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April 03, 2009


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Although the example outlined is not perfect, it's about as good as any single example can get.

I important note to include is that when Mort pays his mortgage up front his returns are guaranteed. Thus if they both would have started this plan in 2006, it's hard to think that Mort wouldn't come out ahead at the end of 15 years. Personally, I like the fixed, known returns and the added element of tangible security that comes with a low mortgage/paid off house.

Great work!

The other problem with this example of course is the tax savings presumption-I make more than the average American taxpayer, and while I only pay 750 a month in mortgage costs, my 'standard deduction' on my taxes still is higher than 10% to charity plus my mortgage interest deduction. Of course, I have none of those key tax shelters-children!

What I'm saying of course is, run the numbers yourself, and know your tax situation.

The kind of 401k Rob invests in makes a difference. If Rob were making payments into a Roth 401k instead of a regular 401k, wouldn't they come out exactly the same?

So at that point, as Baker points out above, in reality if Rob's average annual rate of return on his 401k was lower than the mortgage rate (6%), Mort would come out ahead and vice versa.

You know there is the option of paying into the 401k and using the tax deduction to pay down the mortgage, that's what's always recommended to Canadians when it comes to their RRSP's.

This example doesn't account for matching 401K contributions from an employer. If "Rob" is putting 10% into his 401K and he gets another 5% match on top of that, his earnings would be significantly higher than Mort's.

The linear "average" returns on the 401k investment is painting a pretty rosy picture, too. If the stock market has taught us anything this past DECADE, it is that stock market returns are NOT linear.

This is a very tough nut to crack, you can't come up with an answer without plugging in ASSUMED returns on investments.. I think you'd almost have to use the 10 yr treasury as a comparison.. Then you still have interest rate and inflation unknowns to tackle... Very tough.

FMF, great job in presenting a very detailed hypothetical. The problem, as you point out, is that no one can predict the future--whether it be with respect to our own jobs and tax rates, let alone how the economy will fare. My suggestion is to split the baby. Put half the available money in the retirement fund and the other half towards paying down principal. That's essentially what I'm doing.

I would look not just at making extra mortgage payments vs retirement, but at making mortgage payments vs all savings. Having money in non-retirement funds may lose the benefit of tax deferral, but it has additional considerations of having an extra cushion in case of a real emergency. By a real emergency I mean something for which your 6 months or even a year emergency fund isn't sufficient e.g. 2 years out of a job or a serious illness. Unless one can repay the loan in full quickly, paying extra is not reducing monthly obligations. So I would put having considerable savings ahead of both mortgage and non-matched 401K, especially in this economy.

Another aspect one needs to consider is the effect of inflation - this is something that is often overlooked in this type of posts, but it is an important consideration now. Currently mortgage rates are low, below 5%. Now, guaranteed 5% looks really good now. You cannot get guaranteed 5% anywhere else today. But what about 2 years from now? Will the government's spending and printing money cause high inflation or will the government be able to prevent it by raising interest rates? Will the government raise rates enough that CDs will be paying 8% or 9%? Or will we get Carter-type double digit inflation and CDs and government bonds paying 13-18%? People with 9% mortgages felt really good during Carter era as they saw their mortgage amounts being reduced to nothing. Will we have that? Or we'll have 10 year deflation as in Japan? Or everything will be as is and when the economy starts to recover the government will be able to quickly remove all these extra money from circulation without raising interest rates too high?

If you believe in future high inflation, you want to keep the loan. If you don't - you may want to repay it.

This is essentially an investment decision, and as any investment decision it may have risks and benefits either way. I agree with those who said there is a single answer - one needs to think about one's preferences and individual situation.

As many here have pointed out, it is really impossible to predict future tax increases or cuts, the state of the economy over a decade or more, or interest rates. I therefore liked the guaranteed return when I paid off my house. Many of my friends thought I was nuts - until they lost it all when the tech stocks tanked. Guess what, by then I owned my house free and clear and lost nothing.

I had a similar scenario- I had to choose between paying off student loans and putting the money into the 401k. I split the baby- I paid off my 6.8% rate student loan, but didn't pay off my ~4% rate consolidation loan. I think that this is the best of both worlds. I got a guaranteed 6.8% return on the loan and got to reduce a significant portion of my outstanding debt, but still have the money to save for a house and retirement.

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