Yahoo Finance carried this interesting article comparing making early repayments on a home mortgage against investing the money that would otherwise be spent on those early repayments.
The study on which the article was based concluded that more than 40% of people faced with this issue would be better off putting the additional savings into treasury bonds/mortgage backed securities. For the reasons identified in the article, the 40% number is almost certain low - very low. The time frame for the comparison was 25 years and was based on a number of assumptions on matters such as tax rates, interest rates and the return on the fixed interest securities. While the analysis is obviously dependent on what inputs are used for the financial modeling, the conclusion seems pretty clear to me: if the interest rate on the mortgage is below the long term rate of return (after adjusting for taxes) and your time horizon is long enough, you are better off directing savings to investments and not making early payments on your mortgage.
This is essentially the same conclusion that I wrote about back in February in this series of posts on the returns , the risks and my rather conservative strategy in making additional investments in preference to additional mortgage repayments.
Personally, I prefer equities or real estate to bonds for this purpose as the expected return gap is larger. Obviously circumstances such as tax rates (current and future)and risk appetite are highly relevant. In my own case, while I am happy not to make additional investment in preference to early repayments, I have not taken the logic to its ultimate conclusion and gone for interest only loans.
Saturday, April 28, 2007
An unsolicited offer (3)
As an update, our counter offer has been ignored. There has been no response from the person who made the unsolicited approach so I am now assuming that the matter is at an end.
The home as a retirement asset (3)
In the final instalment in this series I consider the role of the home in a retirement plan. The answers to the two previous questions were very clear (your home is an asset and is part of the calculation of net worth). This one is slightly harder and a lot will depend on factors such as personal circumstances, your personal retirement plan and your expectations about future house prices and rental levels.
Starting with the basics:
1. your house represents a store of wealth. As such it can be utilised to help fund retirement. For people who are poor savers, it may end up being their only significant asset;
2. you have to live somewhere. Unless you want to take environmentally friendly living to its logical extreme and sleep on the streets, your choices are to own or to rent your accommodation. In terms of cash flow owners have to pay various outgoings and maintenance while renters have to pay rent;
3. owning your own home usually has a feel good factor that is difficult to quantify but may well become more significant as people get older. Owning your own home (without a mortgage) gives people a lot of peace of mind.
Focusing on #1 as being the most significant factor, if you start to run out of money in your retirement, the value in your home can be utilised in a number of ways:
A. you can sell it (either outright or as a trade down). Sure, you still have to live somewhere but selling the home should be able to fund several extra years of living expenses. Alternatively, the proceeds from the sale of a home could be used to fund a move to an assisted living community or a nursing home (both or which are very expensive and likely to become more so);
B. you can raise money against it. For retirees this is typically a reverse mortgage which means you get to continue to live in the home for life. The financing costs may be expensive but it is an additional source of money to get you through your retirement years.
My own approach to look to the value of our home as a form of insurance policy. It is not intended to be a primary source of retirement funding but is a store of wealth which can be utilised as an alternative to eating cat food should things go wrong.
As a final point, I do not advocate reliance on the home as a means of funding retirement (other than as a source of a lump sum move to assisted living or a retirement home). Rather, I prefer to recognise the fact that the home has value which can be realised should the primary retirement plan run into difficulties.
Starting with the basics:
1. your house represents a store of wealth. As such it can be utilised to help fund retirement. For people who are poor savers, it may end up being their only significant asset;
2. you have to live somewhere. Unless you want to take environmentally friendly living to its logical extreme and sleep on the streets, your choices are to own or to rent your accommodation. In terms of cash flow owners have to pay various outgoings and maintenance while renters have to pay rent;
3. owning your own home usually has a feel good factor that is difficult to quantify but may well become more significant as people get older. Owning your own home (without a mortgage) gives people a lot of peace of mind.
Focusing on #1 as being the most significant factor, if you start to run out of money in your retirement, the value in your home can be utilised in a number of ways:
A. you can sell it (either outright or as a trade down). Sure, you still have to live somewhere but selling the home should be able to fund several extra years of living expenses. Alternatively, the proceeds from the sale of a home could be used to fund a move to an assisted living community or a nursing home (both or which are very expensive and likely to become more so);
B. you can raise money against it. For retirees this is typically a reverse mortgage which means you get to continue to live in the home for life. The financing costs may be expensive but it is an additional source of money to get you through your retirement years.
My own approach to look to the value of our home as a form of insurance policy. It is not intended to be a primary source of retirement funding but is a store of wealth which can be utilised as an alternative to eating cat food should things go wrong.
As a final point, I do not advocate reliance on the home as a means of funding retirement (other than as a source of a lump sum move to assisted living or a retirement home). Rather, I prefer to recognise the fact that the home has value which can be realised should the primary retirement plan run into difficulties.
Subscribe to:
Posts (Atom)