Is it worth it to pay off debt?

I recently got into a few lengthy discussions about whether you should pay off your house or use that money to invest in a retirement fund. The scenario we were talking about was if you had a lump sum drop in your lap, would it be better to get out of debt or simply invest the money at a higher rate than the debt you were carrying.

All of you Ramsey fans out there would know he would ask "If you were debt free, would your take a loan out on your house to invest for retirement?" -- which is what I asked during my discussions.
Surprisingly, the answers I got back were in favor if investing the money. Even with the risk of the stock market, those involved in my discussions were willing to invest the money (to varying degrees of enthusiasm).

Their arguments basically hinged on the fact that mortgage rates are fairly low, and investment returns are rather high. So, based on this, I decided to crunch some numbers to see exactly how this would break down.

The hypothetical situation is as follows:

You have a $150,000 mortgage at a rate of 5%. You have an investment that will give you 10%. You have $150,000 cash on hand... what do you do?

The first scenario is to keep the house and invest the money over the 15 years. First off, paying a 15 year fixed mortgage at 5% on $150,000 would result in a monthly payment of $1186.19. Over the lifetime of the loan, you would pay back $214,054.20 in principle and interest. Now let's take the $150,000 and invest it at 10%. Without adding any money to it and letting it build over the 15 years, you would end up with $446,274 after taxes (at a 28% tax rate). So, to summarize, we have the following:

• $150,000 Mortgage, 15 year fixed at 5%
• $1186/month payment
• Cost of $214,054.20 over 15 years

• $150,000 Invested for 15 years at 10% with a 28% tax rate
• Gain of $446,274

So, after you subtract out the cost of your house from the gain of your investment, you have netted $232,219.8, not a bad little investment.

Now, let's examine the second scenario. This time, you take the $150,000 and pay off your home. However, instead of pocketing the house payment, you put it into that same investment at 10% for 15 years. After the 15 years and 28% tax rate, you end up with $378,339. The first thing you should notice is that this number is substantially less than the $446,274 you gained in the investment in the first scenario. However, after you subtract out the cost of your mortgage, you have actually GAINED $146,119.20 after paying off your house. To summarize:

• $1186.19/month invested over 15 years at 10% with a 28% tax rate
• Gain of $378,339
• Net Gain in Scenario 1: $232,219.8
• Difference in Scenraio1 vs Scenario2: $146,119.20 in favor of Scenario 2
  

So, by paying off your house with $150,000 and investing your would-be house payment, you end up almost $150,000 ahead of where you would have been if you had gone with the first option. Notice that this is essentially the principal that you were initially thinking of investing. Just at looking at the value of the two choices (aside from investing revenue), option 2 gives you a 100% return over option 1.

Sure, you could find an investment that was over 10% and make the numbers work. However, the risk involved with such any investment that returns a steady rate above 15% would far outweigh the potential gains you would have.

I think the numbers speak for themselves :)

Shopping Around Pays Off

I just wanted to drop in a quick update on the playset. Turns out, with more shopping around, we found a source for a decent sized kit and a source for wood that is substantially less than we had budgeted for the project. The grand total is going to come in around $530 (with me building it all, of course), so the rest of the money can be put toward debt.

This, along with our upcoming budget restructuring should give us some traction to help get things paid down (and to handle the upcoming medical bills).

The Torrent Continues

Well, I thought I was out of the woods until I got an EOB from Anthem today. Piper was in the hospital for three days, and amassed a bill of around $2400. Thankfully, I'm now on my company's insurance so things like this shouldn't happen. Until then, I think I'm going to have to set up payment terms with the hospital. I'm curious to see how much I can spread it out without getting a loan. I would love to be able to make payments on this without dipping into any of my emergency fund.

On a brighter note, I wanted to talk a little about my new insurance. I went ahead and signed up for a flexible spending account with the new plan. Based on last year's expenses, I was pushing 3k in expected outlay. The limit is only 2k, so we will see how long that lasts, but I have a feeling I'll burn through it pretty quickly.

Our insurance is through Aetna, and they have a pretty cool system for the flex spending account. Basically, they try to keep all the paperwork out of it for the members. When they receive a claim from a provider, they look to see if you paid a copay. If you did, they look in your flex spending account to see if you have a balance. If you do, they cut you a check along with the provider -- and you don't have to submit any claims. Things get even cooler at the pharmacy. Since everything is electronic with checking for benefits, the system AUTOMATICALLY PAYS the pharmacy out of your flex spending account and you get your prescriptions for "free".

All in all, after the tax breaks I should net out to having about the same take home pay as I had before when paying for private insurance.

In the mean time, when I get the bill from the hospital I'll be sure to post what I managed to talk them down to. Until then, I'm going to grudgingly wait for the bill to show up.

Crisis Averted

Good news! Yesterday I got a escrow overage check from our mortgage company out of the blue that was for about twice what our medical bills were for. So, not only do I have the money for the playset, I have extra money to use to pay down debt, or to put toward a couple projects we have been saving for. I still need to look to see where it would be best served, but this really excites me.

Between this and some extra work I've been able to pick up, this summer may actually turn out pretty nice :).

Oh well, off to enjoy the rest of my Sunday :)

The Bane of Medical Bills

This always ALWAYS seems to happen. You decide to purchase something large, so you start saving up. You plan, you save, you plan, you save. Finally, you get to the point where you can make the purchase, and BAM -- something unexpected pops up.

For us, this always seems to be medical bills. Granted, with as much as our kids have been in and out of doctor's offices, I should be used to the cycle -- but it still surprises me on occasion. Most of the time, it is more of a "This cost HOW much to get checked??"

We had been saving up for a fairly large playset for the backyard. Our children are starting to get old enough to where one of these would make sense, so we had been planning for about a year. We've had the designs picked out and just had to pick the final level of accessories. Enter new Bills.

All and all, they total of the bills is just shy of what the playset would have cost. On the one hand, it is good that we had the money around and didn't have to get into our emergency fund to pay them off. On the other hand, it is annoying because now I have to start re-saving for the playset.

Ahh, the joys of being responsible.