From: jwang@rad.rpslmc.edu (jinzhao wang)
Subject: Re: Mortgage or retirement
Reply-To: jwang@rad.rpslmc.edu
Organization: Rush Presbyterian-St. Lukes Medical Center, Chicago IL 60612
Date: Thu, 31 Dec 1992 18:10:31 GMT

In article 30DEC199223315551@csa1.lbl.gov, schindler@csa1.lbl.gov (AARON SCHINDLER) writes:
>>My wife and I are planning to buy a house in 1993, and I am not max'ed
>>out in my 403(b) pension contributions.
>> 
>>Can anyone give me any pointers on what the criteria should be used in
>>deciding whether I should either:
>>	1) Go for a 15 year mortgage; or
>>	2) Go for a 30 year mortgage and put the difference into
>>	403(b) savings.
>>       Brian Glendenning - National Radio Astronomy Observatory
>>bglenden@nrao.edu          Charlottesville Va.           (804) 296-0286
>
>PAYING OFF THE MORTGAGE ROUTE
>
>You earn $1.  After taxes you have $0.65.  You send $.65 to your mortgage 
>is a penny earned.")  15 years from now, your $.65 compounding at 5.85% will
>be worth $1.66.  
>
>403b ROUTE
>
>You earn $1.  It goes into your 403b pretax.  After 15 years your $1 compounding
>at 8% will be worth $3.30.  Then (say you are over 59.5 years old) you withdraw
>it from your 403b and pay tax.  Tax =.35*3.3 = $1.16.  Net return
>is $3.30 - 1.16 = $2.14.
>
>As we can see, even if my numbers are off or this isn't your exact situation,
>you are far more likely to come out ahead by investing in a 403b.  "Borrow
>the money for your IRA -- even if you have it."  --Strategy #119 "Wealth Without
>Risk" by Charles Givens.  You get the added bonus that the interest on the 
>money you are borrowing is tax deductible.
>
>|=======================================================================|
>| Aaron Schindler                                Schindler@csa.lbl.gov  |
>|                                                                       |
>| There are two times in a man's life when he should not speculate:     |
>| when he can't afford it, and when he can.        --Mark Twain         |
>|=======================================================================|


Let's further assume that you need a $100,000 mortgage and pay a higher rate (e.g. 9.5%) for a 30-year mortage instead of a lower rate (e.g. 9%) for a 15-year mortgage.

For the 30-year mortgage at 9.5% you need 360 monthly payments of $840.85 each; 
For the 15-year mortgage at 9.0% you need 180 monthly payments of $1,014.26 each.

You need additional $1,014.26 - 840.85 = $173.41 after-tax dollar to pay for the 15-year mortgage. So you have $173.41/0.65 = $266.78 pre-tax dollar less per month to invest in 403(b).

So the question was: Should I put this $266.78 pre-tax dollar in 403(b) or take the $173.41 after-tax dollar and send it to my mortgage banker in exchange for a 15-year?

PAYING OFF THE MORTGAGE ROUTE

After 15 years, you owe nothing from mortgage banker, you have no assets in 403(b). Your cash asset balance is 0.

403b ROUTE

After 15 years, you still owe the mortgage banker $80,526.04 (not much less than $100,000), but your $266.78 monthly contribution accumulate at 8%/12 monthly rate you have cash balance of $92,317.66. However you only have $92,317.66*.65 = $60,006.48 in your account. Your net cash worth at that time: $60,006.48 - $80,526.04 = -$20,519.55.
The net effect is that you just lost your children's one year college education fee (at the time you exactly needed).

SOME MORE POINTS:

A dollar earned in you own mortgage is a sure dollar, while a dollar earned in your 403(b) at 8% may not be so sure (you might do better or worse, the sure thing is that it is more risky).

Generally, it make sense to have more debt at a high inflation period, but not make much sense at current situation. 

What about a peace of mind by having less debt? 

So the conclusion is obvious: choose a 15-year mortgage. No wonder 15-year mortgage is so popular NOW! 

>
>p.s.  I'd be delighted if you found a flaw in my argument.  
>

The flaw is that you ignored the marginal dollar's ability to bring down the mortgage interest rate. What you owed is compounding at a larger base and what you have is compounding at a smaller base (not speed or rate).






Newsgroups: misc.invest