Mortgage – Make Principal Payments, or Larger Retirement Contributions?

Nick Livers, Attorney at Hyden, Miron and Foster and friend-of-the-firm (check out his blog,) asks a great question:

Great post, Abigail. [9 Year Mortgage – Some More Mortgage Payoff Thoughts, -ed.] I have acquaintances that ask me about this from time to time. I tell them what I am doing, and that is adding extra principal payments to every payment.

I’d be curious as to your thoughts into paying a mortgage early vs. taking the extra payments and placing in an investment account. My mortgage is a 3.5% rate. At that rate, I’m beginning to think I would be better off placing my extra payments in my investment account for the next 15 years.

Thanks for the warm fuzzies, Nick!  I can’t give specific advice over the blog (and you wouldn’t want me to,) so here are some ideas about how I would think about the question of paying off a mortgage versus making larger retirement contributions.  The easy way to look at this is through modelling both plans and then comparing the value, today, of each decision.  The one with the higher dollar amount wins.  Another, harder way to look at it is as a judgement between a suite of risks.

Analysis

Before I get into the analysis, I want to be clear that I’m looking at the house in only financial terms.  Almost nobody lives that way, except maybe Hetty Green.  Making the home payoff decision can be invested with a lot of emotional meaning, which would have an effect on what the “best” decision would be.  Anyways, onwards to the analysis.

Here’s how I wold make my model in Excel.  First, I would make an input sheet for all the assumptions I would have to have in each model.  It would have inputs like the duration of the loan, the interest rate, the outstanding principal, and so on for the mortgage.  It would also have assumptions for the investment, such as an expected rate of return.

I would then create a model on another sheet which calculates the effect of adding extra payments to the mortgage.  After that, I would model paying off the mortgage normally and the extra investments in another page.  This is the part that can get really fine-grained, and insanely detailed.  For example, if you pay your mortgage off early, you may not need as much life and long-term disability insurance.  That could be added to the spreadsheet as a variable.  Tax effects could be added, too.  After all, if you pay off your mortgage, you lose your mortgage interest deduction.  You’d have to calculate the benefit lost beyond the standard deduction.  It could get really, really involved.

Finally, I’d toss the outputs onto a separate spreadsheet that show the difference in present value between the two, and maybe put up a nice chart.  What can I say, when I build a spreadsheet, I build a spreadsheet.  The spreadsheet would distill the decision into a pretty simple yes/no decision, if we didn’t take risk into account.  But, we will.

Risks

Whenever you make a financial decision, you are choosing between a suite of risks and rewards.  For example, if you choose to pay off your mortgage early, you are going to have higher cash flow (reward) but you’ve tied yourself up in home equity, which is generally illiquid.  On the other hand, if you invest instead of paying off your mortgage, you’re exposing yourself to investment risks, and the risk of carrying the mortgage.  A spreadsheet has a rough time expressing these risks, since they’re a giant pain to quantify.

Conclusion?

Nick isn’t the only one who has asked me this question in the last two days.  (Really, it’s been eerie.)  I’m working on a spreadsheet that compares the present value of the difference between the two scenarios.  I can’t guarantee I’ll get it done any time soon, since it’s tax season and I’m making it for my own amusement.  Should I ever get it done, though, I’ll see if I can share it.

Advertisements
Posted in Ask an Advisor, Credit | Tagged , , ,

9 Year Mortgage – Some More Mortgage Payoff Thoughts

It turns out the post I made last September titled “9 Year Mortgage – Some Thoughts” has gotten a lot of attention.*  I’d like to write about a larger point that I didn’t make in that post, which really needs to be discussed:  paying off debt using “systems” or “methods.”

Every year or two, I bump into a new system or method that uses some clever mathematical or legal ruse to shave time off a mortgage.  Usually they’re variants of three types of strategies:

  1. Give money to the mortgagor until the debt is paid off.
  2. Do a bizarre investment tap-dance that somehow (maybe) increases the amount of money that is given to the mortgagor until the debt is paid off.
  3. Scam the mortgagor with pseudo-legal shenanigans so the debt won’t have to be paid off.  We’re not going to discuss this here.**

Do you notice the key themes in the first two options?  You pay the debt off.  That’s the “secret” behind paying your mortgage off early.  You give the mortgagor heaps of money until your obligation is fulfilled.

Arguments could be made about the investment gymnastics you would need to make money from a suitably low risk investment and hoop you’d have to jump through to get the tax costs properly figured.  But, if your goal is to pay down your mortgage, why not just pay down your mortgage?  Remember, for every financial product you use, there are costs.  I doubt that the costs of using additional financial products (at a low level of risk) would make up for the extra costs of using the products.  The only product I can think of that might make sense as an investment to help pay off a mortgage (cost-wise) would be a diversified portfolio of debt and equity investments, but this would still be pretty risky compared just paying down a mortgage.

And let’s be frank:  paying off a mortgage by giving the mortgagor sufficient money to pay off the principal works every time.  The investment/financial product/HELOC/mortgage systems, well, generally don’t.

* For this blog.  It’s pretty slow around here.

**  Seriously, if pseudo-legal shenanigans appeals to you, please leave.  We don’t do that around here, and there are plenty of morally stunted people elsewhere on the internet who will “help” you.
G+

Posted in Credit, Current Events | Tagged , , , , , , , | 2 Comments

Women and Philanthropy: Investing With a Gender Lens

Oh my gosh, this is awesome!  Cindy’s helping the Women’s Foundation put on an investing workshop called “Women and Philanthropy: Investing With a Gender Lens.”  It will feature Kathleen McQuiggan, a nationally known business consultant and spokesperson for the cause of women’s equality in business, and Eleanor Blayney, a certified financial planner practitioner , friend of the firm, and author of two books, “Women’s Worth: Finding Your Financial Confidence” and “The Home Budget Workbook.”

In the words of the Women’s Foundation:  “You do not want to miss this opportunity as Eleanor Blayney and Kathleen McQuiggan, two nationally respected experts in the areas of women’s finance and investing, explore the uniquely female patterns and motivations for giving and discuss how gender-based investing is shaping the future of philanthropy.

DATE:  Tuesday, February 12, 2013
TIME:  10 a.m.- 2 p.m.
PLACE:  Heifer International, Little Rock
ADMISSION:  50 for General Public and $150 for CPA and CFP CEUs

“The cost of admission includes lunch and a copy of Women’s Worth: Finding Your Financial Confidence by Eleanor Blayney.”

You can REGISTER HERE!

Posted in Current Events

Reign of the “The Queen of Versailles”

There’s a new documentary out that’s worth watching – “The Queen of Versailles.”  It’s available on Netflix.  The movie’s about Jackie and David Siegel, owners of Westgate Resorts, and their family’s fall from wealth during the recession.  At the beginning of the movie, they’re planning to build the largest home in the U.S. and are surrounded by enormous wealth.  At the end of the movie the half-built home rots, the company evaporates and the staff is mostly gone.  It’s fascinating to see how the other 0.001% lived.

Posted in Current Events | Tagged , , , ,

Core v. Peripheral Employment

"Schädel" by Vincent Van Gogh from Wikimedia Commons

Picture Unrelated

Just the other night, I was talking with a friend from UALR’s MBA program about a new job he just started.  He was really excited about moving from a position that wasn’t really what he wanted to do; to a position that used his degree, was interesting, and had more promotional opportunities.  It reminded me of a theory of human resources I used during my Organizational Behavior class last semester, and how you can use it to improve your career.

First, though, I’d like to take a moment to grump at an idea that “just getting a job” is the answer to not making enough money.  Too often, when you hear about someone who’s not getting by in life, the solution that they’re given is to “get a job,” or even less helpfully, to get a “better” job.  Also, they may be told to “go to school.”  Too often general advice like this is worse than worthless, because it doesn’t solve the problem.

I’d like to introduce an idea to you.  It’s one that revolutionized my thinking on employment and career management.  It the idea of peripheral v. core employment.*

Peripheral employment is (generally):  “part-time, temporary, contract, vendored, and/or outsourced ’employees’ who are generally paid a fixed wage, salary or lump sum, are partially or not at all covered by fringe benefits, and have little or no training, development or promotion opportunities.  The peripheral work force also typically does not participate in decision-making through work teams or organizational decentralization, has little performance-based pay or employment security, and receives little business-specific information.”

While core employees, on the other hand, are:  “typically employed full-time, paid a regular salary or wage, covered by fringe benefits, have training, development, and promotion opportunities along well-defined career paths, and participate in decision-making through work teams and a decentralized organization structure.  The core work force is also typically carefully selected, has employment security and some performance-based pay, and is regularly provided information about the business.”

It’s important to make this distinction between core and peripheral employment because it reflects two different views from the employer on how employee compensation should be treated.  Peripheral employees tend to be treated as an expense to the business, while core employees tend to be treated as an investment.  It follows that employers will try to reduce expenses, which doesn’t bode well for peripheral employees.  Employers are also interested in investing to produce higher returns, so core employees should expect the employer to give them greater resources.  So, core employees often have educational and enrichment opportunities that peripheral employees don’t have access to.  Clearly it’s more desirable to be a core employee than a peripheral employee.

You see, I think this idea is what some people are trying to express when they tell you to “get a better job.”  This isn’t necessarily what the advised hears.  Imagine we have someone who is just not making it in a peripheral job.  They come to the conclusion that they need a different job.  So they move from a peripheral job that pay $9.50 an hour with no benefits to another peripheral job that pays $10.00 an hour with no benefits.  It doesn’t get them where they need to go, but it sure feel like they did something.

The issue is that they’re stuck in the peripheral employment treadmill.  Sure $0.50 an hour increase is nice, but what about job security?  What about advancement opportunities and control of their work?  Does it move them further from peripheral employment to core employment?

So, I would like to encourage you to think about your job in terms of peripheral versus core employment, and how you can move from peripheral to core employment.

*  I’m pulling a lot of this info from “The Dual Theory of Human Resource Management and Business Performance: Lessons for HR Executives” by David Lewin. It’s a great read, check it out.

Posted in Income | Tagged ,

Your Paycheck Changed – Here’s What’s Going On

So you notice your paycheck looked a little different, didn’t you.  A little smaller.  Do you want to complain?  Maybe you’d like to get hot under the collar at President Obama’s “secret, middle-class tax hikes (brought up in the comments below the article, not in the article itself)?”  Allow me to save you some embarrassment.

Your paycheck decrease was due to a recent increase in the payroll tax (you may see it on your paycheck as the line item “FICA.”)  This is a tax that is not income tax, and all wage earners pay this tax.*  Why did the powers that be increase the payroll tax?  Travel with me using the power of glissando, through the murky depths of time, to an era before remembering; January 2011.

Chromatisch Glissando detail from glissando.jpg by Tjako van Schie at nl.wikipedia used under the Creative Commons Attribution-Share Alike 2.5 Generic license

♪♫Glissando!♫♪

Yeah, that’s right; January of 2011.  Unemployment was skyrocketing, occupiers were not yet occupying, and there was an economic malaise in the air.  President Obama enacted a payroll tax holiday for employees by reducing the payroll tax for employees from 6.2% to 4.2%.  The rationale was that, by temporarily reducing the payroll tax, families would take more money home.  It was hoped that this money would be spent, which would act as a stimulus to the economy, and reduce the severity and duration of the recession.

Now, the payroll tax holiday  started under President Obama ends under President Obama.  This was the plan all along, so I’m surprised anyone else is surprised.  If you want to complain that the payroll tax has reverted to its previous rate (which has been in place since 1990,) then do complain.  Just be forewarned, if anyone who has been conscious of the FICA before 2011 hears you, they may not think highly of your intellect.

Hopefully I saved you some embarrassment.  You’re welcome.

*  There’s more to it than that.  If you want more specific details, point your internet machine to Social Security, and enlighten yourself.

Posted in Current Events, Economy, Taxes | Tagged , , , , ,

Because Economics Lends Itself to Rap Anthems

“Dismal science?” Pish-tosh.  Here’s a superficial and minimally informative pair of videos illustrating just how exciting economics can be, in the form of rap music.  Behold!

Posted in Economy | Tagged , , ,

Cindy Featured in Financial Planning’s Practice Profile!

Cindy is featured in this month’s Practice Profile in Financial Planning: “PRACTICE PROFILE: What Women Investors Want – Cindy Conger.”  Here’s  a snippet:

A Time magazine cover this year called women “The Richer Sex.” A new Prudential study found the majority of U.S. women surveyed are now the primary breadwinners for their household. Those are the kind of data points that Little Rock, Ark., wealth manager Cindy Conger pays a lot of attention to.

“Women are the largest overlooked natural resource in the world,” says Conger, for whom single, divorced and widowed women make up about 70% of her client base. (The other 30% is married couples.)

There’s more at the link above…

Posted in News | Tagged

ShareFile Wherever You Go!

So, we recently set up our secure, online document vault at ShareFile.  If you (our client) like the document system, then why not take it with you?  Use ShareFile’s mobile apps to look at your ShareFile vault wherever you need to!

When you’re setting it up, I strongly suggest that you require a password any time you access your vault through the app.  That last thing you need is to have your phone stolen without password protection, because the thief would then have access to your private files.

If you have any questions or concerns about your vault, feel free to give me a call or email.  I’m happy to help!

Posted in News | Tagged

Somebody Slept Through Civics Class…

… and it shows.

Here’s an editorial cartoon from someone who just isn’t paying attention to how taxes work.  Not only that, but the cartoon’s author’s profession is political cartoons, and he’s old enough to be retired – and to know better.  Here’s the cartoon in question:

This is not, in fact, how Keynesian Economics works, even if you're trying to hyperbolize for humorous affect.

This image is hotlinked from gocomics.com, so the picture may go bad in the future.

So, the comic shows* a man who increases his income from $30,000 per year to $33,000 per year, and losing it all in taxes under a Keynesian economic regime (which the author equates with wealth redistribution.)  There is one leetle problem.  Taxes don’t work that way.

In order for taxes to work this way, the marginal tax rate above $30,000 would have to be 100%.  So, I look up the tax due on a taxable income of $30,000** in the 2011 tax table and get a tax of $4,079 for a person filing single.  If I look under $33,000, I get $4,529.  The difference between $4,529 and $4,079 is $450, not $3,000.  Also, if you do the math, the marginal tax rate of the increase is 15%.  Also, the increase in the effective tax rate when the comic character increased his income was 13.6% to 13.7%.

Yeah.

Now, you may be thinking something along the lines of “Hey, lighten up, it’s supposed to be funny.  Who cares if it’s wrong?”  I do, and here’s why: 1) Lots of people think this is how taxes work and 2) They make bad decisions on what sort of public policy they support based on that misinformation.  Unfortunately, I’m one of the many people who has to live with the bad public policies that arise from their inability to understand the most basic facts about how out tax system works.  That’s why I think this sort of thing is worthy of arguing against.

Also, Keynesian economics?  It doesn’t work like that.  At all.  I’ll leave you and your search engine alone if you want to find out more.

* Transcript (just in case the comic disappears):

First panel: Narrator says “You work very hard…” while a cartoon man sighs as he drives a delivery truck.

Second panel: Narrator says “…and you pull in $30,000 per year!” as the same character sighs at the payroll office.

Third panel: Narrator says “So you take on an extra job!..” while the man tosses papers from the driver’s side of his car.

Fourth panel: The narrator says “Now you earn $33,000 per year!” as the man admires his check while walking up a sidewalk.

Fifth panel: A grinning man in a fedora and trench coat snatches the paycheck from the man, to the man’s surprise.

Sixth panel: The narrator says “and the government takes and extra $3,000  in taxes!” while the cartoon man sighs and the man in the trench coat grins as he pockets the check.

** This is a major oversimplification in this case, because our guy would have, at least, one adjustment and his standard deduction, so his taxable income would certainly be lower than $30,000.  I’m ignoring this to keep it simple, folks.

Posted in Current Events, Taxes | Tagged

James K. Galbraith at the Clinton School in Little Rock

So, earlier this week there was a lecture from an economist I follow named James K. Galbraith at the Clinton School.  He gave a perky, upbeat* lecture called “The Bleak Past and the Grim Future,” which you can watch online right now.  You can also hear my lispy voice at the 48:30 mark, when I asked about the CFPB (which I like, and have blogged about quite a bit.)

Anyways, it was a solid lecture that covered a lot of ground I’ve been thinking about in one way or another in the past year or two.  I recommend you take a look at the video – it’s a pretty good lecture and worth the watching.

Also, I got a signed copy of his recent work “Inequality and Instability: A Study of the World Economy Just Before the Great Crisis,” which is pretty meaty.  Neener, neener.

* That’s sarcasm, my lovelies.  Sarcasm.

Posted in Current Events, Economy, Reading | Tagged , , ,

Tanzania Trip!

Cindy recently returned form a trip to Tanzania!  Here are some photos of her safari:
Pics from the Tanzania TripMore Animals!

Posted in Goodies

I Think I Just Got Trolled By a Bank

So, I’m not going to name names here, but the other day I heard a radio spot for a local Little Rock bank.  The radio ad is meant to encourage listeners to refinance their homes with the local bank.  Here’s my hasty, incomplete, and sloppy paraphrasing of their ad, accompanied by the relevant “rage faces.”* A play in three parts:

Part 1: The Ad (Paraphrased)

Rage Face - Troll with MonocleHey there!  Would you like to refinance your home to take out equity that you can spend on a new car or vacation?  You’d be the envy of your neighbors for your financial acumen!  Call now!

Part 2: Listener Response (Abridged)

Rage Face - Angy No

Part 3: Listener Response (Unabridged)

What!?!Are you kidding me?  this is the very thing that contributed to that thing that just happened… what was it… oh yeah – the Recession!  Do you want to make more crummy loans?  Who owns a home and has a memory that doesn’t exceed three-and-a-half to four years?
Seriously?

Seriously. Who thought this was a good marketing idea?  Did anyone think about how this might be received by the listening public?  Let’s explore this a bit.  Travel with me to the past, by the power of glissando.

Chromatisch Glissando detail from glissando.jpg by Tjako van Schie at nl.wikipedia used under the Creative Commons Attribution-Share Alike 2.5 Generic license

♪ ♫ Glissando! The official theme song of time travel! ♫ ♪

We appear int he murky, half-remembered dawn of human history – the year 2008.  It’s the beginning of what would become a serious, prolonged recession in the U.S.  Subsequent analyses would blame too much poor-quality lending on houses as one of the causes of the recession.  This is not a secret.

So, seeing that a tremendous chunk of the American public was recently economically traumatized by crummy lending, and seeing that imploring someone to refinance their home so that they can use it as an ATM is seen as a tremendously irresponsible purpose to make a loan; do you (TrollBank) really think this ad will endear you to the public?

You know, you could just paraphrase your ad to say something along the lines of: “Hey!  We’ll make loans to idiots – just like in 2008!  More recessions for everyone!”

Dark Stare

Not Cool, TrollBank.  Not cool.

*This link may contain naughtiness and inappropriate behavior for the professional environment.  Have fun.

Posted in Credit, Current Events, Economy | Tagged , , , , ,

Suddenly Europe Makes More Sense…


A great metaphor for the EuroCrisis.  I love Spain in this.  Who’s your favorite?

Posted in Current Events, Economy | Tagged , ,

9 Year Mortgage – Some Thoughts

So, the other weekend I was bopping along to the radio while cleaning my house.  A commercial came on for something called “9 Year Mortgage.”  My planner antenna went up as I thought, “Sounds a little scammy, but I’ll check it out.”  And, check it out I did.

The site’s proprietor/mascot/person-whose-face-is-plastered-on-it is a fellow by the name of Howard Ruff.  Now, if you weren’t paying attention during the last prolonged recession (late ’70s), then you missed out on the bear-liest of bears, Mr. Ruff himself.  About 5 years ago I managed to get my hands on a book of his called “How to Prosper During the Coming Bad Years,” originally published in 1979.  It included helpful information on hoarding precious metals and food.  For the coming bad years.

You know, the apocalyptic wasteland of starvation and hyperinflation of the ’80s and ’90s.

Anyways, I check out how the site claims to get a person out of debt pretty quickly, but they’re such teases about how the whole system works.  Since the time frames they discuss are reasonable for someone who actually pays off their debts without using fictional techniques, I’m led to suspect that they’re using a variant of the debt snowball.  So I’m all “Not bad.  Sounds reasonable.  I wonder how much this costs.”

Oh sweet goodness, I am clearly in the wrong business.

According to the site, the cost of the plan is about 10% of the interest savings generated.  So, I’m going to try to roughly model how they might charge fees.  To do that, I’ll make a totally made up list of debts and see what the fee maybe could be.  I’ll try to be reasonable.

Let’s give our experimental household a recently refinanced mortgage, one auto loan, a student loan and some revolving credit card debt.

Fictional Household Debt Principal Rate Term Remaining
Mortgage $150,000 5.00% 30 years
Auto Loan $18,000 7.00% 4 years
Student Loan $10,000 6.00% 5 years
Credit Card 1 $4,000 19.00% 4 years
Credit Card 2 $2,000 20.00% 4 years
Total $184,000

Now, this isn’t too out-of-bounds for the average person.*  There are a lot of people who are trying to get out of far worse debt.  Now that we have our list of debts, and how long they would take to pay off, let’s figure up out total interest expense if we made only minimum payments, over the full payment period.

Fictional Household Debt Monthly Payment Total Interest Over The Life of the Loan Total Principal Paid Over the Life of the Loan
Mortgage $805.23 $139,884 $150,000
Auto Loan $431.03 $4,040 $18,000
Student Loan $193.33 $1600 $10,000
Credit Card 1 $119.60 $1741 $4,000
Credit Card 2 $60.86 $921 $2,000
Totals $1,610.05 $148,186 $184,000

Okay.  Now, let’s make a debt snowball that ends with the mortgage being paid off in nine years.  I’m going to add some money to the pool of cash available for paying down the debts, to simulate budget counseling and an enthusiastic client.  I used the What Is The Cost Debt Snowball Calculator.  I reverse engineered an additional contribution of $510 per month to have all the debts paid off from October first of 2012 to October of 2021.  You can do the same by entering the numbers above and making the total monthly payment equal $2120 per month.

The calculator shows that our model household would pay a total of about $45,000 over the next three years.**  Now, if we take $45,000 from $148,186 we get an interest savings of $103,186.  Ten percent of that is $10,319.

$10,319 is a lot of money.

Now, if you’re someone who needs a lot of help at making a budget, needs a lot of help building a debt snowball, and needs lots of counseling and hand-holding while being intensely committed to one, focused goal; then this might be the right thing for you.  But, then, I wonder why you wouldn’t hire a financial planner in person to help you do this?  The amount of money I estimate that this model would pay out is more than ample to hire a skilled financial planner.  So why not do that?

Also, if you’re even reasonably skilled at addition and subtraction, and can use basic internet forms; why wouldn’t you just do this for yourself?  You’d save, by my estimate, about ten thousand dollars.

So, while I have no reason to think this is any sort of scam, I really don’t think it’s a good deal for most people.

* Sadly.
** You’ll notice the original interest expense amount I calculate and the interest expense the website calculates are different.  Since I’m just roughly modeling this to illustrate a larger point, I don’t care that much.  Let’s stick on the larger point.
G+

Posted in Credit, Current Events | Tagged , , , , , , ,