Market Musings Blog

Should I Pay Off My House?

Posted on 12.19.11 by Michelle Rand in Interest Rates, Investment

Ok, I am officially tired of writing about Europe, so I thought I’d tackle the most-oft question in my thirty years of managing money: should I pay off my house?

We tell clients there are two aspects to paying off one’s home: the first is financial, and that’s where we can be of help. The second is emotional, and clients must navigate that part of the equation themselves.

From the financial side, several considerations come to the fore:

  • What is the cost of your mortgage? If you are paying 5% on your loan, then you must adjust that cost for any tax benefit you receive by deducting mortgage interest. Ask your accountant about the after tax cost of your loan, or if you are facile with math and early into your mortgage, you can adjust your rate by using your tax bracket; be sure to count both federal and state rates.
  • Say the loan costs you 3% after considering taxes. Compare this to what you are earning on the funds you would use to pay off the loan – are your earnings higher than your mortgage cost? Long term municipal bonds pay pretty close to 4% right now; corporate bonds pay 5% to 6%; even dividend yields are close to 3% presently. There’s no doubt about it; mortgage money is cheap. It’s quite likely that your money can return more than 3% over the life of your mortgage, unless the time frame on your mortgage is very short. And intuitively, it doesn’t make sense to pay off a home when we are experiencing the lowest mortgage rates we’ve ever seen in this country.
  • Remember that paying off your mortgage puts more of your own money into the asset called “home”, and if home prices keep falling, then you have wasted capital.
  • Which brings us to a fourth consideration: a home is not generally an income producing asset. Once you pay off your house, you have dented your capacity to produce income from your investments and you have made your investment profile less liquid since homes cannot be sold as easily as stocks and bonds. Hopefully without a mortgage, your expenses will be lower as well, but remember that maintenance, services such as water and electricity, insurance, and property taxes generally rise every year – in fact, your mortgage, if you have a fixed rate, is the only expense that won’t rise. To recapture the funds spent to pay off your loan, you would have to take out a new mortgage, and that can be expensive in terms of closing costs; if you are retired, you may not even qualify for a loan. Interest rates may rise, too, making the new loan more costly than the old. Alternatively you can sell the home, but you have to live somewhere.

On the other hand, paying off your mortgage is a certain “investment” – you extinguish your debt and free up cash flow that would have otherwise gone towards the house, cash that can be invested or used to support your lifestyle.

One compromise to explore is prepaying your mortgage every month. Putting an extra $100 to $500 per month towards the typical mortgage will control the amount of interest you pay over the life of the loan, and it will shorten the life of the loan so you’ll pay off the home sooner. Using prepayments instead of paying off the entire mortgage can accomplish much of what people are generally looking for when they ask about paying off the house: you can feel good about the debt declining every month; you retain your investments’ ability to generate income in the future; and your mortgage will cost you less. Here’s an example: for a $250,000 thirty year mortgage at 5%, paying just $200 per month will shorten your loan from 30 years to 22.58 years, and it will cut the interest you pay on the mortgage from $231,136 to $167,402.

If you want to test a prepayment plan on your own mortgage, go here:

http://mortgagemavin.com/fixed-rate/extra-payment-mortgage-calculator.aspx

Happy calculating!

 

Wah wah wah!

Posted on 12.08.11 by Michelle Rand in Foreign Investing, Investment

The Dow sank almost 200 points today on news that the European Central Bank was not going to play along and buy bankrupt countries’ bonds. This, despite good news in the US on the employment front, where initial jobless claims fell.

Stepping back for a minute to focus on the forest instead of the trees, we notice a few things about the stock market’s action lately:

  • On days when news is scarce or neutral from Europe, US stocks tend to rise. We think this reflects investors’ opinion that US stocks are the best of several not-so-hot alternatives for parking cash because it does look like our economy is plugging along.
  • Any hint of monetary ease – ie, pumping more cash into the world economy – brings a standing ovation from stocks. Witness last week when five major central banks agreed to coordinate action to make it cheaper for European banks to get dollars: the market skyrocketed.
  • On days when no one seems willing to push more money into the system to inflate asset prices, stocks sink. That’s what happened today: ECB president Draghi professed to be “surprised” that markets interpreted last week’s summit results to mean that the ECB would boost its bond buying operations – ie, throw good money after bad into the maw of Spanish, Italian, and Greek bond markets.
We are on the see-saw of asset inflation/deflation. Every time some stimulus program wanes, the markets cry for more – and when they get it, prices go up. Then the effects moderate, and prices sink. Rinse and repeat.

Deja Vue, Redux

Posted on 12.02.11 by Michelle Rand in Investment

This week a few influential countries came up with a chip to “chip in” to the crisis in Europe. The agreement by the Bank of England, our own Fed, the Bank of Canada, the Swiss Bank, the Bank of Japan, and the European Central Bank allows for cheaper loans in dollar terms to stressed Euro banks. While this won’t solve Europe’s underlying problems, it will buy time – and guess what, stocks liked it. The Dow opened the week at 11,231 and closed at 12,019. That’s a move of 7%, somewhat alleviating the last couple weeks’ shellacking.

The Dramamine market isn’t going to stop, so don’t get too happy. Despite solid news from the U.S. in the way of good sales on Black Friday, upward revisions to jobs created, rising sales of completed homes, and a pulse in the manufacturing index, Europe is likely to dominate for months to come. Several European countries must roll over debt beginning in February of 2012 and extending into the Spring. Mopping up uncertainties before then, if finance ministers can manage it, will be helpful.

Are We There Yet?

Posted on 11.30.11 by Michelle Rand in Investment

How many Euro-salvation plans have been put forth by now? More than fifty? More than one hundred? I am not sure, but I can tell you that the latest plan will fail too, because Europe’s politicians remain one or two steps behind the markets. Today the Euro folks put forth a plan to leverage bailout funds from its European Financial Stability Fund (EFSF) by appealing to private investors with a guarantee on newly issued bonds by troubled countries – but the guarantee comes from the Eurozone. Apparently, officials have not recognized that investors are selling Euro paper like there’s no tomorrow. Who’s going to hop up to buy this new paper if they won’t buy the deeply discounted paper already in the market? At least this plan was prefaced with a comment from “a person familiar with the matter” that the amounts discussed would not be enough to save all the troubled countries.

Attention has turned to the IMF and the ECB, with finance ministers now saying that money from these organizations will be necessary to turn back this crisis. Why is this a surprise? We made the point weeks ago that there is not enough money to save all the derelicts in Europe, unless countries who believe they have not been involved in this crisis – China, the US (read “IMF”) – chip in. With every country husbanding its own problems, no one wants to chip in.

And while Euro fiscal integration is a great idea, their markets will fall apart before it can work. It took the US decades to develop a truly integrated federal/state system, and given the way things have been going, we doubt the Euro folks can come up with an agreement about where to go to lunch next, let alone how an interlaced fiscal system would work.

We remain convinced that defaults are necessary, and nearer. In the Spring of next year, several European countries will need to roll over debt. Perhaps someone will finally default, providing a road map for investors, but that’s probably just wishful thinking. More likely, we’ll be stuck with the same IV drip we’ve been experiencing for months now: a little help here and there, but only enough to prolong the pain.

Let’s Do the Euro-Twist

Posted on 11.18.11 by Michelle Rand in Foreign Investing, Investment

Remember the dance called the Twist? Basically the twist is done swiveling around one’s hips, with feet pointing one way and shoulders the other. Watching the Euro zone action has been like watching a twist competition. One part of the Euro-body is moving towards a semi solution that the markets seem to like one day, while another part moves towards newly dismaying outcomes. “Hard” countries such as Austria are having trouble borrowing – a new development – and Spain is about to hit the magic 7% rate for government debt that signifies the beginning of the march towards a bailout. On the other hand, Greece and Italy have new governments, which the markets read as a positive sign.

New hopes rest with the European Central Bank, as investors and politicians have decided that it’s up to the ECB to save Europe by buying massive quantities of troubled country debt. But the ECB has other ideas, and those entail sticking to its edict to control inflation. We’ll see how long that lasts.

In the meantime, here are a couple of facts to chew on about Greece:

  • The first recorded default dates to the fourth century BC, when ten Greek municipalities in the Attic Maritime Association defaulted on loans from the Delos Temple.
  • In the last two hundred years, Greek has defaulted 51% of the time on its sovereign debt.

Makes you wonder why anyone would ever lend Greece money, eh?