fyi, as of apr 2009 i have opted to move beyond step 2 and keep my student loans because they are at 1.875%.

1) Tax advantage of mortgage: If you are married filing jointly and make $100K/yr (100K @ 25% tax rate is $25K tax bill) If you have a $250K mortgage @ 6% with a monthly payment of approx $1500, Your yearly interest would be around $15K. If you itemize, your AGI (Ajusted Gross Income) would now be $85K ($85K @ 25% tax rate is $21,250). So, you would have paid the mortgage company $18K for the opportunity to save $3,750 in taxes. That’s pretty dumb.

2) Capital Gains. If I invest @ the stock market average of 11.78% and have a 6% mortgage, I will net 5.78%. If I invested the mortgage of $250K @ 5.78%, I would earn $14,839.03. I would have to pay $2225.85 in capital gains. This would net me $12,613.18 reducing your effective rate to about 4.93% Not too bad really, but I’m not done yet.

3) Inflation. The Long-term Ave is 3.42% per year. So let’s reduce our rate down to 2.36% (11.78% – 6% – 3.42%). Now we have made $5964.25. ($5069.61 after tax). Keep reading.

Now let’s imagine that we were investing over 20yrs. Our effective rate after mortage interest, inflation and taxes is 2.01%. We would have earned $123,577.21 over 20 years, but If instead of investing we paid off the house today and began investing our payment ($1500) at %8.36 (11.78% – 3.42%), we would have made $564,122.39 in interest. Our total contributions would have been $360K and our capital gains taxes would be $84,618.36. We would net $479,504.03

When you keep a mortgage, you split your earnings with the bank. Can you say stupid!!!

Would you borrow against your house in order to start investing?

Some people consider this a valid thing to do (the old ‘other people’s money’ concept). I personally would rather eliminate the risk and then move forward with full abandon on building wealth. Spin up some spreadsheets. You may find a small advantage to investing while still paying off debt…. it depends on the interest rates, taxes, and inflation. However, you are also taking on risk. For that very small difference, why take on the added risk? If you’re OK with this, more power to you. But its not for me.

When I first evaluated Dave’s baby steps, I found all sorts of numeric holes in the method. However, the longer I’ve looked at them, the fewer changes I’d make. The method is sound when you take all factors into consideration.

If you think you can beat your 8% loan, you’re kidding yourself. Sure, the average return in the market is 10% (my average return in the market over the past 6 years is 21%), but you aren’t factoring in RISK. There is TONS of risk in the stock market. It’s overpriced as it is and just waiting to fall. Investing in real estate 2 years ago would have netted you a huge loss at best, or a foreclosure at worst.

I paid off my house. I could have continued to TRY to match my average return of 20%, which I do with my free cash, however, to risk my house to do that is insane and a horrible investment strategy, not to mention that I’m now investing my entire mortgage payment on a monthly basis for life. I’ll make more than enough money in the next 40 years.

When doing these calculations, you need to account for taxes, inflation and risk, not to mention when you invest your money, a major, major majority of people choose the wrong investment or time getting into the investment wrong. Listen to Ramsey because he has it right.

I keep seeing, “You can deduct the interest”, but that’s an insane argument because you are paying $10,000 to save $2,500. Simple math there.

There is no such thing as good debt. Get a loan for your house, maybe for your education IF the job you are going to get is going to pay off the debt within 2 years, but bottom line is, if you can get yourself completely out of debt, including the house, it makes all of these 1-2% difference arguments a moot point because you will become a millionaire if you get out of debt and save your money wisely. The tortoise wins the race my friends.

- Undertrader

You are absolutely right, I knew I was oversimplifying the situation somehow, thanks for pointing it out.

However, if you are investing in a tax-deferred account (401k, IRA) then the logic would apply.

If you are comparing tax-deductible interest with taxable income, you can ignore the tax implications (assuming that regardless of you decision you could deduct the interest). You can’t adjust the interest on the debt for taxes, but ignore it on the income. Do both or neither.

For “regular” debt, or if you don’t have deductions needed to bother with itemizing deductions, then it is crucial that you take into account the tax. 5% interest in a bank account end up being only 3.75% if you are in 25% tax bracket. This makes a difference for TV GIRLS’s debt. If her alternative is a 5.625% return (or less), which any bank account is, then she should definitely be paying it off.

To calculate your effective interest rate on your loans, just multiply the interest rate by 1 minus your tax rate – for example – if you are in the 25% bracket you would multiply your interest rate by .75 (1-.25).

So your loans would have an effective rate of 6.2% and 4.2% respectively. It might make sense to attack the higher loan since it is higher than most “safe” investments, however, the lower loan you could beat that with an online savings account/CD, so I would wait to pay that down until you have a comfortable savings level.

@Amanda

That is why I said I “could” double that return with a higher risk investment, it doesn’t mean that I would or would feel comfortable doing that, although over the long-term I do feel that an 8% return is a reasonable assumption.

This plan works well for people who are intellectually overwhelmed with the idea of repairing their financial situation or unable to construct their own plan.

This plan also works well for people who are able to use it as a platform from which to launch their plan, and smart enough to ‘personalize’ it, understanding the philosophy of this plan (and always remaining attentive of the concept)…even while not necessarily applying the algorythm exactly.

One of the most important lessons is that of shaking off the peer-pressure practice of living in debt all the time…no matter how you do it. I went this route (painfully), about a decade before I ever heard of Ramsey, and until about a year ago, I thought I was a debtless freak who stood alone paying cash for my cars and refusing to use a credit card. Thank God for Dave.

I do agree that paying down the mortgage is a pleasant psychological boost.