Should I pay off my mortgage loan or invest with the money I am receiving from an inheritance?

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?

Debt, Estate Planning, Investing
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July 2018

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 an inheritance, but also appreciated company stock or stock options, or simply other savings.

Let’s presume that your original mortgage was $200K, 30 years at 3.5%.  At present, you’re paying about $900/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 6.5% (our projection 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 $800K in bonds is $240K 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 it recovers (and it always does.)

Let’s say your $800K does indeed return 6.5% on average, so $52K in the first year.  You can easily route an extra $1000 a month in principal pay-down to your mortgage, which reduces the remaining term from 28 years to 10 – play with this calculator https://www.bankrate.com/calculators/home-equity/additional-mortgage-payment-calculator.aspx for more ideas.  At that point, your investment portfolio, net of $12K/year, should be worth around $1.3 million.  Alternatively, you could payoff the mortgage entirely now, invest $620K in the same strategy.  After 10 years, your portfolio would be $1 million.  If you also invested the $7200/year in cash flow savings from retiring the mortgage, your portfolio would grow to $1.15 million.

Our net recommendations:

  1. Balanced (stocks and bond) 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.

Best regards,
David Edwards, President
Heron Wealth
www.HeronWealth.com

Direct: 347 580-5288
Mobile: 917 705-3893

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