Emergency fund vs mortgage down payment

Inspired by The Financial Samurai post, I decided to ask a similar question here: Should we use a part of our life happens fund and emergency savings to pay down a part of the mortgage?

Here is the situation. 

After a few lump sum payments and 2 renegotiations of the mortgage, we now owe the bank money at a rate of 1,14%. Worst case, it can
double till 2,28%. Sometimes, the Belgian system is just cool. That same system does not allow me to increase the monthly payment or decrease the monthly payment. That can only at set moments. Ours is not due in 1,5 years. The only solution now is a lump sum payment.

Next to that, the current interest payments are almost fully covered by the tax advantage on the mortgage. In essence, you could say we have a 0 pct mortgage.

The cash  would come out of our emergency fund and life happens fund. Not the investable bucket, not the travel fund. In the end, it is all cash on our accounts. Mentally, it is a different ball game. This money is currently yielding less than a 0,5 pct on average. This is not good.

Here is the plan.

I would like to pay off 10 000 EUR on the mortgage. This would bring our open amount just below the magical threshold off 100K. Our monthly payment would be 1003 EUR per month. Most of these arguments are purely emotional. Probably the worst guidance for a financial decision. I know! An extended plan would be to pay off 15 000 to lower these amounts even more.

This payback would not impact our fiscal advantage. So, we still stay at a virtual interest rate of 0pct

The monthly money saved would be directed back to a high yield savings account. These accounts come with some strict rules on how much you can put on each month and a loyalty bonus only due once a year if the money is there a full year.

IMG_0043_4_5_6_8The amber index would get an instant kick. It is derived of the 4 pct rule (Have 300 times your monthly expenses). Off course, this is a fake pumping up of the amber index. It will happen at a certain point in time anyway. And then for the full amount of the mortgage payment.

Next to the 100K and 1K threshold, there is also the advantage that I learn to live with less emergency and life happens fund. I am curious to see how we manage that. Today, we are having the amount that makes us sleep well at night. What if we stretch this a little?

The alternatives

We could put the money to work for us on the stock exchange in high yielding dividends or in an index. In the long term, this would yield 7-9 pct. With the current evaluations of the markets, I have a hard time to believe this. AM I timing the market? Maybe… As this money comes out of the mental emergency fund, this makes it even more difficult!

A derived alternative from this one is to wait for the market crash. I am not patient enough to wait for

The money could also be funnelled to a higher yielding account than today. Still then, this would be less than the interest paid on the mortgage. Or, we could funnel it in pieces to the high yielding account.

Or, we could do nothing. That is not me.

What do you think? Does this plan makes sense or is it totally a bad idea? What alternatives do you see?

 

 

 

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36 thoughts on “Emergency fund vs mortgage down payment

  1. I have a pretty strong emotional bias toward carrying no debt (I bought my condo with cash even though I believe I could beat the mortgage interest rate in the stock market), but your interest rate is crazy low! With the added tax benefits, I would probably be keeping the mortgage as long as possible… but I understand both perspectives!

    Liked by 1 person

    1. Same for us — strong anti-debt bias. But also the same reaction to your interest rate: that’s SOOOO low it’s almost hard to believe! It seems like you have no bad options.

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  2. Hey ATL,

    I can understand why you are thinking this. We want our money to be working as good as it can be for us. We want to be debt free as soon as possible. Paying down your mortgage seems good and means you won’t have to pay interest on that either.

    However, if your interest rate is effectively 0%, then you could increase your net worth more effectively by investing as that money will give you income (and a return) whereas the mortgage is not really costing you anything.

    But I’m not sure you should do either of these things. Financial Samurai earns hundreds of thousands of dollars a year and would (like he said) earn that back in a few months. We/you aren’t earning that much, nor have as successful reliable sources of income as he does, so it’s much more important for us to maintain a healthy emergency/life happens fund. If you think you can pay this money and still feel as secure then perhaps you could use half the money to pay down the mortgage and half to invest. That way you are covering both angles.

    Tristan

    Liked by 2 people

    1. Thx for the ideas. The size of the emergency fund after the transaction would still be ok, not super comfortable. Given the cash we have on the sideline for investments, we still have more than the average rule of thumb. All these comments provide now another perspective on the topic.
      Over the past years, excess cash almost always went to the mortgage… new idea is welcome

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  3. Choosing among the alternatives you indicated above is really tough. I would say to keep paying the mortgage because you are getting two benefits. First, the interest is way too low. I haven’t heard of anybody here in the US who only pays 1ish %. I wish I could get a rate like that when I buy my own house. Second, you are basically getting 0% in interest because the interest itself can be used for tax purposes. But if you are looking into using your funds for something else, I would be tempted to say to invest a portion. At least you are risking only a portion of your money.

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  4. “Sometimes, the Belgian system is just cool.”, at 1.14%? Yeah! That is an amazing interest rate, we are currently aiming for 2.39% for a 5 year fixed mortgage at 102% of the property value. Which is pretty reasonable (albeit not the lowest for various other financial reasons).

    Question, can you get a line of credit on your house? If so, use that as your emergency fund (we did that in Canada, we had no cash at that time just a revolving line of credit on our house that we used as backup). In this case your mortgage payments will drop due to the down payment, but you still have instant money available for an “oh crap” event.

    But you are right, financially it is smarter to invest say 2/3 in to the stock market and keep the other 1/3 of the cash for the unexpected, with the ability to sell certain shares/ETF’s if things get really bad.

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    1. Getting a line of credit on the house is in my knowledge not a common practice in Belgium.
      With all the feedback, I am leaning now towards keeping the cash for an upcoming opportunity

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  5. The best time to pay off good debt is NEVER. Your mortgage rate is low. I would not pay off lump sum and would rather save that money for other investments, perhaps another down payment on another property.

    I have this personal rule, only pay off good debt when your cash is 10x what your debt is. In that case, paying off your debt would be so insignificant in future investments that you might as well get it off your chest for peace of mind.

    Anyhow, my 2 cents.

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    1. Jeff, some good additional thoughts and rule of thumbs. I start to see the advantage of transferring this cash buffer from an emergency fund to an opportunity fund to invest in other assets.

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  6. I, too, have struggled with your same dilemma. I’d be cautious applying excess liquid funds against your mortgage if you don’t have a clear “debt free” target date in mind. If, essentially, returns are the same, I’d suggest maintaining and growing your emergency reserves until you’re at the point you can pay off your mortgage in full. The Radical Personal Finance podcast has had several podcasts on this topic, and the host warns against draining your liquidity unless it will totally pay off the mortgage and result in increased cash flow. Tread carefully, my friend.

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    1. We do have an explicit target date in mind to be mortgage free: before the oldest one goes to college. We are already ahead of the plan by 3 years. If we pay down now, it would be to lower the monthly mortgage amount.
      Thx for offering some other rules/mindsets

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  7. For me, you put one vs another 2 different ideas, both necessary:
    – emergency funds = is a saving for short term events( for me this could cover temporary disability, a job lost, a teeth lost, freezer lost, medical issue for my family)
    – mortgage is a long term saving. Payment down reduce the debt and save the money extra paid to the bank.
    You better compare mortgage down payment with stock investment, who has a better yield ?

    My idea is to keep minimum on emergency fund to feel confortable. But I plan to pay down next spring 18.000 to reduce the mortgage. I estimated that even after payment of penalty, I will pay less 10.000 to the bank, from the total of 15 years. In plus, after this payment I will still have to pay around 70% from the value of the house, so I suppose I can renegotiate the rate to go less, closer to your 1.14% ( now I have 1.8%) and both will reduce my monthly mortgage with 200 ( my estimations).

    Questions:
    1.Because I have no previous experience with mortgage deduction from taxes, do you have experience, if there are affected by a too low value of rate? I could use these 18.000 to better invest… and to pay the mortgage as from actual contract, next 15 years, but to keep the 4.000 taxe deduction every year I live here.
    2. the stock market is down, a good moment to invest. Are you paying any taxes for these? because I reached on the maximum payment of “impôt” and this is ….huge 🙂

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    1. Looks like we have a similar luxury problem.

      The tax advantage on mortgage now depends on where you live. We live in Flanders and we can deduct both principal payments and interest. This way, there is actually no penalty on having a low interest rate. I am not sure what the rules are for Brussels. It is very likely they are similar. The bank should be able to confirm that.
      point 2 is not so clear to me.

      Liked by 1 person

      1. yep, I used same term: luxury dilemma 🙂
        We live in …Zaventem, the apartment and my taxes are in Zaventem, Brussels starts on the other side of the street. We searched in Flanders area just because 10% registration fees sounds better than 12.5% :).

        For point 2, let’s explain: I asked the bank ( ING) about mortgage down payment and they suggested me to think to invest in the stock market. The values are down now, perfect to start an investment fond. For this scenario, there will be a profit: I will pay taxes for this? – because will cut the yield to a half.

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        1. stocks are down, that is relative. The S&P 500 is almost back at an all time high… Some European stock trackers are indeed “down” but not in a way to call it more than a correction…
          It all depends on the risk tolerance you have, the goal you have, the experience you have…

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          1. I have zero experience; this was the recommendation of the ING consultant. And that’s why I am reading you 🙂 = to learn :).

            My only alternative idea of investment is….. to buy another house with “rente viagère” for 15 years ( I don’t know the english terms); in 15 years I will end my mortgage slowly, close the “rente viagère” , and some extra cash in emergency fund.

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            1. With a rent viagère, you pay as long as the owner lives…Maybe 15 years, maybe 2 years, maybe 25 years… (at least, that is how I understand the concept. a notary can explain. An informative call is for free).
              When it comes to investing, some go rentals, some go stock. There are a lot of flavours.
              With financial advice in general, it is good to do your research. As such, funds are not a bad way to start. They are diversified from the start. Question is: what fund do you buy, how much of your portfolio do you put in there. I would suggest that you look at the portfolios of different bloggers to see what is out there.

              Liked by 1 person

  8. If it were me, your mortgage interest rates are so low, and although I hate debt, if a mortgage/house is going to be your forever home, there is not rush in paying it off that quickly. If you can be patient with the stock market and put your money there for 10+ years, I think that is a better effort for your money

    Liked by 1 person

  9. Super jealous of your mortgage rate!

    Our mortgage will be the last place I start to payoff early – just because the rate is not that bad (for the US) 4.25% and I would rather invest the money right now so it can grow longer.

    I have started to think about our emergency fund, we are getting close to the “magical number” where I will not have to contribute to it every paycheck and can put that money somewhere else.

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  10. 1.14% var is a nice rate, we ended up at around 2.5% fixed after refinancing last year. It’s an interesting dilemma, on one hand it’s nice to see your monthly outlays go down but on the other hand that money could earn a higher return via investing. We did a repayment on our mortgage a couple of years ago, now it’s not really an option anymore as we’re close to the fiscal optimum.

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  11. Hey ATL,
    is it possible for you to have a home equity line of credit on the side? If you can, this would enable you to drop down your debt by using your savings but keep this liquidity (with a $0 balance line of credit linked to the equity on your house) if anything happen.
    Is it possible?
    Cheers,
    Mike

    Like

  12. I’m going to error on the side of caution for an emergency fund. One way to think of it is like a Michael Jordan story I once heard on the golf course. A guy found out he was playing with MJ and his foursome in a celebrity golf tournament, when he met MJ he was thrilled but knew that he gambled on golf and was not in his league financially (not many are). However MJ said to him let’s play for the $1000, the guy said he could not afford this large amount of money. MJ asked him OK what amount would make you feel just a little uncomfortable if you lost the bet? The man responded: $20. So that day they played for $20, the man took every shot very serious, lined up every putt, and was trying his hardest to win.

    Moral of the story, find the amount that makes you feel just a little uncomfortable in your emergency fund and stay at the number.

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  13. Just wondering what you decided to to with this? (Sorry if you’ve covered in in a post somewhere!)
    That’s a very low mortgage rate! In Australia they’re around 3.7-4.9% which is quite low here from a historical standpoint. I think with a mortgage around 1.5% I’d invest any surplus cash (after an emergency fund etc) in the stock market (equities outside my home country perhaps) and use the dividends to pay down the mortgage, or reinvest them. Only once the emergency type funds are above a minimum would I feel comfortable doing that though – I’m quite cautious when in comes to financnes!!

    Like

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