Home loan questions, if you please...

Some background:

My special Lady Friend and I have bought a house together. I moved here first, got a job, put half down on the house, and we got to it.

 build thread

Her house has sold, and we finally have a bit of money. Our initial thought was to pay off the house, and go from there. The problem is according to our lender, the payoff is exactly the same as if we paid this off over a 30 year loan. Not one dime break in price. We bought the house last November, and understand there may be a break if we at least carry the loan a year. We may have missed a clause in the loan paperwork, stating such, but are a bit miffed to not get some kind of a break. 

The questions: Do we have options? Could we refinance with a huge down payment? Switch the loan to a credit union? Are we hosed? Seems to me, carrying the loan, and getting some interest on the cash could be a better move, but we LOVE the idea of having this M36E3hole paid off. 

Any insight is appreciated, and thanks in advance.

You won’t get a break on the principal amount they lent you, but paying it off now means no more interest on the money. They can’t charge you the same payoff as if you owe them 30 years worth of interest. 

What? There's an early payoff penalty equivalent to 30 years of interest? That smells like bullE36 M3. I've seriously never heard of such a thing.

If that is the case, predatory doesn't even begin to describe those kinds of loan terms.

Now if it's just the principle I wouldn't expect a break on that. The lender would lose money on the principle if that were the case, which isn't exactly good business. They might be offering a quarter percent or something nominal off the principle after X number of years, but by then they've harvested a load of interest money and it doesn't matter as much.

wheelsmithy said:

The problem is according to our lender, the payoff is exactly the same as if we paid this off over a 30 year loan. \

Something is not right.  Have that conversation with your lender again.

What they said.  You don’t save any principal.  What you (should) save is 30 years of interest.

Side note:  Once you get this figured out... consider other options besides paying off house.  Its not a good use of money.

In reply to wheelsmithy :

Something about what you wrote seems not right so I'll just write out some fake numbers

Lets say you bought a $200k house.  You said you paid half down so that leaves a mortgage of $100k.  

A $100k loan for 30 years at 4% gives you a house payment of $477 for just the loan (before taxes and insurance)

$477 x 360 payments (12 months x 30 years) = $171,720 total paid or a "fee/interest charge" of about $71k over the life of the loan.  

Are you saying that if you pay off the loan early that they still want the original $100k plus all $71k?  

1) Yeah either you;re misunderstanding something or you accidentally borrowed from the Caprese Mob or something. Figure that out first.

2) Regardless, if it's like most real estate these days, the appreciation on the house probably more than makes up for whatever interest you're paying, assuming you got into your loan for the 4-5% that's typical these days. You also have a ton of equity already. I think there are probably more aggressive uses for the lump sum than paying down real estate that's already making you long term gains.

ProDarwin said:

Side note:  Once you get this figured out... consider other options besides paying off house.  Its not a good use of money.

That can be debated forever. Some people value having no debt greater than others, he could be one. 

Steve_Jones said:

ProDarwin said:

Side note:  Once you get this figured out... consider other options besides paying off house.  Its not a good use of money.

That can be debated forever. Some people value having no debt greater than others, he could be one.

This.  If I was carrying a mortgage worth of debt at 4% so I could invest it at 5%, for that 1% I'm theoretically costing myself, I would rather cancel the debt and just invest what had been the mortgage payment every month.

As usual, the answer is Miata.  Perhaps a new one for her and a Spec Miata for you? 

Pay off your higher interest loans first like credit cards, car loans.   Then try to never get behind on credit cards again. 

And you do need to figure out that payoff thing.  You owe the principle.  I just can't see you owe 30 years of interest if you pay off today.

I am pretty sure a federal law was passed years ago preventing lenders from requiring the full interest from the life of the original loan if you decide to pay off the principle early.    

Duke said:

Steve_Jones said:

ProDarwin said:

Side note:  Once you get this figured out... consider other options besides paying off house.  Its not a good use of money.

That can be debated forever. Some people value having no debt greater than others, he could be one.

This.  If I was carrying a mortgage worth of debt at 4% so I could invest it at 5%, for that 1% I'm theoretically costing myself, I would rather cancel the debt and just invest what had been the mortgage payment every month.

If your investment is only earning 5%, then you done messed up. If a mortgage is 30 years, and we compare it to any 30 year period in the history of the US stock market, the stock market returns 7-8% after inflation which opens the door for more temptation. You can take a guaranteed 4% return by paying down a 4% mortgage, or you can go after what are likely to be 7-8% returns elsewhere.

Its still a debate between hypothetical, potentially higher gains and guaranteed debt, but assuming 5% investment returns is probably overly pessimistic.

STM317 said:

Duke said:

Steve_Jones said:

ProDarwin said:

Side note:  Once you get this figured out... consider other options besides paying off house.  Its not a good use of money.

That can be debated forever. Some people value having no debt greater than others, he could be one.

This.  If I was carrying a mortgage worth of debt at 4% so I could invest it at 5%, for that 1% I'm theoretically costing myself, I would rather cancel the debt and just invest what had been the mortgage payment every month.

If your investment is only earning 5%, then you done messed up. If a mortgage is 30 years, and we compare it to any 30 year period in the history of the US stock market, the stock market returns 7-8% after inflation which opens the door for more temptation. You can take a guaranteed 4% return by paying down a 4% mortgage, or you can go after what are likely to be 7-8% returns elsewhere.

 

Its still a debate between hypothetical, potentially higher gains and guaranteed debt, but assuming 5% investment returns is probably overly pessimistic.

The trouble with the theory is that situations change.  For any period where in theory you are getting 7-8% return there will be a period where that return is reduced.  Selling in a down market isn’t smart but there are times when reality catches up and you have to.  

In reply to frenchyd :

7-8% isn't the best that it gets. The 7-8% is an average over pretty much any 30 year period in the history of the market. Like any average, there will be times of higher gains and times of lower gains. If you hold an index that follows the market for 30 years, you'll probably end up with a total return around that 7-8% unless the stock market changes drastically like it never has before.

John Welsh said:

In reply to wheelsmithy :

Something about what you wrote seems not right so I'll just write out some fake numbers

Lets say you bought a $200k house.  You said you paid half down so that leaves a mortgage of $100k.  

A $100k loan for 30 years at 4% gives you a house payment of $477 for just the loan (before taxes and insurance)

$477 x 360 payments (12 months x 30 years) = $171,720 total paid or a "fee/interest charge" of about $71k over the life of the loan.  

 

Are you saying that if you pay off the loan early that they still want the original $100k plus all $71k?  

 

 

And, of course using these same fake figures, if you were to take the theoretical 100k that you could use to pay off the house, and instead invest it in something that returns 7% compound interest -- like buying a broad spectrum of the stock market and holding it while reinvesting the dividends, then the math works out to that $100k turning in to $761,000 at the end of 30 years. Of course, you'd still have to pay your mortgage...

STM317 said:

In reply to frenchyd :

7-8% isn't the best that it gets. The 7-8% is an average over pretty much any 30 year period in the history of the market. Like any average, there will be times of higher gains and times of lower gains. If you hold an index that follows the market for 30 years, you'll probably end up with a total return around that 7-8% unless the stock market changes drastically like it never has before.

My point is that 7-8 % is an average over  the next 30 years 

Well my net worth and Bill Gates’s net worth average somewhere around 75 Billion dollars. But it’s not money I can put in the bank.  

You can do better than 7-8 % or worse.  The question is are you absolutely sure you’ll do at least 7-8%?  Or is it just a constructed number like the average between myself and Bill Gates?  

In reply to frenchyd :

I'm saying the US market as a whole tends to average those gains over 30 years, not necessarily individuals. However, If you're invested in an index fund that holds a little of every company in the market, then you gain/lose exactly what the stock market as a whole gains loses. The market has never dropped over a 30 year period, so something significantly more dramatic than the Great Depression, multiple World Wars, the dot com bubble, or the Great Recession of 08-09 would have to take place. Or you'd have to have a bunch of those events occur basically back to back with no recovery. While that's possible, it seems unlikely and would be completely unprecedented. Frankly, if you're concerned about that type of event then you should be investing in food, water and ammunition rather than the stock market.

So yes, the odds are in your favor of having more wealth after 30 years if you invest extra money into an index fund that follows the entire market rather than paying extra on a mortgage with a 3-4% interest rate. There are no guarantees in the stock market, and mortgage debt/interest are guaranteed so as I said earlier, it's a difference between very likely (but not certainly) earning 7-8% in the market vs a guaranteed return of whatever your mortgage rate is. Some people are willing to forego potential gains for the security of a paid off house while others trust the math and take their chances at making more in the market. You've got to be able to sleep at night, which for some means paying the house off and for others means using their money as efficiently as possible to grow their wealth. Can you trust history/ the odds, or do you need emotional security? Neither one is a bad use of your money, it's just that one path is probably more optimal/efficient than the other at building wealth.

Hi everyone, thanks for the responses. I have an admission:

I'm an idiot. Yes there is no break on principal, nor should there be. My Special Lady Friend had wound herself up over this all day, and once I returned from work, and had a couple of shots, I joined right in. This has been a highly emotional, and financially stressful journey, and we both jumped to some poor conclusions, with little math or reason involved.

Sometimes when you want something to be true, your judgment gets a bit cloudy.

Since I brought you all this far, I'll give some more information jermaine to the conversation. We have zero credit card debt. No car payments, she has a student loan, which makes zero sense to pay off. I have an extremely low paying job, which barely keeps us afloat, usually slightly in the red each month. She has no job at the moment. Having no house payment would make my meager income somewhat viable.

So, again, thank you all for your patience and advice, hopefully my folly will help someone down the road. 

GRM, where even stupid questions are answered in a sincere and helpful manner. 

You guys are the greatest.

With no debt you don’t need much income to live. To many people that is the goal, regardless  of "average scenarios" people want to pitch. If you can live with not much income, but have good income you can stockpile a lot of cash.  The stories you see on the news of a teacher retiring with millions? It’s because they have no debt. 

Wheelsmithy has no car loans, no credit card debt, and put 1/2 down on his house. How many of the posters saying "don’t pay it off" can say that? There is no way a guy with no debt who is debating paying off the house will take financial advice from people with car loans, credit cards, and big house payments. 

In reply to Steve_Jones :

Just to tack on a bit.

The ideal scenario is to invest the lump sum of money and make more on the investment than you would over the same period investing the money used to pay the mortgage.

That makes sense from a math perspective as compounding interest works heavily in your favor.

The downside is the risk you assume by maintaining the mortgage. In a recession scenario, similar to that of 2008, you run the risk of losing your cash flow used to pay on the mortgage. That leads to drawing on the investment and could  run the risk of selling below the initial investment unless you've stacked up a good amount of realized gains through dividends (cash only nets 1% so that point is moot) just to stay afloat.

What paying off the mortgage does is insulates you from that shock and frees up cash flow. That can then be used to build wealth, albeit slower, and give you the means to build a large cash emergency fund without austerity.

Again the math doesn't lie but if you're cash flow restricted having that cushion is a God send in a bad situation.

Steve_Jones said:

Wheelsmithy has no car loans, no credit card debt, and put 1/2 down on his house. How many of the posters saying "don’t pay it off" can say that? There is no way a guy with no debt who is debating paying off the house will take financial advice from people with car loans, credit cards, and big house payments. 

Since I've been the most vocal about the cost/benefits of investing vs paying the mortgage off early, I'll show and tell. We have Zero debt besides the mortgage. House downpayment wasn't quite as impressive as Wheelsmithy's, but was still nearly 40%. With 7-8% returns, we're on pace to be able to retire by late 40s/early 50s with a paid off house, and we'll probably never make 6 figures. You're preaching to the low-expenses choir. Honestly, I invest and pay my mortgage down at the same time, but I understand that it's likely costing me a decent amount of money long term to buy myself some emotional security in the short term, and that's the main point I wanted to get across.

I'm not totally against paying a mortgage off. As I said, there are definitely worse things you can do with the money. It's just sub optimal if the goal is building wealth. 

That being said, if you're barely scraping by, and prospects for improving that situation don't look great, then getting that primary expense off your back makes sense to me. You're goal isn't building wealth at that point, it's surviving in the short term and that gets a lot easier if a few hundred $$/month don't have to go to the mortgage lender. Now if she's about to get started in a career, and will soon be contributing to the household income, then I might suggest toughing it out a bit longer until building wealth and long term planning can become a priority again over short term security.

Steve_Jones said:

With no debt you don’t need much income to live. To many people that is the goal, regardless  of "average scenarios" people want to pitch. If you can live with not much income, but have good income you can stockpile a lot of cash.  The stories you see on the news of a teacher retiring with millions? It’s because they have no debt. 

Wheelsmithy has no car loans, no credit card debt, and put 1/2 down on his house. How many of the posters saying "don’t pay it off" can say that? There is no way a guy with no debt who is debating paying off the house will take financial advice from people with car loans, credit cards, and big house payments. 

I just took out a car loan, but only because I wanted to (because my money earns more elsewhere).  I also put 20% down on my house... Because I wanted to (again my money earns more elsewhere).  I have no other debt and could pay off my house tomorrow if I so desired.

Still all I said earlier was that the OP should consider other options besides early payoff.  Its fine to choose that after weighing all the options.  Don't just pay it off early because 'debt is evil'.

In reply to STM317 :

You make a very good point regarding the math of long term investment.  I will not fault you for that logic.  I completely understand the idea of a greater return over the long haul.  Plus I further understand that my experience should not guide everyone.  Some will wind up ahead and good for them, they beat the odds. 

But the simple fact is few, very few of us who invested in our IRA’s  and 401 K’s  in the 80’s and 90’s survived past 2008.  I carefully invested the second time my surplus cash over the most profitable of my working years. Feeling very prudent and virtuous I used the greater return on the stock market to justify not paying off my modest mortgage.  

The numbers I’m seeing now place the average value of those investments at barely over $10,000.  

While it’s true that many of us Baby boomers are in retirement already It does not follow that soon after retirement those accounts would be drained. 

I’m also reading where 40% of the population cannot meet a $400 emergency need for cash without selling something or going in debt. 

My own experience with the stock market is twice I made significantly great returns. Yet both times wound up in the long haul with nothing.  

I very much feel that the stock market is like that other risk taking venture, Gambleing. 

My Mother liked to gamble, she liked the excitement.  She would tell me about how she won $65,000 on just one had of cards. She enjoyed the private Jets they would send for her. And the luxury suites.  

Three years after her husband left her 19 million dollars I came over to find her in her bathrobe on the floor trying to figure out how she could live on just her Social Security. 

Risk is just that. True the stock market can offer much better odds on that risk than Vegas, however, the offices that offer stocks are at least as expensive as the Hotels in Vegas. Both were paid for by the customers. 

ProDarwin said:

Steve_Jones said:

With no debt you don’t need much income to live. To many people that is the goal, regardless  of "average scenarios" people want to pitch. If you can live with not much income, but have good income you can stockpile a lot of cash.  The stories you see on the news of a teacher retiring with millions? It’s because they have no debt. 

Wheelsmithy has no car loans, no credit card debt, and put 1/2 down on his house. How many of the posters saying "don’t pay it off" can say that? There is no way a guy with no debt who is debating paying off the house will take financial advice from people with car loans, credit cards, and big house payments. 

I just took out a car loan, but only because I wanted to (because my money earns more elsewhere).  I also put 20% down on my house... Because I wanted to (again my money earns more elsewhere).  I have no other debt and could pay off my house tomorrow if I so desired.

Still all I said earlier was that the OP should consider other options besides early payoff.  Its fine to choose that after weighing all the options.  Don't just pay it off early because 'debt is evil'.

I agree that debt in and of itself is not evil or wrong.  There are plenty of good and smart uses of debt. However there is also good and smart freedom in being debt free.  

My personal Hero, Warren Buffett  used that freedom to gain great wealth and do much good.  However unlike most of us working stiffs he achieved a position  of having honestly surplus cash.  Not cash that could be used to risk in the market or pay off bills, but real surplus cash. 

That gave him the freedom to time his sales.  Something that debt denies us.