Personal Finance Question

Hi,

Way too little information actually! I don't remember seeing whether you had any other debts outside of your mortgage, so I think any posts about this are probably premature.

Do you own car debts, credit cards, etc??? If so, how long has it been there? Credit cards you're paying 19% on for years on end are probably smarter to pay off if you can stay away from them instead of putting stuff on them.

What the What wrote:

So, tell me mr. genius, how exactly is it that a person with $100k in assets and $50k in debt is so much better off than the same person with $80k in assets and $30k in debt?

This ought to be fun.

If you assume reasonable numbers - say the assets are investments yielding 8% and the debt is paying 3% - the first scenario is clearly better.

Thanks for asking.

mr. genius wrote:

What the What wrote:

So, tell me mr. genius, how exactly is it that a person with $100k in assets and $50k in debt is so much better off than the same person with $80k in assets and $30k in debt?

This ought to be fun.

If you assume reasonable numbers - say the assets are investments yielding 8% and the debt is paying 3% - the first scenario is clearly better.

Thanks for asking.

The following is the context in which the scenario was put forth:

What the What wrote:

2) The fact that the debt is partially inflated away is a red herring and entirely irrelevant to the discussion. Your investment returns are ALL partially inflated away by the exact same inflation. Try to think. Seriously, try to think clearly. It shouldn't be painful.

To which ~ wrote:

All of this is just comically bad. You don't see the difference between owning assets vs debt in an inflationary environment? If you're a troll you certainly have promise.

So now it must be asked - are you able to follow simple logic? Because if you are capable of this then you will be able to see that assuming different returns on the assets compared to the interest rate on the debt is COMPLETELY missing the point.

Again, note what was written: "You don't see the difference between owning assets vs debt in an inflationary environment?". Hence the ONLY thing that is being debated on this particular item and the particular example that I gave is the question of whether or not inflation somehow magically makes it better to keep the debt and increase assets rather than reduce the debt and leave assets where they are.

Starting point: Debt = $50k, Assets = $80k. Question in this example is what to do with an extra $20k focusing on the impact of inflation as that is what the brilliant '~' chose to challenge.

Assume inflation = 3%

Assume both debt interest rate and asset return = 6% (note that making them differ from one another is completely changing the question being considered). The earlier claim was that debt was magically deflated away while inflation did not have essentially the same impact on investment returns.

Scenario 1 - Reduce debt by $20k: Debt = $30k, Assets = $80k

A year later that debt is now $31,800, assets are $84,800 for a net worth of $53,000. Inflation reduces this in real terms by 3%

Scenario 2 = Leave debt alone, increase assets by $20k: Debt = $50k, Assets = $100k

A year later that debt is now $53,000, assets are $106,000 for a net worth of $53,000. Inflation reduces this in real terms by 3%

Gee, those two look awfully familiar. What ever happened to that magical quality by which debts are deflated away while asset returns are somehow magically immune to the exact same impact?

What is truly weird is that some of you (not all of you - I realize that some are just trolling for kicks) - but some of you actually believe the nonsense that you post. It appears that 'Larry Liberal', '~', 'brasky', and 'Coldwell Banker' all fall into that category of actually believing things that are clearly, indisputably incorrect. I hope that at least one of these individuals has actually learned something here.

That is all the time I am willing to waste on trolls and folks incapable of understanding simple concepts.

Ciao.

you are wrong

Hey - Thanks for raising those questions.

No debts besides the mortgage. No credit card or car debts...

All other info is the same.

~ I am 26 and my wife is 29

~ $108K after taxes

~$2000 for mortgage per month (with taxes and PMI)...with ~$30K left to go to get PMI totally paid off. Mortgage rate is 4.125%

~ $30K in savings...wanting to do intelligent investing...Choices we're considering are basically putting ~$20K into the mortgage vs. putting it into a Vanguard Index Fund we have in an IRA vs. some combination of the two and have more come out of my paycheck to go into my 401K (company match is already maxed).

~ Very slow 5K time relative to Letsrun standards

All the insight so far has been great - hoping not to raise too much chaos with the debates, but it is definitely helpful to see the different sides.

What the What wrote:

~ wrote:

The first statement is factually inaccurate. Even when taken at face value the most advantageous decision is to invest.

INCORRECT! once again.

While the terminology confuses many (apparently including you) the effect of paying down the principle on a mortgage is EXACTLY the equivalent of compound interest regardless of the terminology involved. It reduces the principle outstanding, thereby reducing the interest accruing the following month, thereby increasing the principle part of the normal payment the following month, thereby further reducing the principle outstanding two months hence, thereby...ad infinitum.

i.e., compounding

And as far as making the most advantageous decision, just in case you were not aware - reducing one's debt IS investing one's money and has PRECISELY the same impact on one's wealth as increasing one's assets.

As I said, one ought to invest in wherever you can get the best return.

This is correct. Paying down one's mortgage gets the same compounding benefits as interest on other investments. I'm not gonna throw my CV on here, but I know my shit when it comes to math and finance.

If you pay down $30,000 and your annual PMI is close to $1500, that's an extra 50 basis points of return, so basically risk-free 4.6% yield.

OK, so there are intelligent people on the LetsRun boards. Good to know.

- Cheers

So basically this thread could have ended after the first reply?

It's not just a matter of "gauranteed returns" though. It comes with a price. Your home is your MOST illiquid asset, and by pouring money into it you are basically saying that 1.) You are fine getting a very very small return on your money (I mean SMALL), and 2.) that you don't want to see that money ever again until you sell your house. Not for your kids college, not to open your own business, and not to keep food on the table in case things go south. On top of that, your rate is so low, that if you factor in how much you are deducting on taxes (basically subtract 1-1.5% from your interest rate), and how much is eaten up by inflation (another 1.5-2%), you're basically getting a free loan.

ya..... wrote:

It's not just a matter of "gauranteed returns" though. It comes with a price. Your home is your MOST illiquid asset, and by pouring money into it you are basically saying that 1.) You are fine getting a very very small return on your money (I mean SMALL), and 2.) that you don't want to see that money ever again until you sell your house. Not for your kids college, not to open your own business, and not to keep food on the table in case things go south. On top of that, your rate is so low, that if you factor in how much you are deducting on taxes (basically subtract 1-1.5% from your interest rate), and how much is eaten up by inflation (another 1.5-2%), you're basically getting a free loan.

Homes can be sold, low interest equity loans can be taken out... it's more liquid than you think. Yes home values can go down and it can be a crappy time to sell when you need to, but the EXACT same thing happens to stocks and every other investment with decent potential returns.

There's also security and peace of mind with lack of debt: I pay off my mortgage as a supplement to my life insurance policy. I have decent term life insurance, but I'm on track to have the house paid off in 4 years which is well before the term expires. If anything happens to me, my wife will never have to worry about the mortgage. Or it gives her the option to sell and pay cash for a smaller house and use the difference for kids colleges.

Whatever stock tip the taxi driver or your buddy at the water cooler gives you (or a poster on LR), that's where you should put all your money.

The great thing about this is that you don't have to do any research.

Which is fine, but if you already have a good cash pillow, it makes no sense to let that money sit dormant in a house when it could be invested, as the thread was originally discussing. Putting it in your house is like putting it under a (very heavy) mattress.

Euclid wrote:

Hey - Thanks for raising those questions.

No debts besides the mortgage. No credit card or car debts...

All other info is the same.

~ I am 26 and my wife is 29

~ $108K after taxes

~$2000 for mortgage per month (with taxes and PMI)...with ~$30K left to go to get PMI totally paid off. Mortgage rate is 4.125%

~ $30K in savings...wanting to do intelligent investing...Choices we're considering are basically putting ~$20K into the mortgage vs. putting it into a Vanguard Index Fund we have in an IRA vs. some combination of the two and have more come out of my paycheck to go into my 401K (company match is already maxed).

~ Very slow 5K time relative to Letsrun standards

All the insight so far has been great - hoping not to raise too much chaos with the debates, but it is definitely helpful to see the different sides.

Pay down your debts a little faster with a bias to saving more now.

Just putting money into a 401k is not enough savings. The maximum funding per year is a bare minimum. The contribution by the employer is great. Don't stop doing that. Just know that you need to save more than that.

Stop funding the IRA and fund a ROTH. They are far more flexible.

Also, some arguments about a house are right. In general, don't treat it like it is your "retirement account" because it's not a great investment since the bank's schemes were discontinued.

dumb wrote:

You probably need more like $20-25k cash on hand as an emergency fund if your mortgage alone is more than $2000/mo. Planning to loot your IRA contributions on an emergency basis is a terrible idea.

Agree with this post. I have an $1850 mortgage and don't feel secure with anything less than $20K in savings. Wife doesn't work though so I'm at a bigger risk than you.

I have read this thread three times and What the What may be right but you are doing a terrible job explaining why.

I imagine a scenario: I am 25, I have a $100k mortgage, 30 years, 4%. I'm paying $477 a month for that. In year 5, I have an extra $30k. I invest that $30k and it sits for 25 years at which point my home is paid off, I don't add a dime to it. After those 25 years at 8%, I have $205k and a paid off house.

Or, in year 5, I decide to drop a $30k lump payment down on my mortgage. Doing so at that point reduces my loan by 11 years, which means that for each of those 11 years, I'd have roughly $5700 per year to invest (the $477 x 12 months I'm not paying for my mortgage). Calculating a $5700 initial investment, making 8% per year, plus adding $5700 per year for those saved 11 years and compounding interest, I come up with a potential of $102,500 -- less than half of what you'd have made if you simply invested the 30k instead of paying down the mortgage.

What am I missing?

Nothing. If you're in your mid-20s with no kids and you can pay your mortgage with substantial saving you are PISSING INTO THE WIND if you aren't putting money in the market. Not to mention that the market is in a substantially better position than it was when you were in college. A mortgage that you are current on is good debt. Rushing to rid yourself of debt in your 20s seems freeing, but your income (hopefully) isn't going anywhere.

If you are THAT risk averse, go Roth.

You are assuming 8% return vs 4% mortgage interest rate. Of course an 8% investment return is better than a 4% investment return. There is nothing wrong with those assumptions (although the 8% is obviously uncertain). It also has nothing to do with the above discussion which focused on such things as:

A) Are investment returns superior to paying down the mortgage because investment returns compound whereas paying down the mortgage does not? This was shown to be false.

B) Are investment returns superior to paying down the mortgage because of the effects of inflation? This was shown to be false.

If you are going to simply assume 8% vs 4% then of course you will get a better result with 8%. It just has nothing to do with what was in dispute.

dont forget that what the what calculates inflation to be 3% over the next year.

Well that's just stupid.