Hi, I am a long-time lurker looking for some advice from FWF. My approach in this post will be to basically highlight my thought process and get some feedback. I am a standard tech worker-bee and am good at what I do but really am not good at finance stuff. Investing and multiplying my earnings is a skill I really don't possess (I speak from experience . Therefore, what I propose to do is not going to be applicable to a lot of folks (particularly those good at investing) but might be applicable average types like me.

Anyway, here goes. I do follow the news via internet and various forums. This is what I see happening around us and rest of the world:

1. Stock-markets not doing too well.
2. Inflation is up (no matter what the economists say, I am seeing real erosion in the buying power of my dollar, and I'm not just talking gas.) Only things cheaper are housing and stocks!
3. Banks are failing. Sure the Fed might cover but this is only going to erode the dollar some more.
3a. Small possibility of massive banking kahuna.
4. Foreigners are going to slowly diversify from the dollar.
5. We (the US government) are spending (guess by printing dollars) on various activities not related to improving our economy.

Here is my situation:

I built up solid cash reserves, which we worked really hard at btw. Leaving it in a bank either gets me no interest (if it's in a bank I can trust) or gets me reasonable return (in a less than super-stellar rock but leaves me sweating in anticipation of 3a). I am definitely not capable of investing the money in the stock market and guarantee myself even 6% returns. My current mortgage is an ARM that will reset rates in Jan 2009. I would love to upgrade to a nicer house but then would be stuck with 2-houses (pretty sure can't unload my house in this market) and 2-mortgages.

My initial plan was to keep my mortgage until Jan 2009 and then if the adjusted rate was much higher, just pay-off the whole mortgage at that time. However, with the current situation, I am wondering whether the best course of action would be to pay it all off right now. (I do have the cash and even after paying it off should have ok reserves such that I won't have to struggle too much to maintain my living for a while even without a job.) If I manage to keep my job for the next year or two, I could save some more and have enough to make a down payment on a bigger house (Say in 2010). At that point, I might be able to unload my current house also.

Question:

Is it stupid to consider paying off the mortgage so fast? My reasoning for doing this is that I can't/don't know how to generate better returns for the cash outside. I am worried that some economic catastrophe might hit; so I can "lock" some value for my cash right now. Only downside is reduced comfort level (of having money in the bank so to say)?

Welcome out of the shadows of lurking.

If you pay it off, the government will not give you a hand out.

gdurrell said:jayK said:If I were you, I would refinance to a fixed rate mortgage or something like PenFed's 5/5 ARM. Holding fixed-rate debt is an excellent hedge against inflation, and while short-term returns might not look so good right now, you should be able to easily beat 6% in the long run.

The other downside to paying off your mortgage is that a single asset is now a very large portion of your portfolio. You'll be better off keeping your portfolio diversified across several asset classes.

What you say makes perfect sense in ordinary times. And it may well turn out that we are living in ordinary times. Would you still suggest taking the same approach if there was a 5% possibility of widespread bank failures?

Also by your definition, isn't paying off a mortgage also a hedge against inflation (whether it's in a fixed mortgage or paid-off mortgage, it's sort of the same in that it is related to the house)?

Why is diversification in this instance advisable? I have home-insurance to cover my investment and can save a nice mortgage interest payment (that will however not save me much on taxes). Sure my home's worth will likely go down further, but then I am on the hook for the mortgage anyway.

When jay says that having a mortgage is a great hedge against inflation, what he means is that right now you have "today dollars" and tomorrow you will have "tomorrow dollars". IF tomorrow dollars are worth less than today dollars (inflation) then it makes sense to borrow today dollars (which are valuable) and then pay it off with tommorrow dollars (which are less valuable).

All that said, I'm going to go contrarian here. The sky is not falling, and if it were the last thing you'd want to do is pay off your house. If you really think that the banks are going to fail, you should borrow as much money as you can and buy several houses. But don't do any of that, because very few banks will fail, and the US economy won't plummet because of them. You need to put your money in either an index fund (which just invests in a bunch of stocks across the board, thus mimicking the entire market) or better yet in a target retirement fund (which invests in bonds, stocks, and other investments and changes over time to match how close you are to retirement).

Right now is a great time to buy stocks, because they are down, and down means they cost less. If you buy stocks (or a stock based fund) and it goes down a little more, that's ok. You bought at a bargain price, and they'll go up sooner or later.

One factor when you pay off your mortgage is you lose the interest deduction. It may be worth it to keep some mortgage around if you can use it to offset income somewhere else. It really depends on your tax situation...you'd have to crunch the numbers and see.

Also, if you want to be liquid with little risk, go to the solid high-interest banks (ing direct, HSBC Direct). 3.5% is better than 0, but it sounds like you'll have to split your cash hoard among different banks so you stay under the FDIC limit. That should insulate you somewhat from bank failures. You could go with a really safe fund (t-bills, commerical paper, etc), but they wouldn't get you much more than the 0-risk savings, and they do have some risk.

What is your ARM adjusting to?

You could also leverage yourself more by buying another house, and rent out your current house. That'll get you down the rental income road. It's riskier, but may have a better payoff down the line.

Try reading this thread for a lot of previously posted information on this exact question.

jayK said:
Now let's say you pay off your mortgage. You now have $300K in home equity and $50K invested in other assets, so your home is now 86% of your portfolio. A 20% drop in the value of your home translates into losing 17% of your total assets. By paying off your mortgage, you are placing a big bet that the value of your home will increase faster than inflation. That's why diversification is so important, you don't want all your eggs in one basket.

Here's what I don't get about this theory. If the OP is considering moving, if the value of his home shrinks, it doesn't affect how much he owes on his mortgage. So, for simplicity, let's say he bought a house for 120K and took out a mortgage for 100K at 6%. The value of the house drops 50% so by the time he sells the house, it's worth 60K.

Scenario 1, he doesn't pay off the mortgage early. He's paid off 10K by the time he's ready to move. So, he owes 90K on the mortgage and he sells the house for 60K. He's out 30K at the time of settlement.

Scenario 2, he pays off the mortgage early. He's paid off an extra 10K for a total of 20K by the time he's ready to move. So, he owes 80K on the mortgage and he sells for 60K. So, he's out 20K at the time of settlement.

So, even though the house dropped in value, he still got a 6% return on the portion of the mortgage that he paid off early? Didn't he???

Aren't mortgage rates based on expected future inflation? That is, aren't current mortgage rates set so that the bank can still make a real profit after inflation? Even though high inflation means that you are paying back the bank in increasingly less valuable dollars, wouldn't the mortgage rate be correspondingly higher?

I don't understand any diversification logic. Isn't by buying the house you indeed invested that much in the house and it is kind of asset? Any loss in the house value you have to take weather or not you pay or keep on mortgage. Only time you can get away from that if you somehow declare bankrupcy or hide your other assets (it should be illegal) from bank to take your other asset towards the house mortgage.

Edit: The only advantage that i can see is that one can invest that money somewhere else and may potentially get a better return (better than mortgage rate) to offset some of the loss? Make sense..

The responses on this thread are helpful. While I still am still not sure which way to go, I might be able to begin formulating a strategy clearly in a few days.

In the meanwhile, here are some of my responses to some pieces of advice--

(1) Paying off mortgage will mean losing tax break-- In my case, it won't make a big difference. The remaining amount on my loan is under 100K and even if I itemize my returns the interest deduction will likely not make a big difference.

(2) Investing the money in stock market will yield long-term returns that trump 6%-- I do buy this advice. But I'm not sure this is going to help in the next few years. To illustrate further-- In my case, I have been sitting out of the market since 2000/1. I lost a big chunk of money in the dot-com period and got out. Since then the market has gone nowhere -- i suspect my money-market returns of 4-5% compounded are in general about the same or perhaps even better than the indices. I do realize that there have been periods when the market has done very well in the last few years but I am no good at timing and cannot count on my abilities (or even the ability of mutual fund managers who've proved they don't know much more than the Index) in this regard. In summary, I see very low risk in sitting out of the market for a couple more years, and instead "lock" my returns by paying off the mortage. [Just remembered: I do have some (well under 50k) money still in the market via 401K.

(3) But neither of the previous two points would cinch the deal for me. I am actually a tad worried about two other things -- Value of the dollar going forward. I am seeing real loss of buying power (inflation) coupled with instability in the banks. Safety of my cash reserves (much of my net worth) appears (very very low probability but real probability). So I am thinking use the money now to clinch something that will have value (at least to me since I live in the house).

(4) Inflation usually means BOTH wages and prices go up -- This was an argument made by one of the posters to justify keeping the cash and investing. I seriously am not seeing wages go up. If any of you can vouch for wages rising, please let me know which sectors. I am not averse to jumping jobs if it really means I can get a raise but IMO at this point (and into the next few years until a new wave of some sort happens) wages are not going to see any upward pressure.