I recently wrote about a variety of factors impacting whether one should pay off debt or invest. Everybody’s financial situation is different and this decision has numerous variables. I thought it would be helpful to share stories and reasoning from those who’ve made this decision. Below is a set of questions in which I interviewed the most willing participant I could find:
Sorry if that’s a little weird. In the coming weeks, I’m going to post the answers to these questions from other bloggers. It will be fun and informative to see how each situation and decision was different.
How much debt did you start with and how did you accumulate it?
I took out a 336K mortgage on my primary residence in 2015. Doing so was part of our family’s plan to reduce our cost of living so my wife could stay home and raise our son. I have no other debt aside from credit cards that we pay in full each month.
Time or Money – How we cut our budget to become a one income family.
How We Made The Switch From Double to Single Income – Guest post on Keep Thrifty
What is the term and interest rate?
My loan has a 30-year term with a fixed interest rate of 3.625%.
Did you look into refinancing or consolidating the loan?
At one point, I considered refinancing to a 15-year fixed loan. Shorter term loans tend to have lower rates. I wanted to see if the lower rate was enough incentive to speed up my repayment plan.
If so, what was the result and why?
I decided against the refinance (for now). The slight benefit in rate I’d have realized didn’t seem worth paying fees to refinance. A 15-year loan would increase my payments and reduce my available monthly cash flow. I do not want to reduce my options right now.
How much did you have available monthly to use for debt or investments?
After maxing out my 401(k), HSA, IRA and my wife’s IRA, I should have about 8K left this year.
What investments did you consider when you evaluated your debt/invest decision?
I’d put incremental investments into Vanguard’s Total Stock Market Index Fund (VTSAX).
In what type of account(s) would the investment be held?
I’ve already set aside the funds to max out my retirement accounts. My remaining “best available options” are a 529 plan for my children’s college savings or a plain old taxable brokerage account. (A “taxable” account is an investment account that’s funded with after tax money. It doesn’t have any of the advantageous tax benefits that retirement accounts do).
I’m picking the taxable account over the 529 today. I already have a healthy balance in my kids 529s. For this money today, I prefer the increased flexibility of a taxable account over the tax benefits of a 529.
If the likely scenario comes up that we need more than I’ve already saved for college, this decision could be sub-optimal due to loss of the 529 tax advantages. It’s a risk I’m willing to make.
I can use money from a taxable account to pay for college but 529’s have restrictions on use to avoid a penalty. My children are both under four years old after all, so I should have time to catch up on college savings if necessary.
Did you consider the tax deductibility of interest or the tax burden on investments in your decision?
I always consider the tax impact of financial decisions. What kind of money nerd would I be otherwise?
In 2017, the interest paid on my mortgage is deductible because I’m going to itemize my tax return. I’d have itemized with or without any mortgage interest. Therefore, the effective rate I paid on my mortgage was even less than the 3.625% stated rate.
In 2018, the new tax rules change my tax return drastically. The standard deduction increased. Plus the deduction for state income tax and property tax is now capped at $10K combined. This will cause me to take the standard deduction instead of an itemized deduction. The effect is that my mortgage interest will cost more than last year since I will no longer have a tax benefit from deducting it.
There are no tax benefits for investing in a taxable account per se. In 2018, long-term capital gains and qualified dividends are taxed at 0% if your taxable income is under $77,200 for married filing jointly. They are taxed at 15% if your taxable income is between that amount and $279,000. I’d fall in that 15% capital gains tax bracket today.
I plan to sell my taxable investments and realize most of the potential gains when I’m “retired” with lower taxable income. Ideally, this will allow me to pay NO TAX on most of the expected gains.
Did you choose to pay off debt or invest?
Even after the change to the tax impact of my loan, I’ve continued to make the minimum mortgage payments and invest the extra money. As of this writing, my investment of choice has returned 6.69% since its inception on 11/13/2000. Yes, future returns are uncertain. Even so, I’ll happily make a calculated bet that my investment will outperform the 3.625% interest I’m paying on my loan.
After all, the Stock Market Will Always Go Up Over Time.
Whenever I begin to live on my investments, I’ll probably want to change my plan. I’ll pay off the mortgage to reduce sequence of return risk to my portfolio. While I’m in the wealth accumulation phase, I’m willing to roll the dice on the positive expectation of stock market returns.
I’d also bet $200K on a coin flip with positive expectation!
What three key factors drove this decision?
1) My willingness to take calculated risks to reduce the time it takes to reach my financial independence goal.
2) The after tax expected returns on my investment being greater than the mortgage interest rate.
3) The benefit of liquidity of my investment. I can sell shares and cash out my investments if necessary. Having investments accessible may be helpful if I want to take a risk and change careers in the future.
Did you give up a 401(k) match or similar “free money” opportunity to accomplish your goal?
Nope. I’d never give up a 401(k) match to pay down low interest rate debt.
When you started paying it off, when did you anticipate finishing the payoff?
We took out a 30-year loan in 2015. I was 32 and anticipated paying it off when I retired. At the time, I’d have guessed (without knowing the 4% rule) this would happen around age 55. After running the numbers, it’s looking to be closer to age 45. I plan to pay off the remaining mortgage in large chunks once I’m close to my financial independence number.
Looking back, would you do anything differently?
Not at this time. The market has been on fire (no pun intended with the financially independent retire early acronym) lately. But I’m not expecting this run to continue for the next 10 years. How sweet would it be if it actually happened though? If it did, I’ll probably be FI sooner than my goal. I’d have the cash to pay off the loan and can use my time for whatever I wish.
Will you choose to invest or pay off debt with your next available dollar?
What do you think of this interview format? Was it helpful? Is there a question missing that I should add?
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