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The "Dave Ramsey" approach of paying down debt rather than investing is appealing to me, and I think a lot of people ignore the extra risk of investing. If I ca

The "Dave Ramsey" approach of paying down debt rather than investing is appealing to me, and I think a lot of people ignore the extra risk of investing. If I can make 4.5% risk-free paying off a mortgage vs 6% in stocks, I'd pay off the mortgage. But here is another consideration I've never seen discussed before: mortgage interest is static, but investment returns are dynamic. My mortgage interest rate is fixed for 30 years, and that's a long time for the stock market to change. What I mean is, the day I close, my interest rate is probably only a little lower than stock market returns. But surely in 10 or 20 years the stock market will have times at 10% or 15% returns, and I'll still have that low-interest mortgage. It almost seems unfair to the bank! So even though my natural inclination is to pour retirement savings into my mortgage, I wonder if it would be better to keep the leverage of such a low-interest loan so I'll have cash for investing when the market has better returns or lower risk. 30 years is a long time. What do people think?

nawitus 11y ago
This might be one reason why interest rates are typically not static in Europe. They have a static interest margin, though. The "weird" thing is that the interest margin is low when the economy is doing well but high when the economy is not doing well (e.g now), but the Euribor rates the inverse of that. In other words, someone who took a mortgage 4 or 5 years ago are probably now paying close to zero interest, and anyone who takes a new mortgage now has to pay close to 1.5% interest (which is almost completely composed of the margin). And when/if the economy picks up in 3 to 4 years, that person with the 1.5% margin is going to be paying a lot of interest.. It's also very difficult to get a mortgage with a fixed interest at least in Finland. Not unheard of, of course, but the terms are likely pretty bad.
bcheung 11y ago
Not a fan of Dave Ramsey. He's great if you don't know finance but his advice is geared towards people in the poor and lower middle class brackets that want to stay there. Same with Suze Orman. Get an overfunded whole life policy and put the extra money into that. Google "Infinite Banking" or "Cash Flow Banking" to understand how it works. Current guaranteed rates are 4.5% with dividends it comes out to around 5.5% (in the current market, it tends to follow interest rates very closely). That's 4.5% guaranteed for life from companies that have been around longer and still posted profits through the great depression, dot com crash, and 2008 housing crash. Gains grow tax free and if you take it out as a loan it is tax free as well. Any money you withdraw is tax free up to the amount you have contributed so far. You can take out a loan for any purpose, for any reason, at any time. If you don't pay back the loan the company could care less because they are getting the interest and it just comes out of the death benefit. Actually, they prefer you don't pay it back because they make more interest. So it really is win/win. Tax free "withdrawal" for you and more interest for them. Also, it's a loan against, not a loan from. That means you are borrowing money from the insurance company not your money. The entire balance is still compounding. And, as an added bonus, you are getting permanent life insurance for your family. Some risks with paying off a mortgage earlier: 1) Equity in a home earns 0% interest. You're money is not compounding. Got $500,000 in equity. Guess what, that $500,000 is earning 0% interest. 2) Your leverage is decreased when you pay off your mortgage. If you have only 20% down (500% leverage) and your home goes up 10% then you just made a 50% gain. If you pay off your loan then your 10% gain becomes a 10% gain. 3) The money you put into your loan could have been earning interest. Yes, you're paying money on the mortgage interest but the mortgage balance is decreasing while the investment balance is increasing. You can think of it this way. Should you take out a loan at 5% to invest at 5%? The answer is yes, you will come out ahead. The reason is that you are only paying 5% of the whole amount in the beginning. Towards the end you are paying 5% on a very tiny balance. If you pay in level payments then your loan is effectively costing you 2.5% while your investment is getting 5%. It's net positive. 4) Paying down your mortgage means you have more money at risk and less options. If you have some bad luck and default then the bank gets first right to all of your equity. If that equity is stored in a whole life policy it is protected from creditors (may vary from state to state but most are pretty generous). If the bank stands to lose a lot of money they will work with you and give you some flexibility, lower rate, allow you not to make payments for a while, etc. If they can just foreclose then they will do that. The reason a foreclosure is more favorable when you put in more equity is because they can sell it at a lower market rate and still get their money back. If it is underwater and you have very little equity then they would be forced to take a loss from the foreclosure. 5) Your mortgage interest may be tax deductible depending on your circumstance. You are giving that up. Todd Langford has a really good series of videos that talks about finance and opportunity costs: https://www.youtube.com/watch?v=lp1BZcex6ds https://www.youtube.com/watch?v=lp1BZcex6ds https://www.youtube.com/watch?v=v7QCe3rmAv0 https://www.youtube.com/watch?v=v7QCe3rmAv0
- pjungwir 11y ago
  I really appreciate your comments! So what are the downsides of a whole life policy? It can't all be pros and no cons, right?
  - bcheung 11y ago
    The downsides are: 1) It can tie up cash flow. If you don't make the minimum payments your policy can "eat itself" until it lapses, at which point you lose that money. That being said, there is a large degree of flexibility when designing policies. Set the minimum low and contribute more. Fall back to the minimum when times get hard. If you are further into the policy it can self-fund (basically the dividend payments can cover the premiums and then some). At that point, you don't need to continue any money whatsoever to continue the policy. Most people still contribute money though since it is effectively free interest. 2) It has high load in the beginning. It typically requires 7 years just to break even. The first 3 years you typically will be losing money. It's only designed for long term. 3) You have to be able to qualify for insurance. If you can't you can insure someone you have an interest in parent, child, spouse, sibling, nephew, etc. You're basically trading a little bit of flexibility with your cash flow in the beginning. If that money is going to be going towards investments anyway though, it really is a good strategy. Also, you can always take out a loan against in the policy to invest in something else. If you have a decent investment you're actually getting increased leverage. See this video for how this strategy can be used with real estate investing to get much higher returns: https://www.youtube.com/watch?v=cgK_dOIesZo https://www.youtube.com/watch?v=cgK_dOIesZo
- tmorton 11y ago
  Whole life policies are pretty terrible, because they're high-fee and opaque. It's very difficult to compare them like-to-like, and that's on purpose - each insurance company wants to sell a slightly different set of guarantees, risks, benefits and fees. Term life insurance is what you need to protect your family. 401ks, IRAs, then simple index funds are superior investment vehicles. Here's the really short guide to life insurance: http://www.reddit.com/r/personalfinance/wiki/insurance http://www.reddit.com/r/personalfinance/wiki/insurance
ghaff 11y ago
And there will be times when equities will lose value. And you can't reliably time any of this anyway. In general, the best strategy is to diversify and maintain some level of liquidity. By all means, pay down your mortgage principle from time to time (or increase your monthly payment a bit) but probably not to the degree that you have no equity investments and/or very little cash on hand.

nawitus 11y ago

This might be one reason why interest rates are typically not static in Europe. They have a static interest margin, though. The "weird" thing is that the interest margin is low when the economy is doing well but high when the economy is not doing well (e.g now), but the Euribor rates the inverse of that. In other words, someone who took a mortgage 4 or 5 years ago are probably now paying close to zero interest, and anyone who takes a new mortgage now has to pay close to 1.5% interest (which is almost completely composed of the margin). And when/if the economy picks up in 3 to 4 years, that person with the 1.5% margin is going to be paying a lot of interest.. It's also very difficult to get a mortgage with a fixed interest at least in Finland. Not unheard of, of course, but the terms are likely pretty bad.

bcheung 11y ago

Not a fan of Dave Ramsey. He's great if you don't know finance but his advice is geared towards people in the poor and lower middle class brackets that want to stay there. Same with Suze Orman. Get an overfunded whole life policy and put the extra money into that. Google "Infinite Banking" or "Cash Flow Banking" to understand how it works. Current guaranteed rates are 4.5% with dividends it comes out to around 5.5% (in the current market, it tends to follow interest rates very closely). That's 4.5% guaranteed for life from companies that have been around longer and still posted profits through the great depression, dot com crash, and 2008 housing crash. Gains grow tax free and if you take it out as a loan it is tax free as well. Any money you withdraw is tax free up to the amount you have contributed so far. You can take out a loan for any purpose, for any reason, at any time. If you don't pay back the loan the company could care less because they are getting the interest and it just comes out of the death benefit. Actually, they prefer you don't pay it back because they make more interest. So it really is win/win. Tax free "withdrawal" for you and more interest for them. Also, it's a loan against, not a loan from. That means you are borrowing money from the insurance company not your money. The entire balance is still compounding. And, as an added bonus, you are getting permanent life insurance for your family. Some risks with paying off a mortgage earlier: 1) Equity in a home earns 0% interest. You're money is not compounding. Got $500,000 in equity. Guess what, that $500,000 is earning 0% interest. 2) Your leverage is decreased when you pay off your mortgage. If you have only 20% down (500% leverage) and your home goes up 10% then you just made a 50% gain. If you pay off your loan then your 10% gain becomes a 10% gain. 3) The money you put into your loan could have been earning interest. Yes, you're paying money on the mortgage interest but the mortgage balance is decreasing while the investment balance is increasing. You can think of it this way. Should you take out a loan at 5% to invest at 5%? The answer is yes, you will come out ahead. The reason is that you are only paying 5% of the whole amount in the beginning. Towards the end you are paying 5% on a very tiny balance. If you pay in level payments then your loan is effectively costing you 2.5% while your investment is getting 5%. It's net positive. 4) Paying down your mortgage means you have more money at risk and less options. If you have some bad luck and default then the bank gets first right to all of your equity. If that equity is stored in a whole life policy it is protected from creditors (may vary from state to state but most are pretty generous). If the bank stands to lose a lot of money they will work with you and give you some flexibility, lower rate, allow you not to make payments for a while, etc. If they can just foreclose then they will do that. The reason a foreclosure is more favorable when you put in more equity is because they can sell it at a lower market rate and still get their money back. If it is underwater and you have very little equity then they would be forced to take a loss from the foreclosure. 5) Your mortgage interest may be tax deductible depending on your circumstance. You are giving that up. Todd Langford has a really good series of videos that talks about finance and opportunity costs: https://www.youtube.com/watch?v=lp1BZcex6ds https://www.youtube.com/watch?v=lp1BZcex6ds https://www.youtube.com/watch?v=v7QCe3rmAv0 https://www.youtube.com/watch?v=v7QCe3rmAv0

pjungwir 11y ago
I really appreciate your comments! So what are the downsides of a whole life policy? It can't all be pros and no cons, right?
- bcheung 11y ago
  The downsides are: 1) It can tie up cash flow. If you don't make the minimum payments your policy can "eat itself" until it lapses, at which point you lose that money. That being said, there is a large degree of flexibility when designing policies. Set the minimum low and contribute more. Fall back to the minimum when times get hard. If you are further into the policy it can self-fund (basically the dividend payments can cover the premiums and then some). At that point, you don't need to continue any money whatsoever to continue the policy. Most people still contribute money though since it is effectively free interest. 2) It has high load in the beginning. It typically requires 7 years just to break even. The first 3 years you typically will be losing money. It's only designed for long term. 3) You have to be able to qualify for insurance. If you can't you can insure someone you have an interest in parent, child, spouse, sibling, nephew, etc. You're basically trading a little bit of flexibility with your cash flow in the beginning. If that money is going to be going towards investments anyway though, it really is a good strategy. Also, you can always take out a loan against in the policy to invest in something else. If you have a decent investment you're actually getting increased leverage. See this video for how this strategy can be used with real estate investing to get much higher returns: https://www.youtube.com/watch?v=cgK_dOIesZo https://www.youtube.com/watch?v=cgK_dOIesZo
tmorton 11y ago
Whole life policies are pretty terrible, because they're high-fee and opaque. It's very difficult to compare them like-to-like, and that's on purpose - each insurance company wants to sell a slightly different set of guarantees, risks, benefits and fees. Term life insurance is what you need to protect your family. 401ks, IRAs, then simple index funds are superior investment vehicles. Here's the really short guide to life insurance: http://www.reddit.com/r/personalfinance/wiki/insurance http://www.reddit.com/r/personalfinance/wiki/insurance

ghaff 11y ago

And there will be times when equities will lose value. And you can't reliably time any of this anyway. In general, the best strategy is to diversify and maintain some level of liquidity. By all means, pay down your mortgage principle from time to time (or increase your monthly payment a bit) but probably not to the degree that you have no equity investments and/or very little cash on hand.