Author Topic: Best of both in the Pay Down Mortgage vs. Invest debate?  (Read 3787 times)

GoodStash BadStache

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Best of both in the Pay Down Mortgage vs. Invest debate?
« on: October 22, 2014, 10:37:19 AM »
Hello,

I'm new to the MMM forum, but have been a regular reader for some time now.  One of the most common debates that seems to come up on this forum and other financial sites is choosing whether to put additional money into paying down a mortgage balance or investing for the future.  Rather than rehashing the high points of each option, I thought I'd see what MMM reader's thoughts are regarding a 3rd option that provides some of the advantages of each strategy.  As a caveat, this primarily applies to those of us that have refinanced down to a low interest rate in the last few years (if you're paying >5% the vast majority should pay the mortgage down).

What I'm doing currently is basically setting aside any extra payments I could make on my mortgage into an intermediate-term or total bond fund.  This gives a more conservative investment portfolio, but still allows you to take advantage of the prevailing low mortgage interest rates.  Once the bond fund balance equals the mortgage balance you could choose to pay off the mortgage or draw down the bond fund to make payments until the mortgage is paid off.  The way I see it, this should appeal to those who would like to pay off their mortgage, but know that the investing math makes more sense.

arebelspy

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #1 on: October 22, 2014, 10:50:47 AM »
Is the return on the bonds greater than your mortgage interest rate?

Many people look at paying off their mortgage as buying a bond with a rate of the mortgage interest rate.

I'd rather let the money grow in equities, especially given the long timeframe (30 years) that's typical of most mortgages.  If the market doesn't return at least 3-4% nominal (aka 0% real or so) over the next 30 years, most people's FIRE plans will be in quite a bit of trouble.
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rpr

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #2 on: October 22, 2014, 11:00:14 AM »
What is the yield of this bond fund? If the after tax yield is less than the mortgage interest rate, then you'd be better off paying the mortgage.

For the last couple of years, I have been investing in a Vanguard stock fund. I have a thirty year mortgage at a 3.5% rate. I am planning to payoff in 20 years. What gets invested in the stock fund is the difference between the thirty year and twenty year payment amounts. My hope is that in twenty years time or sooner, this account balance will exceed the balance of the mortgage and I could be in a position to decide whether to pay this off or not.


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Cheddar Stacker

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #3 on: October 22, 2014, 11:12:19 AM »
What is the yield of this bond fund? If the after tax yield is less than the mortgage interest rate, then you'd be better off paying the mortgage.

+1.

I'd prefer equities for 2 reasons:
1) Theoretically higher return.
2) Lower (Qualified) tax rates and deferred tax payments if held long-term.

Welcome to the forum.

GoodStash BadStache

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #4 on: October 22, 2014, 11:23:37 AM »
Thanks for the replies.  In my case, one factor that I didn't mention is that our mortgage is 2 years into a 15 year note @2.75%.  The bond fund has a distribution yield ranging around 3% currently (2.5% SEC), so based on current distributions the math indicates I'll break even or come out slightly ahead by investing into the bond fund.  In our case, we have other after-tax stock index funds, but consider the bond fund to be "earmarked" to our mortgage.

One other reason I thought this might appeal to people pursuing early retirement is that if you're within a few years of your employment exit date and not planning to sell your house after retiring, once your bond balance matches your mortgage balance you could subtract your mortgage payment from your retirement budget, while maintaining more liquidity in your assets.
« Last Edit: October 22, 2014, 11:28:07 AM by GoodStash BadStache »

Cheddar Stacker

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #5 on: October 22, 2014, 11:32:21 AM »
If you can obtain a bond return that matches or exceeds your mortgage balance, it beats paying down your mortgage since it keeps you more liquid, but I still think stock returns will provide the biggest benefit.

I do think it's a nice conservative play though if that's the way you lean.

One other tax drawback though - you're trading a 2.75% itemized deduction for a 2.5-3% increase in AGI. There are situations where this could be helpful (if you barely exceed the standard deduction and need to keep the mortgage interest), but in most situations increasing your AGI is a losing play. Even if it looks apples to apples you might be slightly losing because this could be create unintended consequences to the rest of your tax return.

GoodStash BadStache

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #6 on: October 22, 2014, 12:15:14 PM »
As it turns out, 2013 was the first year we've taken the standard deduction, but on the flipside we're in municipal bond funds, so our federal AGI doesn't go up either.

One of the reasons I wanted to bring this idea up is that it seems like people seem to lean very hard in either direction (100% mortgage payoff or 100% stocks invested) and I wanted to float out an alternative.  Over almost every intermediate time-frame (10-20 years) stocks have outperformed more conservative asset classes, but when looking at an early retiree I thought it might also be wise to look for ways to limit risk (especially early in retirement).  For some people that might mean adjusting their overall investment mix to a slightly more conservative ratio by buying bonds, rather than reducing mortgage debt.

When looking at the big picture, I guess it boils down to whether you'd be willing to borrow money at your current mortgage rate and if so, how you'd invest it.

arebelspy

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #7 on: October 22, 2014, 12:42:33 PM »
When looking at the big picture, I guess it boils down to whether you'd be willing to borrow money at your current mortgage rate and if so, how you'd invest it.

Absolutely.  I'd sign up - in a second - for a tax deductible long term fixed, non-callable loan at a rate below inflation. That's free money, to me.

Others wouldn't. That's fine too.  But it's worth understanding and making your own decision on, and why.
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rpr

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Re: Best of both in the Pay Down Mortgage vs. Invest debate?
« Reply #8 on: October 22, 2014, 12:53:02 PM »
There is no crystal ball. Nobody knows nothing.

The conventional wisdom is that as you approach retirement then you shift to a more conservative asset allocation. Reducing mortgage debt is indeed the same as reducing equity allocation.

I'm happy with my fixed income funds inside tax deferred retirement accounts and have my taxable accounts contain equities which get preferential tax treatments.

Things can be slightly more involved if you are already retired and cannot add to tax-advantaged accounts. But if you already have a large enough stash in both taxable and tax advantaged, money can be easily moved between stocks and bonds. This may not be easily possible if the accumulations in the taxable/tax-advantaged are different.

In the end, it doesn't matter. Do whatever lets you sleep better!!