How low does an interest rate need to be

[cronewitch]

Keeping low rate debt seems to make sense if you can earn that with investments. What is your magic number to make a loan a keeper.

My highest rate debt is 3.458% and I don't plan to prepay it. It is tax deductible so I save about 15% on taxes and prepaying wouldn't improve cash flow for at least 7 years.

I think I can do better in mutual funds than I can prepaying the debt and the income would be mostly long term gains and dividends.

I think I would keep debt up to about 5% maybe even 6%.

[❤ mollymouser ❤]

If we had the means to pay it off, no debt would be worth our keeping ~ for peace-of-mind reasons. (My wonderful DH is "allergic" to paying interest ... which is why we paid off our home in about 2.5 years!)

[verrip1]

Not sure that I understand what criteria you use for defining debt as being good.

In the case of a house mortgage interest rate with associated tax implications, if your real, net-of-tax-implication interest rate is near or below 2.5% you'd be good, up to 3.5% so-so, and >4% bad IMO.

A 6% coupon sounds bad to me, given what banks yield in savings accounts today. A really lousy spread for anybody but the bank.

[Deleted]

I am not prepaying my 5% mortgage or my 5+% student loans.

[SVT]

I don't plan on prepaying my 6.8% 30 year student loans.

[kristi28]

We are not in a rush to prepay our mortgage (4.5%). Even though right now returns are low, we figure that over time having use of our money will be better for us than the paid off house at that rate.

[moneywhisperer]

Mortgage at 6% or less would be a keeper for me.
Federal Student Loans I would not prepay since they have deferments & income based repayment options that can be a significant benefit when your world is upside down.
Anything else would have to be under 4% for me to consider the loan to be more valuable than a lack of debt

[cronewitch]

I wouldn't keep money in savings at 1% unless I was young and nearly broke so I needed an emergency fund very liquid. I keep a bit in checking but most money is invested not stored in a bank.

You can't save your way to having much money, inflation runs more than savings accounts if you got 4% and inflation is 3% you might get rich but it would be very slow. A bank is more likely to pay 2% with 3% inflation so you get poorer every year.

[hawkeyes2001]

30 year mortgage at 5% and student loans consolidated at 1.875% is about all the debt I"m willing to handle. I honestly don't think I could take on any more debt regardless of how low the rate would be.

[quotequeen]

My highest rate debt is 5% and I'm not rushing to pay it off, but I might still get rid of it early. I'd say that's approximately my limit.

[Deleted]

Jan 2, 2011 5:06:39 GMT -5 @toughtimes said:

Having a 6% mortgage while earning 1% on savings is hardly a great thing.

And what if you're making an annualized IRR on investments of 5.9% from 2003 on, and your mortgage interest rate is 4.675% and the HELOC you took out to buy the car is at 2.75%? That's what we're seeing in our portfolio. Rate on the first mortgage is fixed; we're down to a balance of $2K on the HELOC.

[The J]

I guess it's 5.25% for me, since that's currently my highest rate debt.

[phil5185]

My threshold is about 5.5%. When I can get 5.5% fixed rate for a long term, I purposely borrow more money. And I won't prepay anything that I have <6%.

[WannabeWealthy]

Well, I will be pre-paying my mortgage (~4.75%) because I'm so old (41) and want to retire by 60 with no mortgage.

I also believe in getting a 8-month EF that's liquid (not invested) before taking your take-home pay and dumping it into investments. That EF has to be immediately liquid so it's not there to make a whole lot of money (IMO).

-M

[Tiny]

I'd say my threshold would be about 6%...
I'm not pre-paying my 5% mortgage (on investment property), I am working a self imposed 18 month payment plan for my HELOC balance (under 9K) which is currently at 5.5% with an "interest only due each month" scheduled payment. I've got all my other financial bases covered so the extra goes to the HELOC for now. I'm flexible though and would change the 18 month plan if some better use of the money comes along...

[phil5185]

Well, I will be pre-paying my mortgage (~4.75%) because I'm so old (41) and want to retire by 60 with no mortgage.

Shader - Happy Birthday!

So, 41 is Old ? I'm 71 (and retired before 60). Anyway, I wish that you could transfer that 4.75% note to me, especially if it is 30 yr, FR - those are golden.

[jimb]

Jan 2, 2011 11:12:02 GMT -5 WannabeWealthy said:

Well, I will be pre-paying my mortgage (~4.75%) because I'm so old (41) and want to retire by 60 with no mortgage.

I also believe in getting a 8-month EF that's liquid (not invested) before taking your take-home pay and dumping it into investments. That EF has to be immediately liquid so it's not there to make a whole lot of money (IMO).

-M

When you can afford to pay down a mortgage faster, you’re usually in high enough tax brackets for fed and state that it makes more sense to contribute the max to all your opportunities to defer taxes in plans like a 401(k), 403( b), TSP, and to take the tax advantages of either a traditional or Roth IRA when possible first.

Since your extra money is tied up for a long time where it’s hard to get to when you pay it on the mortgage, you also need a substantial emergency fund, and probably should pay off virtually all other consumer debts other than perhaps low-rate student loans or short-term car loans.

And I'm not convinced that even 8 months is a big enough emergency fund these days ... although a lot of of the extra you might need in a dire emergency can well be within bigger contributions to a 401(k) or IRAs for you (and your spouse if applicable).

But once you have maxed all your tax-advantaged investment opportunities and have enough for emergencies, and have reduced other debts; then[/i] for after-tax money, you can’t beat the return for paying down a mortgage.

The net long-term result is absolutely guaranteed by the laws of math, not speculation of what you might make in the stock market.

The net result is better than the mortgage rate itself; and it’s far better than you can get in any other guaranteed return with no risk, such as CDs or money market accounts. It’s far better than most people have averaged in the stock market for over 10 years; and competitive with what many knowledgeable people are predicting for the stock market for many years to come.

Futhermore, most people hedge their bets in their 401(k)s and other long-term investments with a balance of equities in stock mutual funds, and other more stable investment with lower returns, such as bonds or cash equivalents.

So once you are contributing enough to your tax-deferred retirement plans, and have adequate cash reserves, you could afford to put more of your money in aggressive funds in those accounts, and let the guaranteed no-risk portion of your long term for your spare after-tax money go toward paying down your mortgage.

To give you an example of the return for paying off your mortgage by the time you retire in 19 years:

Per $100,000 at 4.75% for 30. years, the payment for P&I is $521.65 per month, and the total interest paid will be $87,793. If you were to pay $145 per month extra to reduce the principal balance starting now, the $666.70 per month will pay it off in 228. months (19. years) and the total interest will be $52,007. So paying the $145 on the mortgage guarantees you a savings of 132. months (11. years) and $35,786 in interest on the mortgage.

Since it's hard to compare interest rates when you're looking at non-linear progressions, let's look at the equivalent long-term return for investing the money somewhere else.

We know that extra $145 per month will have the mortgage paid off in 228. months. Normally, you would still owe $53,551 at that time. So the $145 in some other investment would need to give you an absolutely guaranteed no-risk rate of return that would give you $53,551 after taxes in 228 months, which could then be used to pay off the mortgage balance at that time.

In a CD or MM account, paying 31% tax out of earnings yearly, your $145 per month investment would need to earn a guaranteed no-risk average of 6.816%.

In the unlikely event that you could defer all taxes on dividends for the entire time in an after-tax, taxable account, and then paid a total of 21% fed cap gains and state income tax on the earnings, your $145 would need to earn a steady average of 5.635%.

If the cap gains rate were 25%, plus 6% state income tax on the earnings, your $145 would need to earn a steady average of 6.189%.

While Phil is retired and he (and a lot of us older folks) made a lot of money during better days of yesteryear when real estate was appreciating and the dot-com era was in full swing, nowadays a lot of people would jump at the chance to get the exact equivalent of a series of CDs or a money market account that absolutely guarantee a return of 6.8% for 19 years, or a guaranteed investment for after-tax money for 19 years that would give a return 5.6 to 6.1% or so.

One other thing to ask yourself. If you take the advice of Phil or any of the other "keep a big mortgage" advocates and gamble your home that you'll do a lot better than 6% for the next 19 years: and if we have a really bad time for the next 5-10-15 years like we've had for the last 10-12 years, are Phil and the others going to step up and make up the difference ... or help you make your mortgage payments?

Speaking from experience of being retired for over 20 years (since age 45) ... and having NO mortgage for more than 16 years, I can also tell you that even if you could earn a little more with some of your after-tax money by gambling with your home, there is no way to put a numeric value on the feeling of well-being and security of never having to worry about being able to make the mortgage payment.

jimb

[formerexpat]

Anything under 6% post tax gives you a 1.5% spread on the LT return of the LT bond index.

That would be my cut off but my highest debt now is at 5.3% with just $3.5k of it left.

My mortgage is 5% pre-tax and 3.2% post tax [incl. state impact] so I'm taking that puppy the full 30.

[formerexpat]

The net long-term result is absolutely guaranteed by the laws of math, not speculation of what you might make in the stock market.

jimb

The laws of the market say that speculation is essentially zero in 30 year blocks. Earnings and dividends is pretty much all that remains.

[telephus44]

Right now, I wouldn't prepay anything over 5%. I am paying extra on my mortgage, but only until PMI is gone - and I'm not putting every extra penny toward it, just an extra $100 or so - and as soon as PMI is gone I'm going to let that ride as long as I can. My mortgage is 5%.

Actually - my car loans are 5.5% and 5.9% and I'm not prepaying those, either.

[mesquite77]

7% is my most expensive mortgage, but it would be an expensive re-fi, we owe about $27k and its worth about $55k. It cash flows though. We did just re-fi a 5.5% into a 4.375% 30 yr on our residence - cashed out ready for another RE purchase.

OTOH, I just paid off my student loans (tax deductible 5.5%), seemed silly to pay $59/mo for the next 7 years.

[Urban Chicago]

We have a 4.9% mortgage and a 3% student loan.

If I could I would prepay the mortgage enough to get out of PMI. After that, I have more important things to do than prepay the loans, like college funds, retirement, home improvements, etc...

Once all those were taken care of, the mortgage would be gone.

[kinetickid]

Jan 2, 2011 0:06:43 GMT -5 ArchietheDragon said:

I am not prepaying my 5% mortgage or my 5+% student loans.

I have no plans to pre-pay my 3.5% student loan debt, either, though I've considered taking out some subsidized student loans during grad school and using them to pay off the unsubsidized loans from my undergraduate studies. Would that be unethical?

[Deleted]

I am prepaying my 6.375 mortgage and just want to know what it feels like to not have a housing expense, other than property taxes (low in my area) and insurance.