Mortgage Math and FI Date

[battling-hedonism]

Hi there! I keep a spreadsheet of my expenses and have totaled what those monthly numbers would be with and without my mortgage paid off.

The piece I'm struggling with is that I thought I knew that mathematically I should NOT pay off the mortgage since its only a 3.25% rate, but the numbers below indicate that I could FI right now if I pay off the mortgage or be not even close to FI if I don't pay it off. How does that make sense?

To give clear numbers, my mortgage is $890k (California). I earn $2225 in rent for a back unit per month separately. After factoring in the rent I receive, my expenses per month are roughly $6,500 with the mortgage, and about $2,000 with the mortgage paid off. Those non mortgage expenses are a little too high but that's another topic entirely, I'll work on that. Anyway, using a 3% rule, the resulting FI number to cover those expenses is over 2.5 Million with the Mortgage and only $805,000 without the mortgage. That's a much bigger difference than the $893K mortgage itself. I currently have 1.8 million dollars in investments. That means I don't have enough to FI with the mortgage, but if I paid off the 890K I magically have enough? What am I doing wrong here?

[Morning Glory]

You are treating the mortgage as if it goes on forever.  One if the calculator sires (cFIRE sim maybe???) has an option for "extra expense " for a limited period of time. Perhaps an easier way to do this is to have (enough to FI without the mortgage + enough to pay off the mortgage) in an investment account,  which for you would be ~1.7M.

Please note this is for PI only. Make sure that your property tax and insurance is included with your regular expenses,  not your mortgage,  for this purpose.

[swashbucklinstache]

Agreed. Your principal and interest won't increase with inflation. Maybe more importantly, you may not want to think of 3% as appropriate for the mortgage because you don't need to have any money left over when it is gone and it's not an indefinite cost. These together plus a low fixed rate suggest something like the balance of the mortgage invested, even in TIPS, might be what you're after for PITI depending on the relevant PI vs TI. That's philosophically and in practice I recommend what morning glory says below.

[cangelosibrown]

In addition to the other responses, keep in mind that the principal portion of the mortgage isn't actually an "expense." More like forced savings. Your mortgage insists that you're putting ~30k a year into principal payments, but that isn't an argument for spending 895k this year into a principal payment.

[clifp]

In addition to the other responses, keep in mind that the principal portion of the mortgage isn't actually an "expense." More like forced savings. Your mortgage insists that you're putting ~30k a year into principal payments, but that isn't an argument for spending 895k this year into a principal payment.

Very good point.

In the era before crazy low interest rates (2000-2021), the amount of principal paid off in the first 5 or so years, was negligible. So  treating your mortgage as an expense was perfectly reasonable, but with 3% rate that's not the case.  Here is a thought experiment.

Assuming you have a lot of equity, you could get home equity loan on the property.  Each month you withdraw an amount equal to the principal you paid on your first mortgage from your home equity loan, and pay the interest on the home equity loan, and the rest you could spend.  Now assuming you could find a home equity loan, with a 3.25% rate (you can't).   When your mortgage was paid off, you'd have a Home Equity Loan balance of $890K, but you'd have been able to spend a lot of money.

Now I'm definitely not recommending you do this, but conceptually it is a good way of looking at things.  Also for a California or HCOL state a reverse mortgage is a viable plan, if you start to run out of money.

[battling-hedonism]

Thank you guys! That all makes perfect sense. I'm clearly not a math wizard. I was really wrestling with this in my head but you all cleared it up. Much appreciated!

[jsap819]

Hi there! I keep a spreadsheet of my expenses and have totaled what those monthly numbers would be with and without my mortgage paid off.

The piece I'm struggling with is that I thought I knew that mathematically I should NOT pay off the mortgage since its only a 3.25% rate, but the numbers below indicate that I could FI right now if I pay off the mortgage or be not even close to FI if I don't pay it off. How does that make sense?

To give clear numbers, my mortgage is $890k (California). I earn $2225 in rent for a back unit per month separately. After factoring in the rent I receive, my expenses per month are roughly $6,500 with the mortgage, and about $2,000 with the mortgage paid off. Those non mortgage expenses are a little too high but that's another topic entirely, I'll work on that. Anyway, using a 3% rule, the resulting FI number to cover those expenses is over 2.5 Million with the Mortgage and only $805,000 without the mortgage. That's a much bigger difference than the $893K mortgage itself. I currently have 1.8 million dollars in investments. That means I don't have enough to FI with the mortgage, but if I paid off the 890K I magically have enough? What am I doing wrong here?

The way I calculate my number is my expenses without the mortgage at 3-4% SWR plus the balance of your mortgage. So you say your expenses is about $2k after your rental income. At 3% SWR, your number comes to about $800k. Add your mortgage balance of $895k and your number is a little under $1.7 million.

Since your mortgage rate is currently 3.25% with however many years remaining, you only need to beat that rate yearly until the mortgage balance is $0. As of this typing, 30 year treasury is yielding 4.67%. Technically you would invest the $895k, let's call this your Mortgage Payoff Fund,  into something like that and just withdraw the monthly mortgage payment for the next 30 years. After the mortgage is paid off, you'd still have a good chunk of money left over to do whatever you want with it since you were beating your rate .

Then your expenses I'd withdraw your $2k/month from $800k separate from your mortgage payoff fund. This is the basic gist of it. Hopefully you get an idea of why most people (like me) just add the mortgage balance to our retirement expense number. Don't forget to include taxes into this.

[VanillaGorilla]

Hi there! I keep a spreadsheet of my expenses and have totaled what those monthly numbers would be with and without my mortgage paid off.

The piece I'm struggling with is that I thought I knew that mathematically I should NOT pay off the mortgage since its only a 3.25% rate, but the numbers below indicate that I could FI right now if I pay off the mortgage or be not even close to FI if I don't pay it off. How does that make sense?

To give clear numbers, my mortgage is $890k (California). I earn $2225 in rent for a back unit per month separately. After factoring in the rent I receive, my expenses per month are roughly $6,500 with the mortgage, and about $2,000 with the mortgage paid off. Those non mortgage expenses are a little too high but that's another topic entirely, I'll work on that. Anyway, using a 3% rule, the resulting FI number to cover those expenses is over 2.5 Million with the Mortgage and only $805,000 without the mortgage. That's a much bigger difference than the $893K mortgage itself. I currently have 1.8 million dollars in investments. That means I don't have enough to FI with the mortgage, but if I paid off the 890K I magically have enough? What am I doing wrong here?

Yup, that's generally how it works - carrying a mortgage into retirement increases sequence of returns risk.

The problem is principle - even with a 3% mortgage your monthly principle and interest is a 5% withdrawal rate. This is ameliorated somewhat by US mortgages being fixed, so it doesn't offer the same failure rates of a true 5% withdrawal rate. CFireSim allows you to model a fixed expense that's not inflation indexed, and shows a 3% mortgage being not unduly risky compared to a 4% withdrawal rate.

ERN simulated this question nicely, though the limitation is that he modeled inflation fixed at 2%: https://earlyretirementnow.com/2017/10/11/the-ultimate-guide-to-safe-withdrawal-rates-part-21-mortgage-in-retirement/

These days, given that bond yields are higher than your mortgage rates, you could hold a bunch of varying-duration bonds to cover your mortgage, though then you have to watch out for tax consequences and cash flow. Potentially you'd have a headache balancing tax advantaged vs taxable accounts.

The pro-mortgage crowd and anti-mortgage crowds here are both pretty vociferous, though I don't see a huge difference between them. If you're risk-tolerant and complexity-tolerant, and/or willing to consider future employment, carry a loan, but watch for taxes. If you're risk averse or simplicity-prone, wait until you have your FI number + mortgage balance in investments, then pay off your mortgage and retire.