Bad Advice, Retirement and your Mortgage

Discussion in 'Economics' started by piezoe, Jun 24, 2008.

  1. piezoe

    piezoe

    On Yahoo today (Front page of Financial home page) there was an article purporting to give advice on whether a retiree should pay off their mortgage. The advice given was not to pay it off if your could earn more on your savings than your mortgage rate.

    This is OK as far as it goes, but there was no mention of the effect of inflation on real interest rates nor was there any mention of what the mortgage tax deduction does to your real interest rate. The deduction was mentioned only in passing and then only to say you would lose it if you paid off your mortgage.

    The advice offered was next to worthless. Losing the mortgage deduction is never a reason not to pay of a mortgage, and should never be thought of in those terms.

    A wise banker, he was president of a major bank in Colorado at the time, told me years ago, when i was a young man, that one should practically never pay off a fixed-rate low interest mortgage early. Those words have stuck with me. Although at the time i did not understand why. But i now realize that it has to do with inflation and the inexorable devaluation of currency over time.

    In addition to the defaults Banks are currently saddled with they have loaned out billions that are now yielding a negative real rate of return. This is what happens when your have low interest rates and rampant inflation simultaneously.

    In this situation virtually no one with a low interest fixed rate mortgage should accelerate payment on the principal.
    When the APR is adjusted for both the mortgage deduction and the real rate of inflation, in just about every case the real interest rate will be negative. The bank is paying you to use their money.
    Expect to start receiving correspondence, if you have not already, pointing out how much you could "save" by accelerating payment on the principal, or going to a thirteen payment plan. :D

    P.S> Of course the money saved by not accelerating payments on the principal should be invested to yield enough to keep up with inflation. Not an easy task.
     
  2. Making extra mortgage payments is equivalent to make a risk free investment. If your interest rate is low enough that you have better risk free alternatives, than clearly the math says to stretch out the payments.

    But what you haven't mentioned are the intangible benefits of paying off your mortage. The feeling of satisfaction and security that this provides.
     
  3. piezoe

    piezoe

    To each his own, but if your real interest rate is negative you would be ahead not to pay off your mortgage early and put the saving into Treasuries, even if the Treasuries were not keeping up with inflation.

    Of course banks are counting on most people with fixed rate mortgages thinking as you have mentioned. And they will do what they can to encourage that kind of false wisdom.
     
  4. Its not always false.

    I spent 1987 paying off my mortgages despite good interest rates and everyone else buying stocks (some on their mastercards).

    I was a very happy punter in November 1987.

    Remember: trade with what you can afford to lose.
     
  5. If you do not have any income then you do not have a mortgage interest deduction. If your interest expense is LOWER than the standard deduction, then you do not have a mortgage interest deduction.

    You would need to get more information about the retirees before coming to your conclusion (i.e., how much money they expect to earn).
     
  6. piezoe

    piezoe

    I suppose the older we are the more likely we are to be brainwashed into traditional thinking with respect to mortgages.

    The practical problem one encounters is finding a safe place to put the money you would have otherwise spent on paying off your mortgage that pays greater, inflation-adjusted interest than you are paying on your mortgage. When there is rampant inflation, safe and liquid investments also tend to have negative real rates of return. Basically we are screwed! :eek:
     
  7. piezoe

    piezoe

    I assume anyone on ET would be able to do simple math and take the necessary factors into account. Perhaps that is assuming too much however.:)
     
  8. Is mortgage interest tax-deductible in the USA? If not, then paying off the mortgage is a great idea. If so then it is more borderline. However, paying off a mortgage does have the benefit of earning the mortgage interest rate *risk-free*, and reducing your overall debt burden, which gives you a cushion in case of emergencies. Finally, there are the peace of mind benefits, the forced saving etc that are useful for many people.
     
  9. How often do treasuries return more than the mortgage interest rate? Mortgages are riskier so they should have higher returns in most situations. And repaid principal results in a tax-free gain (via reducing the repayments), whereas investing into treasuries is taxable. Not to mention that paying down debt is risk free, whereas buying debt isn't.
     
  10. heypa

    heypa

    I'm retired. I have a paid up mortgage. In the last 10 years I never seriously considered taking out equity so that I could invest it. There is peace of mind having only taxes and maintenance costs on the old homestead.
    As a child of the Depression I am biased against owing unnecessary money. Live in Cal. so taxes under prop. 13 can only go up 1% a year. Therefore rising equity wont let taxes price you out of your home.
    Of course with our stupider than normal politicians ( If thats possible) the state is in a hell of a fix.Don't know how thats going to turn out.
    Thank God we live in a Constitutional Republic run by statesmen not greedy bastards.
     
    #10     Jun 24, 2008