Pay Off Your Mortgage or Conserve Your Nest Egg??
Q: I’m a retired USAF sergeant and I purchased a retirement home five years ago for $270,000 with a 30-year fixed rate mortgage at 4.5 percent. I have already paid about $60,000 in interest payments to my big box lender, as you call them.
Over the years my wife and I have built up a cash nest egg of over $500,000 and I keep wondering if it wouldn’t be smarter to use half of it to pay off the mortgage and avoid the $12,000 per year in interest I’m paying to my lender.
Currently, our $500,000 in savings is only earning about 2 percent and we don’t foresee this changing in the future.
I’d be willing to pay you a fee for your expert advice if required. Thanking you in advance for your assistance.
A: Thanks for the offer, but no fee is required.
Right now, it seems as though the smart move is to simply pay off your mortgage. And, it could be a good long-term decision, since you’re earning so little in your savings and you have so much cash available.
You could then “repay” your savings with the money you’re not spending on your mortgage payment each year.
Before you write the check, consider this: 4.5 percent is a tiny amount of interest on a relative basis. You didn’t mention if you have a 30-year or 15-year mortgage term, but if you have a 30-year term, you can simply make extra payments of principal on a regular schedule so that you pay off the mortgage in 15 years or even 10 years.
The reason many financial advisors would tell you to keep your investment cash separate is that there may be other places to put that cash that would earn you more money – if not now, then in a year or two.
There’s no reason to have a half million dollars in a savings account. You won’t need all of that cash at once, and you may have other opportunities to invest that will bring in 4, 5 or 6 percent per year without taking on much additional risk.
The conversation you and your wife need to have centers on risk. Are you willing to take some risk in order to earn a little better rate of return?
If the answer is no, you prefer it all in cash or Treasuries, then you should immediately pay off your loan. You’ll be left with $250,000 in cash and an extra $15,000 or more per year that you’re not using to pay down your loan. For retirees, this kind of thinking makes a lot of sense.
If the answer is yes, then you should think about a strategy that would allow you to pay down your mortgage faster, and invest in an assortment of mutual funds that meets your investment objectives and risk tolerance.
Finally, keep in mind that if you pay off the loan, you may not be able to get another loan a couple of years down the line. Interest rates may be considerably higher or your circumstances might be different and you won’t qualify for the loan. For some people, having the cash in hand is a benefit and gives them some security in case they have a need for the cash.
To that end, I suggest you look for a few top fee-only financial planners and ask them for a free consultation. The best ones will give you an hour or so to help you analyze your portfolio. You might also ask them if you can pay them a flat fee for a full financial plan (that might run anywhere from $250 per hour to $2,500 for a full-blown plan).
Stay away from things like annuities (unless it is an immediate annuity, which will guarantee you a stream of income over the rest of your life), fancy whole-life insurance plans and other expensive products that I feel generally better serve the folks who sell them than the folks who buy them.
And, don’t agree to buy anything from anyone until you have spoken with at least 3 different financial planners.
From Randy on Facebook:
Excellent review. It would be helpful if the poster listed what his gross monthly retirement income is. While the 500k is a lot of money, at 2%, it would take 36 years to double, not considering taxes, if held in a taxable account. 4.5% rate, 5 years in to a 30 year note on 270k, there is still a lot of future interest payments to be saved by … See Moreprepaying.
Earning 2% on a CD or MM, If it were my account, I’d put 50k toward the payoff of the mortgage, schedule the balance for a 10 year payoff. For a higher return on principle of the remainder of the 500k , invest in a intermediate bond fund with Vanguard, Fidelity or Pimco, 4-7% net return, keeping maybe 100k as a cushion in CD accounts or MM.
Again, this is just an opinion and not advice.
Randy – I always publish all of the information that I have in these columns. In this case, he’s retired Military, so his retirement income can’t be that much. I think your suggestions are good ones. But if you want a risk-free investment, it’s hard to make the case that even an intermediate bond fund is risk free. People have lost lots of money in bonds over the past few years. Thanks for your comments.
You stated that “you may have other opportunities to invest that will bring in 4, 5 or 6 percent per year without taking on much additional risk.”
Can you expand on that statement. I too have significant funds, in a 1.35% MMF. What options pays up to 6%, with modest risk. I have avoided longer term fixed rate investments, anticipating that Bernanky/Obama will have to raise federal fund rates, to continue to attract needed foreign funding – for our soaring TRILLION $$ debt load. If/when interest rates rise, I would lose principal (if redeemed early).