Wednesday, January 25, 2006

This is an excerpt from an article titled "Pay down your mortgage or invest"

I disagree and will tell you in my next post.

If you can earn more by investing the money than you save by paying down the mortgage, then it makes sense to invest versus paying down the mortgage. The apples-to-apples comparison is the expected after-tax return on your investment versus the effective rate on your mortgage.

Not everyone can use the mortgage-interest deduction when filing his or her income tax return. If you aren't using it, then the effective rate on your mortgage is the interest rate on the loan. If you are using it, then the effective rate is roughly the mortgage rate times 1 minus your tax rate. With a 6-percent mortgage and a 25-percent marginal federal tax rate, the effective rate on the mortgage is 4.5 percent (0.06 x (1-0.25)).

My example ignores any interest deduction on your state income tax return. Incorporating a state tax deduction further reduces the effective rate.

It's pretty hard to beat 4.5 percent on an after-tax basis in a CD or savings account. A high yielding five-year CD is currently around 5.15 percent. The after-tax yield is 3.86 percent. Again, I'm assuming a 25-percent marginal rate on federal taxes and no state income tax (.0515 x (1-0.25)). Incorporating state income taxes further reduces the after-tax rate of return.

Invest instead in the stock market, and you can manage the tax impact of the investment earnings. Dividend income is currently taxed at 15 percent for most taxpayers, as are long-term capital gains. Invest the money in a tax-advantaged retirement account and you change the timing of the tax impact and the applicable tax rate on your investment earnings

2 Comments:

At 9:18 AM, Blogger DougAndrewCD.com said...

I agree with you completely. I think the 101 concepts are the smartest way to approach managing equity, regardless of what you may have learned from your grandparents. It's new world now. Are you in the Financial Planning or Insurance business by chance?

 
At 9:19 PM, Blogger Joe said...

I have been in the mortgage business and have recently transitioned to life insurance sales. I hold a 7 and a 63 because I was an equity trader( perhaps you saw my other blog)for a small boutique firm. My website and blogs leave a lot to be desired, let me look over your site and I'll include it my links. The wealthbuilderinfo.com site has a few interesting Macromedia presentations on the subject.

 

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