan. He stated that his clients that paid off the mortgage retired 10 years earlier then clients that didn’t. How could this be?
The answer is quite easy: Life happens. So, let’s say we have a mortgage of 350k. We start saving and investing money. After a few years, we saved about 75k. During that time, we have foregone new furniture, expensive vacations, and our cars are needing to be replaced. Well, we could use some of that money for these things we “need”. Right? And there is the trap. There is a huge temptation to use that money. After all, what’s a few thousand dollars? You’ll make it up next year.
And that’s the answer. Most average people, myself included, don’t have the discipline necessary to leave that money alone. It’s just too tempting.
If you pay down the mortgage every month, you don’t see the wealth accumulating and it’s a lot easier to forgo the temptations.
With what to do about the mortgage answered, all my other answers are easy. Pay off all debt!!!
One last thing, I plan to live in my house for the next 20 – 30 years. If you are in a starter house or plan to move in the next 5 years, you might want to use the extra money to save up for a bigger down payment for your next house.
Debt Reduction or Investing
December 26th, 2007 at 03:26 pm
December 26th, 2007 at 03:39 pm 1198683587
December 26th, 2007 at 04:21 pm 1198686074
December 26th, 2007 at 05:00 pm 1198688429
Englishteacher - Being debt free does insulate you from things, but so does having a large investment portfolio.
I say to invest unless you have debt at an interest rate higher than what you could reasonable expect to earn from the investments. And, as you point out, you need to have the discipline to let your money grow and not spend it just because it is there.
December 26th, 2007 at 05:06 pm 1198688812
I really liked your point that paying down the mortgage is kind of like forced savings, and that most people don't have the kind of discipline required to allow that money, if it were instead invested, to remain 100% invested rather than spent.
December 26th, 2007 at 05:15 pm 1198689307
December 26th, 2007 at 06:38 pm 1198694288
Sure, prepaying your mortgage is "forced savings" but why save at 4 or 5% when you can save at 8 or 9 or 10%? People use the same argument to rationalize getting a huge tax refund every year. That is "forced savings" at ZERO interest which makes even less sense.
December 26th, 2007 at 07:15 pm 1198696532
December 26th, 2007 at 07:32 pm 1198697563
Then how will they ever save for retirement? If they pay off their house, then what? They'll have a bunch of money freed up each month. What happens to it? Does it just get spent or will they magically develop the discipline needed to start investing at that point?
December 26th, 2007 at 07:43 pm 1198698233
In fact, I like the investing option in that it keeps your assets liquid enough to keep your money versatile. If we drop our money into a mortgage, then we can't exactly get it back. At least, not without leveraging the equity for yet another loan of some kind.
On the other hand, while I agree that people SHOULD do that, the reality is, we'd be lucky if some people save at all!
So, for people who may not be financially savvy (yet), or if they know that they'll be too tempted to spend it elsewhere, then I say pre-paying the mortgage is the way to go. I agree it's not the ideal answer, but if my friends for example can at least do THAT much, I'd be happy as can be for them.