I had a long conversation with Bert today on the phone as he was on his way to Detroit. It was regarding what the heck to do with my idle cash that I typically use for investment purposes, but am getting anxious as it has been almost two weeks since purchasing a stock. We were trying to discuss if and why I should make extra payments towards my mortgage, which I typically do once per year. Here is how our discussion went.
As I have discussed regarding my fixed expenses way back when, I have a mortgage, currently at $84,007.14:
Now, the trouble here is the interest rate is only 4.375%, as you can see above and I’m about 3 years into my mortgage. I have made an extra payment every year since I’ve owned it, as that typically reduces your actual maturity date by 6-7 years if you perform this. At 4.375% – it’s harder even today to get a 30 year mortgage with that sort of rate; also – after-tax it is roughly around 3.67-3.75% when taking deductions into the equation. Now, I don’t plan on selling this house, as it is in a prime real estate location that is surrounded by 2-3 colleges/universities, is a family-oriented neighborhood, has development projects coming up all of the time and has a semi-easy access to Cleveland’s public transportation system, as well as 2 beautiful mall/outlet areas. Therefore, I would rent it out before anything, as I had in the past by having a roommate (which turned sour), and simply purchase another property or some other living arrangement if I were to leave. Conclusion: It seems as though I’ll never sell & get rid of the mortgage loan. The issue now has to do with my cash. As you all can remember, I am aiming to save 60% of my income, with sometimes hitting that target or slightly less, but nonetheless – I am saving quite a bit of money every month. Therefore, I am sitting on cash that is earning me a whopping 0.75% if I am not investing into dividend paying stocks. Talking with Bert, the question then is – do I pay down the mortgage or invest? If there is no current stock opportunity do I start applying more extra payments here and there? The question and thought has beaten me up for 3 years.
Paying Down the Mortgage Pros & Cons
Obviously, we are going to the pro & con list here to either: pay the down the mortgage or invest. We will begin with paying down the mortgage. Here are the benefits/reasons I can think of and the cons:
- Pro: If no investment opportunity exists that has a P/E is undervalued enough with a dividend yield above your after-tax rate on your mortgage, extra payments to your mortgage is a way of investing as it reduces your time and interest to pay over the mortgage.
- Pro: Making extra payments obviously reduces your time-frame of having the mortgage as all extra goes to principal
- Pro: Builds more equity into your house by reducing your debt, thus the fluff of networth grows
- Pro: Building the equity, mentioned above, also allows potential for Home Equity Line of Credit (HELOC) opportunity, which essentially is using collateral (house) and borrowing against that at a very low interest rate, which then the funds could be used for other investing opportunities at a low cost of borrowing
- Pro: If stuff “hits the fan”, selling the house will provide more than just enough to cover the remaining mortgage
- Pro: If down the line I rent this out or live in it with a family (fingers crossed haha), it’ll be nice to look back knowing that the extra payments would allow my family to live debt free here or with rental – increase my positive cash flow.
- Con: Missing investment opportunities
- Con: Using excess cash by placing it into an illiquid investment (an asset that is difficult to sell or move quickly)
- Con: A natural disaster could wipe the house out, but insurance would be there. Just would be sad!
- Con: In case rates go lower than they’ve ever been, which I don’t expect to happen, it may not/would not make sense if I’ve made all of these extra payments at this rate
Phew, now that those bulleted points are there showing the benefit to pay down the mortgage or invest into the market. From what I can see looking at the pro/reasons & cons to paying it down – if there aren’t any investment opportunities and you are sitting on idle cash that you don’t plan on using (wedding, wedding ring, new rental property, a business, etc.) then – why wouldn’t you pay down the beast? If you started making extra payments and say in 15 years it’s over – I just freed up quite a bit of cash flow in my life. Well, let’s see pros & cons to investing instead.
Investing Pros & Cons
- Pro: Investing instead of paying down allows you to buy a dividend cash flowing asset that covers the monthly cost of living.
- Pro: Buying an undervalued dividend paying stock allows further appreciation for a stock security (but who really cares about appreciation)
- Pro: Buying a dividend stock allows dividend reinvestment, which ultimately buys more assets and increases your cash flow automatically, so the true yield of your investment is larger than the current yield.
- Pro: Paying down your mortgage here and there vs investing does not impact your cash flow today, but does so at a later time. Dividend stock investing impacts your cash flow immediately upon ownership and purchase.
- Con: The dividend stock may cut their dividend
- Con: The dividend stock may depreciate or not grow their dividend
- Con: Dividend tax rates could go up to ordinary income levels, effecting your after tax of receiving dividend income, essentially reducing the amount you are receiving
- Con: The company may go bankrupt
- Con: Bond rates could all of a sudden triple or CD rates could spring back up to their previous highs, thus causing you to think about selling your dividend stock, pay capital gains tax + fees of the trade
Pay Down the Mortgage or Invest Conclusion & Help
I am here really to see what the community would do. Right now this is what my gut says: If I can’t find an investment opportunity in a given month (aka no stock activity from using our screener) and I have saved what I typically have done with no need for more emergency cash or upcoming life event (such as the wedding, a ring, a business investment etc) – I would make an extra full month payment. My payment is roughly $447 per month and with my investment purchases always seeming to float in the $1.5 – $2.5K range, this doesn’t total deter/eat into my fund to invest into the market. But I just still am not sure. Would you pay down the mortgage or invest into the stock market if you had idle cash? Would you make an extra payment in a month that you had no stock investment activity? Would you all of a sudden split what you do with your savings, say 75% to investing and 25% of your savings every month goes towards the mortgage? What if you were in this scenario: Stocks were at all time highs that you were interested in, dividend yields were around 2-2.50% on equities, you have not purchased a stock in 2-4 weeks and you are sitting on a full month’s worth of savings – would you make an extra payment then or wait in cash at 0.75%? I know this is going to be all over the place, but your responses, considerations and viewpoints are critical! I have struggled with this battle ever since owning my home. Would love everyone’s input – so thank YOU. I know it’s been discussed before to either pay down the mortgage or invest but I need to make an action! Can’t wait to read what you all think, hope everyone had a great weekend!