Question: My spouse and I will be inheriting about $750,000 to $800,000. The payoff balance of our mortgage is estimated at about $180,000 at 3.5 percent APR for 30 years. Would it be worthwhile to allocate some of the money we are inheriting to pay off the mortgage loan? We still have 27 years left to pay. Alternatively, should I invest the money and continue paying my mortgage?

Answer: This is a common trade-off question among families who have a substantial liability like a mortgage and also have a substantial asset. In your case this is an inheritance, but the asset could also be appreciated company stock or stock options, or simply other savings.

Let’s presume that your original mortgage was $200,000 for 30 years at 3.5%. At present, you’re paying about $900 per month, of which about 60% is interest and 40% is principle. You’re getting a tax break on the interest amount, so your after tax cost is closer to 2.75%. 

Meanwhile, you could invest in a balanced (70% stocks/ 30% bonds) portfolio of tax efficient ETF’s and obtain a return of 6.5% (our projected return net of advisor fees over the next 20 years). So why wouldn’t you just invest in the market and pocket the difference of 3.75%? Well, of course, the 3.5% is locked in, but the 6.5% is ONLY a projection – you could have a couple of poor stock market returns and really regret not just paying off the mortgage.

Ah, but that’s the advantage of the balanced portfolio over a pure stock portfolio. 30% of $800,000 in bonds is $240,000 reserved in stable value securities. You could pay off the mortgage at any time from the bonds, and still have funds working in the stock market for when the market recovers (and it always does).

Let’s say your $800,000 does indeed return 6.5% on average. This would be $52,000 in the first year. You can easily route an extra $1,000 a month in principal pay-down to your mortgage, which reduces the remaining term from 28 to 10 years – use this calculator for more ideas.

At that point, your investment portfolio, net of $12,000 per year, should be worth around $1.3 million. Alternatively, you could pay off the mortgage in its entirety now,  and invest $620,000 in the same strategy. After 10 years, your portfolio would be $1 million. If you also invested the $7,200 per year in cash flow savings from retiring the mortgage, your portfolio would grow to $1.15 million.

Our net recommendations:

1. Balanced (stocks and bonds) not all stock portfolios for the assets

2. Commit to extra principal payments to cut the life of the mortgage in half

3. Preserve the tax benefit of the interest deduction for now

4. Preserve the decision making flexibility in investments that is not available in illiquid real estate equity.

Do you have questions?
Feel free to contact me.

David Edwards, President
DavidEdwards@HeronWealth.com
Direct: (347) 580-5281