Wednesday, June 23, 2010

Living On The Edge

My coworkers and I started talking about retirement at lunch. I said my retirement depended on the type of house I want to live in after my mortgage on the rental house is gone. I mentioned that I was planning to use all of my cash reserves in order to pay off my mortgage by the end of the year. One lady said that she couldn't imagine doing that. What if something happened, she said. She would rather keep her cash and take an extra year to pay off the mortgage. That would be torture to me. I couldn't stand having that money in the bank while I was paying interest on a mortgage. Plus, if something did happen and I had to use the money for other things then the bank could foreclose even if I owed only a little. I don't want the bank to have that option. Her argument was, what if I got sick and couldn't work anymore. Maybe I don't understand what the risk is. If I got sick now then I would be covered by my work's disability insurance. I would get 60% or whatever that percentage is of my salary. The bank would take my house and I would lose the equity. I would owe lots of bills, the ones that insurance doesn't cover and who knows what else. If I got sick and couldn't work after my mortgage is paid then the bank couldn't take my house. I don't know what would happen with the bills but maybe I would have to sell the house to pay the bills.
To me it seems safer to not have a mortgage. I certainly hope I don't find out what would happen. What I plan on happening is that my next paycheck after I pay off the mortgage will go to replenish my emergency fund. And the next paycheck after that...and so on until I have enough extra money and decide to part ways with my job. It doesn't seem that risky to me but maybe I am blinded by the sight of the finish line.


Dave said...

I can relate to some of what you are trying to decide.

While I did not pay down my mortgage gradually the way you have, I paid off the last 2/3 of it in its 9th and final year (1997-98) in 3 large chunks. I had a large investment portfolio already so those three chunks represented only about 1/3 of my total assets.

As you suspect, once you pay it off, you will be able to quickly replenish the funds you used to pay it off. Even when I made my last big chunk to retire the mortgage, I was already higher than before I made the first big chunk. Some of this was due to the stock market boom in the late 1990s, however.

Another thing to remember is that any tax increase as a result of losing the home mortgage interest deduction may be mitigated by being able to take the standard deduction, a "floor" if you see what I mean. This happened to me for state income tax purposes, not federal.

I can see how your coworker would be nervous about using all of your cash reserves to pay off the mortgage. Using your own words, if something were to happen and you needed to have some cash around for other things and you had no mortgage but also no cash reserves, wouldn't you also be in some trouble?

With your mortgage amount going down, you aren't paying a whole lot of interest anyway so don't fret so much over that. I don't think you should totally or nearly totally drain your cash reserves just to pay off the mortgage.

You also have a somewhat unsteady rental income, from the tales you have posted here. To drain your cash reserves with such an shaky secondary but vital income source which you would then have to rely on more to cover your expenses should there be a problem would be, IMHO, needlessly risky.

I don't know how much greater than your remaining mortgage your cash reserves are, but I think you need at least 3 months worth, probably closer to 6 months worth, after you pay off the mortgage. Then you can rebuild the cash reserves.

Dave said...

Daizy, I thought of a few more things.

Paying off the mortgage is a one-directional act because if you decide at some point you need that money you use for other things (i.e. other monthly bills), it is not so easy to get that money out like from a home equity loan. But if you don't pay off the mortgage and decide later that you can, it is very easy to do so - you just pay it off. So be sure you won't need that money for other things when and if you decide to move forward with that.

If you decide not to pay it off and you get sick and can't work, you will need your cash reserves, the same cash reserves you would use to pay off the mortgage, to make your monthly mortgage payments anyway. I assume your cash reserves are at least $20k so between that, your rental income, and any disability payments you are getting you can meet your monthly expenses for a while.

Over the Cubicle Wall said...

I think your lifestyle cost is low enough that you could afford to pay for it with a minimum wage job if you lost yours, or with 60% disability if you got hurt.

The people at your work that live paycheck to paycheck or worse, in debt, are the ones who should worry about living on the edge.

Daizy said...

I still can't think of a scenerio where it woud be better to have the cash. My mortgage is the scariest debt I have. If I pay it off then they can't take the house away. All other debts would be bad for my credit report but wouldn't involve anyone taking my stuff away. I would much rather have the mortgage paid and have to put bills on a credit card if something happened. And since my budget is only $700 a month, I will most likely be able to replenish my 3 month emergency fund in one month. Now if I didn't have enough to completely pay off the mortgage then I would keep the cash reserves which is what I am doing now. I only have $7k in reserve and I still owe $18k on the mortgage.

Daizy said...

Over the cubicle, ya, my monthly expenses are very low. the mortgage is actually higher than my expenses at $780/m. Once the mortgage is gone it shouldn't be very difficult to support myself. The dogs had better start looking for jobs though!

Dave said...

So Daizy, let me see if I have this traight. You have $7k in reserve and your outstanding mortgage principal (as shown on your home page) is just under $19k, right? You can pay down the mortgage but you can't pay it off yet. If your reserves are rising while your remaining mortgage balance is dropping, then you will soon (hopefully, perhaps by the end of this year?) reach a point where the reserves would exceed what you still owe. Is that what you meant when you wrote "use all of my cash reserves in order to pay off my mortgage by the end of the year?"

Wouldn't putting your bills on a credit card be risky because the (non-deductible) interest you would pay on that compared to the (deductible) on the mortgage would be much higher?

You will reach the point where your reserves will exceed the outstanding balance on the mortgage, and by an mount which will still leave you with a reasonable cushion (for a few months) until you can build it back quickly, as you pointed out. But you don't seem to be there yet.

Daizy said...

Yes Dave, that's pretty much my plan. As soon as the mortgage and the reserve fund equal eachother I will gleefully pay off the mortgage instead of waiting a month or two to save extra money. For that first month after I pay it off I will have to use a credit card as my emergency fund. Things could go horribly wrong and I could lose my job and get in a car wreck all in that same month but I would rather have my house free and clear. My coworker said she wouldn't do that. She would wait a whole year longer just to have more cash on hand.

As for the deductible interest, it's a rental house so the main tax benefit is depreciation. I haven't itemized in years. Not enough personal deductions.

So, I would rather us my credit card as my emergency fund for a month or two rather than delay paying off the mortgage. If something kept me from paying the mortgage, that would be horrible. If something kept me from paying the credit card, that would be bad but at least they couldn't take the house.

Hopefully, all will go well during that crucial transitional month (it should be this November) and I will not need to use the credit card emergency fund at all.

Dot said...

I think it is a very well thought out plan. You know the pros and cons of each choice and are using your experience to decide when to use your reserves to pay off the mortgage. Nothing is set in stone. When the time gets closer if you feel it is not right to use the reserves, just make a few more mortgage payments. If everything seems to be going well use the money to pay off the awful debt. It wouldn't be the first time anyone used a cc for emergencies, and you only plan to do it for a few months. The most important thing is it is a well thought out plan with options.

Anonymous said...

Why are you worried about the lender taking your home if it is not paid off? If you happen to fall into a situation where you lost your job/ability to work and had both the reserves and your mortgage you can make the decision as to how bad the situation is based on all the relevant factors at the time the shtf. You might decide that you will put your expenses on plastic and continue paying down or paying off the mortgage but you might decide, that using some of your reserves makes more sense then using a credit card/declaring BK and that you can continue to pay the mortgage for an extended period of time.

You have more OPTIONS at almost no interest/tax/risk cost to you if you keep some reserves until the time that they represent 6 or more months of living expenses above your mortgage balance. Based on your posts that shouldn't take too long (2 to 4 more months I am guessing). Credit cards can be closed or credit lines slashed in the event you lose your job. Selling the house or your land on short notice to meet obligations that could otherwise be paid with liquid funds would be a very unfortunate situation.

Daizy said...

Dot, yes I think about it a lot. I know its a bit of a gamble but it will eliminate half of my expenses, will give me peace of mine about the house and will be so exciting to pay off. I can't think of any better use for my money.

Daizy said...

Anonymous, I tend to spend money that isn't put away somewhere. I can see myself getting in to trouble by spending it on a dog fence then lose my job and not have enough for the house. Every other bill that I have is flexible, food, internet, phone, I don't ever want to have to tell the bank that I can't make a payment. It is safer for me to pay the house when I have the money without delay. It will force me to be patient about the rest of my wants.