Keep money or pay off house?

Question

My Mom is about to collect on an insurance policy. When it's all said and done, she'll have about 550K in cash.
She still has a first and second mortgage.
House value is about 215K.
She owes 136K on the first but the interest rate is 5.25. I don't know how much she owes on the 2nd but it's about $185 a month. First mtg is about $1400 a month and includes insurance and taxes.
She makes about 3K a month but needs to live off of about 50K a year to keep her standard of living.
Her financial advisor wants her to pay off the house. However, if she does that, the money is no longer liquid, it's not earning anything and she'll lose the tax advantage of the interest write off. Any ideas?

Answer 1

pay the house off. at 5.25% interest for the house, compared to a max of 5% on a cd with the money you would still lose money. Pay off the mortgages, and invest the rest of the money. Smartest move you could ever make.

Answer 2

Paying off a first mortgage is NEVER a good idea. The cash can be invested and make a larger return in interest than she will ever get from the house and the money is still liquid.
Consider this: let's say that your mother paid off the 1st and 2nd and had little or none of the insurance money left. Then she loses her job and has trouble for some reason finding another. She goes to the bank to get a loan to carry her through because she's got all this equity in the house, right? WRONG!! They won't loan her money on her own house if she doesn't have a job because the ability to repay isn't there anymore.
I would pay off the second and invest the rest in something long term because even if she retires, the interest from the investment will make the house payment. My suggestion is for her to make a spreadsheet and that shows her the long term advantages of having a mortgage and keeping her cash working for her. She will also need a tax break that the mortgage will give her. Although paying off your house as fast as possible is the traditional thinking, it's not the correct thinking - I don't care what her financial advisor says. Do the spreadsheet and see for yourselves.

Answer 3

Invest the money. Equity is worthless. You're last sentence is right on. You're better off investing the money as long as its someplace where the principal is guaranteed. (CD's, Annuities or UL insurance). Keep yourself in a cash position- think of it another way- when you get the money, you will have 2 major assets (home and cash). If you put the money into the home, you now only have one asset, and you might lose it at any time due to market fluxuations. If you keep the money aside and invest it, your home can go up and down in value, but you have your cash out working for you and have two assets working for you instead of just one. One last thought- if I told you I had a great investment for you- a CD that earns 0% and your principal is not safe, would you invest in it? Everytime you make a payment to the principal of your home, that is where you are investing. Find yourself a new financial advisor.
john s is forgeting about the mtg tax deduction which would put the actual cost of the loan below 5%.

Answer 4

Follow the advice of the investment adviser.

The tax advantage on home loan interest, while valuable, is not as great as you may think. If your mom is in the 32% tax bracket with federal and state tax combined, then for every dollar she pays in interest on the loans she only gets 32 cents in tax relief. That means that she still pays 68 cents per dollar in income tax. It is not a dollar for dollar reduction in her taxes.

Part of the reason she needs 50k per year is the existing mortgages. If they both go away ($1,585 per month, or $19,020 per year) and all she has to fund is the anual property taxes and insurance costs, then her cash requirements will also be reduced acordingly.

In addition to that, she will have some of the 550k left after paying off the home loans. Let's say she buys a new car as well and the amount left is 200k, and she invests that and is able to earn six percent per year. That gives her an additional 12k per year income. And on a home valued at 215k, that should pay the anual property taxes, insurance and all of the annual utilities for her, plus give her money left over.

I don't know the full financial condition of your mom, but if she had no mortgage, no credit card debt, a new dependable car and money investeted that provides her with some annual income, that can't be a bad thing.

Answer 5

Who cares about the tax advantage of the interest write off?

I agree with her financial advisor. It is ALWAYS advisable to eliminate debt (even a mortgage) whenever it is possible to do so. If she eliminates all of her debt, then you will find that it takes an amazingly LOW amount of income in order to maintain the standard of living when you're not making any other payments other than taxes and utilities. If she makes $3K a month right now, but is paying $1585 in first and second mortgages, that'll be like adding $1585 to her monthly income!

Tax advantages are NEVER a good reason to do anything. They can be a benefit to take advantage of if your situation is comparable to the one the tax advantage is offered for, but it should NEVER be the driving force behind a financial decision.

It doesn't matter if the money isn't liquid. She won't be needing it if she has an extra $1585 per month to put in her pocket over what she's used to right now.

Answer 6

Pay off the house. The interest payments as a tax deduction don't pay anything, all you are doing is making money for the loan company. Every time she pays a mortgage, she is losing money from the interest. Pay the loan and put the rest of the money into something that will pay interest back instead of your mother paying interest out. Why go to a financial adviser and then not take his advice just because it's not what YOU wanted to hear? The interest on a mortgage usually ends up costing about 2 or 3 times the actual amount of the loan.

Answer 7

Lets focus on two things you said: (its)"not earning anything"(and she will lose the) "tax advantage of the interest write-off"
#1 Can you earn more then the interest rate on the loan enough to offset the risk of whatever your investment is? Answer - No or probably I am 99% sure No. Earning a rate of around 6% is probably doable in a CD but we are talking about earning .75% above the mortgage rate.

#2 Its better to pay interest and get a tax break on it then to not have to pay it at all? Uhhh, no, thats a little like saying I'd rather lose money in the stock market because then I don't have to pay taxes.

The financial advisor is correct, plus FYI needing 50K per year to maintain your standard of living shouldn't be part of the equation, your mom has a spending problem if thats what it takes for her to live for 1 year. Once she pays off the house she may have 300k left or thereabouts, without a mortgage payment 97% of the U.S. could live on that 300K for the rest of their lives. She should evaluate her decisions on what she has available to her, not what she needs to continue to live how she is living.

Answer 8

Paying off debt has EXACTLY the same financial value as applying money to an investment with the same interest rate. So, paying off a mortgage that carries a 5.25% interest rate is the same as investing the mortgage balance in a financial instrument that earns 5.25%.

The point about tax advantages of the interest on the mortgage is a valid consideration in this instance because it lowers the effective interest rate your mother is paying on the mortgages. With earnings of 36k per year, she is probably in a 10% to 15% tax bracket. The tax advantage of the interest write-off on the mortgages, then, lowers the effective interest rate by 10% to 15%. So, the real interest rate on her mortgage is probably between 4.5% to 4.7%. She only needs to find an investment that pays a higher rate to do better with her money than using it to pay off the mortgage.

It may be easy to find an investment that pays more than the effective interest rate on the mortgages in the range of 4.5% to 4.7%. But, there is the matter of discipline to consider as well. The only way investing the money is better than paying off the mortgage is to invest it at a higher rate than the effective interest rate on the mortage AND, THEN, LEAVE THE INVESTMENT UNDISTURBED FOR THE SAME LENGTH OF TIME REQUIRED TO PAY OF THE MORTGAGES. If there are 15 years left to pay off the mortgages, you must leave the money invested for 15 years without touching it. Otherwise, paying off the mortgage would have been a better financial decision.

All things considered, I agree with your mother's financial advisor. Paying off the mortgages is a sure thing. There is no question of having the discipline necessary to not touch an alternative investment. A financial hardship could arise in the future that might also require invading the investment chosen instead of paying off the mortgage. But, if mortgage is already paid off, your mother will be in a better position to handle future financial hardships as well.

Payoff the mortgage.

Answer 9

I know it's not as exciting, but I would pay off the house. Although the interest rates aren't very high, she will be saving a lot of money on the mortgages by paying them off sooner. She makes a pretty good chunk of money each month. She'll have even more not paying her mortgage every month. If there is still some left over, I'd invest. Good luck!

Answer 10

The money may not be liquid, but she can get a home equity loan if she needs to.

That's a great rate, but even so... Pay off the house. If she doesn't, she'll just have to keep paying the mortgage and keep paying the interest on it. She'll save some interest if she pays it off now (even with a penalty, if she has one for paying it off early), which means that the total payment for the house will be cheaper.

Pay it off. Assets are better than debts.