Sunday, June 14, 2009

When To Payoff Mortgage: Housing Myths Part 13

Previous: Payoff Mortgage v. Invest Stocks: Housing Myths Part 12

Do not simply compare nominal interest rates, even tax-adjusted rates (which many people miscalculate). Where you are in the mortgage repayment amortization schedule is only one of the additional factors that determine your cost-benefit analysis.

Tony asked, "I have a current home loan of 50,000 and I have 70,000 in a money market. My current interest per month is 260.00. My gian on my money market is only 53.00 in interested per month [less than %1 APR]. Should I pay off my mortgage or keep paying it and saving in my money market? I also have 100k in a cd that yields 4% at this time."

Where are you in the mortgage repayment amortization schedule?

Mortgages front-load the repayment of interest so paying down extra early in the mortgage saves much more money than does paying down extra late in the mortgage.

Compare two people who owe $50k @ %5 interest:

Two people each owe $50k @ %5 nominal interest rate but one person saves $47k by paying it off today and the other person saves only $2k by paying it off today.

The effective annualized interest rate is lower for Person #2 (in the last year or two of a mortgage) than for Person #1 (in the first year of a mortgage).

What is your tax-filing marital status, top federal/state/local top marginal tax rate, and total itemizable deductions?

Calculate both taxes and tax deductions correctly.

A $100k %4 APY CD yields $4k gross but a 10% top marginal tax rate cuts your effective net interest income to $3.6k after federal income tax while a 35% top marginal tax rate slashes your effective net interest income to only $2.6k after federal income tax--and maybe even less after state/local income taxes.

Parting with $50k savings to payoff a $50k mortgage depends partly on your top marginal tax rate that reduces your income from savings:

4 Percent APY Savings Rate:
  • $2.0k gross interest income ($50k at %4 APY)
  • $1.8k after 10% tax rate
  • $1.3k after 35% tax rate
1 Percent APY Savings Rate:
  • $500 gross interest income ($50k at %1 APY)
  • $450 after 10% tax rate
  • $325 after 35% tax rate
A new $50k %5 30yr mortgage costs $2.5k of interest in the first year so a single person with about another $3.5k of other itemizable deductions (property tax, etc., considering the new IRS property-tax deduction) sees ZERO tax advantage or tax reduction from the mortgage interest costs, when compared to being debt-free with a standard deduction.