Author Topic: The old pay down mortgage versus invest debate.. one aspect seems overlooked  (Read 18195 times)

westcoaster

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One aspect of the "pay down mortgage versus invest in the market" debate that I don't see addressed very often is how much time someone has left on their mortgage. If someone has 3 years left on their mortgage, I would think it's more likely that over that 3 year span the market may deliver a worse return than if you had paid down your mortgage. But if you have 29 years left on your mortgage, isn't it much more likely that investing the money would generate a higher return over than 29 year period? I haven't done any hard analysis on this, but I would think if we looked at what's happened in the past, there would be more times that a 3 year period in the market failed to deliver a 4% return than a 29 year period.

What do folks think about this? Why isn't this addressed as often as I think it should? Maybe it goes without saying? Or maybe I'm missing something?



 

boarder42

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you refinance or move and get a 30 year at today's rates. 

now you have 30 years left.

birdman2003

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I think it is overshadowed by the debate on personal sense of risk involved with letting debt hang around to invest in the market (i.e. if you owned your house without a mortgage, would you borrow against it to invest in the market?).

If you would borrow money against a paid-off house to invest in the market and get a mathematically higher rate of return, then you would probably be fine with making your monthly mortgage payment and investing the rest.

If you would NOT borrow money against a paid-off house to invest in the market because it feels risky, then you would probably be better off paying off the mortgage early instead of investing.

For me, I am investing in a separate account and once the account balance matches my mortgage I will liquidate and kill the death-pledge (mort = death, gage = pledge).

nereo

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I don't think that aspect has been 'missed' in the may threads on paying down your mortgage, but it certainly is worthwhile to consider.

It's just another variation on "opportunity cost".  If you have the ability to axe your mortgage in ~2 years with additional earnings your opportunity cost might be very small (or even negative, if the markets go down).  If paying down your mortgage takes longer - say 12 years, the opportunity costs an be huge.

It should be noted that this ties directly into how much you can save each month, not into total savings available.  For example, I could axe my mortgage now but it might take me 10 years to replenish those savings.  Consequentially, it isn't worth it (to me) to get rid of my mortgage but I expect the opportunity cost of loosing the growth from those savings to exceed what I could do with no mortgage.
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cawiau

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We have 29 years left on our mortgage at 3.75%. Mortgage payment (interest+principal+property taxes + insurance) is less than 20% of our gross income.

Sometimes we daydream about paying it off early (6-8 years) but then wake up. Same goes for my wife car note at 0%... We hate making monthly payments, but at 0% why rush paying it off.

Having the cash on hand (taxable account/savings) seems to offer us more options for now)


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Exflyboy

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

maco

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Something else related that came up on another thread recently, is that my mortgage is at least half of my monthly spending. My FIRE number would be way lower if I paid off the mortgage, and the difference in FIRE numbers is larger than the balance of the mortgage.

ReadySetMillionaire

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We have 29 years left on our mortgage at 3.75%. Mortgage payment (interest+principal+property taxes + insurance) is less than 20% of our gross income.

Sometimes we daydream about paying it off early (6-8 years) but then wake up. Same goes for my wife car note at 0%... We hate making monthly payments, but at 0% why rush paying it off.

Having the cash on hand (taxable account/savings) seems to offer us more options for now)


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GF and I are in a similar boat.  We make about $9k gross per month and bought a small ranch and now have an $860 mortgage payment.  We dream about paying it off early (could probably do it in 6-8 years as well) but I think we are going to up our payment to $1000 per month (i.e., an extra $140 per month). It seems like a good balance of paying it off early (should erase 10-12 years from the mortgage) and not getting too crazy within paying it off at the expense of socking away money in other accounts.
« Last Edit: December 10, 2015, 09:25:47 AM by ReadySetMillionaire »

MDM

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...there would be more times that a 3 year period in the market failed to deliver a 4% return than a 29 year period.
True statement.

From a risk analysis perspective, a related question would be whether the percentage of times a 3 year period in the market returns >4% (or whatever the mortgage rate) is >50% or not.  Given the market increases >4% in an average year, I've assumed the chances are >50% that the market will increase >4% CAGR over 3 years, but data would beat an assumption.

Although we're firmly in the camp that says "play the odds and invest rather than pre-pay," for full disclosure we did pay our last mortgage early - a full six months early.  We got a windfall, and we used exactly the OP's logic that, in such a short time frame, the odds were ~50/50 on investments beating the mortgage rate so we took the sure thing.  Had we still had a year or three to go we probably would have invested.  YMMV.

MDM

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Something else related that came up on another thread recently, is that my mortgage is at least half of my monthly spending. My FIRE number would be way lower if I paid off the mortgage, and the difference in FIRE numbers is larger than the balance of the mortgage.
If by "FIRE number" you mean "25 times (ongoing expenses that increase with inflation)" the mortgage payment does not belong inside the parentheses, for two reasons.  First, it isn't ongoing and second, it does not increase with inflation.

You might calculate your FIRE number as "25 times (ongoing expenses that increase with inflation) plus (remaining mortgage principal)" - how do things look if you go that route?

boarder42

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Can you guys not understand the simple simple math here. Even if your mortgage is half your expenses. Putting money towards principal doesn't help you fire any earlier. It make it later. Especially if you aren't maxing tax advantaged accounts.

It's purely emotional. If you want to pay it off pay it off but be truthful to yourself and know you're paying it off to give yourself a false feeling of comfort.

Basically you're just doing what TSA does at airports to yourself. Giving your self a false feeling of being safer. You're actually more unsafe.

Exflyboy

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Can you guys not understand the simple simple math here. Even if your mortgage is half your expenses. Putting money towards principal doesn't help you fire any earlier. It make it later. Especially if you aren't maxing tax advantaged accounts.

It's purely emotional. If you want to pay it off pay it off but be truthful to yourself and know you're paying it off to give yourself a false feeling of comfort.

Basically you're just doing what TSA does at airports to yourself. Giving your self a false feeling of being safer. You're actually more unsafe.

Well that depends.. if your disaster plan (i.e you lose your job and will lose your house) is to pay the 10% penalty to get at your 401k plans then yes I might agree.. But remember in a deep recession stocks are in the toilet and you could very easily lose your job and your home

boarder42

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stock armageddon oh ok b/c owning a home during that time will be worth something...

if you're planning a retirement based off of index funds then you may as well save down to a 2% SWR if you're going to pay off your house first b/c the same logic of stock armegedon i need to pay off my house applies to the fact that a 4% SWR wont work.  and you're gonna need to be in 100% bonds. 

fa

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We paid off our mortgage some 15 years ago.  The joy of no monthly payments, the knowledge that we own our home outright and certainty that loss of income would be a far smaller problem....PRICELESS (to borrow a  Mastercard ad).  No amount of calculation of opportunity cost on a spreadsheet compares to the feeling of waking up feeling secure.  You can't really put a price on peace of mind.

As for the opportunity cost of paying off the mortgage...  Well, nobody knows.  The next 20 years may be nothing like the last 20.  No amount of retrospective studying will guarantee you a ROI higher than the mortgage going forward.  You know for sure what your ROI is when you pay off that mortgage.

boarder42

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We paid off our mortgage some 15 years ago.  The joy of no monthly payments, the knowledge that we own our home outright and certainty that loss of income would be a far smaller problem....PRICELESS (to borrow a  Mastercard ad).  No amount of calculation of opportunity cost on a spreadsheet compares to the feeling of waking up feeling secure.  You can't really put a price on peace of mind.

As for the opportunity cost of paying off the mortgage...  Well, nobody knows.  The next 20 years may be nothing like the last 20.  No amount of retrospective studying will guarantee you a ROI higher than the mortgage going forward.  You know for sure what your ROI is when you pay off that mortgage.

so where do you expect your retirement money to come from.  sunshine and rainbows?  the general premise behind early retirement is an SWR of around 4% with funds invested in equities (sure there are other ways to get there, but thats what most are doing)

you have a false sense of security and a false peice of mind thats what every mathematical, logical answer points to. 

so pay it off just make sure you know its illogical and just a false sense of security similar to TSA b/c you're actually less secure.

nereo

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We paid off our mortgage some 15 years ago.  The joy of no monthly payments, the knowledge that we own our home outright and certainty that loss of income would be a far smaller problem....PRICELESS (to borrow a  Mastercard ad).  No amount of calculation of opportunity cost on a spreadsheet compares to the feeling of waking up feeling secure.  You can't really put a price on peace of mind.

As for the opportunity cost of paying off the mortgage...  Well, nobody knows.  The next 20 years may be nothing like the last 20.  No amount of retrospective studying will guarantee you a ROI higher than the mortgage going forward.  You know for sure what your ROI is when you pay off that mortgage.

so where do you expect your retirement money to come from.  sunshine and rainbows?  the general premise behind early retirement is an SWR of around 4% with funds invested in equities (sure there are other ways to get there, but thats what most are doing)

you have a false sense of security and a false peice of mind thats what every mathematical, logical answer points to. 

so pay it off just make sure you know its illogical and just a false sense of security similar to TSA b/c you're actually less secure.
@ boarder42 - while I generally agree with what you are saying, I don't think there is a need to drag the TSA into a discussion about paying down a mortgage vs investing debate.  Can we keep it on topic?  Thanks.

justajane

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

nereo

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We paid off our mortgage some 15 years ago.  The joy of no monthly payments, the knowledge that we own our home outright and certainty that loss of income would be a far smaller problem....PRICELESS (to borrow a  Mastercard ad).  No amount of calculation of opportunity cost on a spreadsheet compares to the feeling of waking up feeling secure.  You can't really put a price on peace of mind.

As for the opportunity cost of paying off the mortgage...  Well, nobody knows.  The next 20 years may be nothing like the last 20.  No amount of retrospective studying will guarantee you a ROI higher than the mortgage going forward.  You know for sure what your ROI is when you pay off that mortgage.
Your statement that "you know for sure what your ROI is when you pay off that mortgage" is not accurate because it ignores inflation.  Yes, paying off a mortgage at 4% is equivalent of getting a 4% nominal return, but what's really important is the real return.  Given that the average inflation over the past 5 years has been <2% it's easy (but foolish) to ignore inflation altogether and forget that 3% is closer to the norm and decades with 5%+ have occurred in the last century.  Ergo, the ROI on paying down a 4% mortgage is anything but 'known for sure.'  It's likely the real ROI is in the -1%  to +2% range... not very good at all.

You've experienced some positive psychological benefits from paying down your mortgage faster - that's great, and shouldn't be under-estimated. But those benefits don't extend to everyone.  To each their own...

arebelspy

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

Also I'd rather have 200k (or whatever your mortgage balance was) in the bank during financial problems, and use that to pay the mortgage, or opt not to, if that's the better decision.

Even having it fully paid off, I'd rather have liquid cash in times of trouble than a paid off home.

Think of it this way: You lose your job, are broke, and someone offers you 200k or a paid off 200k house.  Which do you take?  I'm sure taking the former.
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DividendMoney

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If you would NOT borrow money against a paid-off house to invest in the market because it feels risky, then you would probably be better off paying off the mortgage early instead of investing.

For me, I am investing in a separate account and once the account balance matches my mortgage I will liquidate and kill the death-pledge (mort = death, gage = pledge).

This is exactly what I did.

Even if you want to pay down your mortgage faster, you shouldn't destroy your liquidity by making extra payments. Invest until you can wipe out the monthly cash flow requirement. 

This hybrid approach is the best IMHO because you get the 'advantage of investing in the markets' until you can eliminate your monthly cash outflow requirement (mortgage payment) AND you don't pinch your liquidity in the meantime - in case of a major market event or personal crisis.

ETA: I immediately secured a HELOC against my paid off home (Which has had a Zero balance since, but it's nice to know it's there in case of Emergency or opportunity.)
Also note: I did not use all of my investments to retire the mortgage. All of my tax deferred accounts remained untouched. This was unregistered investment account money only.
« Last Edit: December 10, 2015, 07:43:33 AM by DividendMoney »

justajane

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

Also I'd rather have 200k (or whatever your mortgage balance was) in the bank during financial problems, and use that to pay the mortgage, or opt not to, if that's the better decision.

Even having it fully paid off, I'd rather have liquid cash in times of trouble than a paid off home.

Think of it this way: You lose your job, are broke, and someone offers you 200k or a paid off 200k house.  Which do you take?  I'm sure taking the former.

I agree completely. The only thing skewing our future calculations is college and the FAFSA game. If we have X amount in taxable investments, this will be counted against us in the formulas, but if it's in your primary residence or retirement? Doesn't count.

nereo

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If you would NOT borrow money against a paid-off house to invest in the market because it feels risky, then you would probably be better off paying off the mortgage early instead of investing.

For me, I am investing in a separate account and once the account balance matches my mortgage I will liquidate and kill the death-pledge (mort = death, gage = pledge).

This is exactly what I did.

Even if you want to pay down your mortgage faster, you shouldn't destroy your liquidity by making extra payments. Invest until you can wipe out the monthly cash flow requirement. 

This hybrid approach is the best IMHO because you get the 'advantage of investing in the markets' until you can eliminate your monthly cash outflow requirement (mortgage payment) AND you don't pinch your liquidity in the meantime - in case of a major market event or personal crisis.

That's certainly one strategy.  I favor just keeping the mortgage and the savings - especially at current mortgage rates.  My parents set up a 'mortgage investment account' similar to what you are describing.  The seperation of money was just mental accounting.  After a little more than a decade they had enough to pay down their home, but left it alone.  They refinanced when rates dropped and pulled equity from the home into the 'mortgage investment account'.  Now, 35 years after moving into their home they have about 20 years left on their mortgage and an account that has about 3x the value of the house (not just the remaining mortgage).  That's on top of their 'normal' retirement accounts.

Every so often it's mentioned that 'hey, you could just eliminate the mortgage and free up cashflow' but the answer always comes back to 'but why would we do that?'  Even at a conservative 3% WR they could cover the monthly payments several times over.  They have a good inflation hedge for the next 20 years and a home in a desirable area that's outpaced inflation by a fair bit over the last three decades.

There's different strategies for everyone.

elaine amj

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

I wish I had thought of that. That would have been a nice compromise. We did only put in the extra money as a lump sum once a year, so that gave us a year of liquidity. Oh well, when we finally decided to attack our mortgage, it really only took us 5-7 years. We'll be done by next summer.

DividendMoney

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There's different strategies for everyone.

Agreed, for sure.

I'll admit that my views are skewed due to the fact that my parents lost their business and our home when my Dad got sick. I was in Grade School at the time.  It's made me a very conservative person... great saver, but not a user of leverage for investing.

To each their own.

ReadySetMillionaire

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Can you guys not understand the simple simple math here. Even if your mortgage is half your expenses. Putting money towards principal doesn't help you fire any earlier. It make it later. Especially if you aren't maxing tax advantaged accounts.

It's purely emotional. If you want to pay it off pay it off but be truthful to yourself and know you're paying it off to give yourself a false feeling of comfort.

Basically you're just doing what TSA does at airports to yourself. Giving your self a false feeling of being safer. You're actually more unsafe.

Posters here frequently take complicated decisions and oversimplify them into black and white issues. It honestly feels like we're debating gun rights, abortion, healthcare, etc., when in fact, all of these issues require an extremely nuanced and detailed inspection of evidence and reason.

Instead of debating political issues on here, it's things like buy vs. rent, pay down mortgage or invest, have cable TV or don't, bike to work or you're an idiot, etc. This is all very complicated stuff and applies to each person individually. It's not black and white.

Thus, I get pretty agitated with condescending posts like the one quoted above. You have no idea what that person's financial situation is, you have no idea how they grew up, their family situation, etc. You also discount the emotional and personal aspect of PERSONAL finance as if humans are supposed to be robotic calculators removed from emotion. They're not.

Take me, for example. My parents got divorced when I was 18 (ten years ago). They are now 60 and each have $125k left on their mortgages. Were (or are) they mustachian? No. But I've seen how the process of refinancing and taking out HELOCs has negatively affected them beyond description. They are both going to have to work until they are 70.

Meanwhile, my GF's parents have a paid off home. They paid it off about 5 years early by paying like $50 more per month. GF's dad is basically retired (does accounting on the side) and her mom still works because she loves her job.

So my own personal observation of seeing my parents pay on a mortgage for the last 35 years has led me to strongly, strongly, strongly want a paid off home when I'm ready to retire. You can sit here all you want and say NUMBERS NUMBERS NUMBERS. I really don't care.

Now am I going to go crazy paying it off ? No. Tax refunds, bonuses, etc. are going to go in a tIRA, 529, or money market account of some type and thus increase our savings rate. We plan to just pay about an extra $140/month. That number is based on having the house paid off by the time I want to FIRE (45). Not having a mortgage payment means that my COL will be lower for retirement, thus meaning I don't need to save as much for retirement.

Sure, $140/month for 18 years is almost $30,000 cash. And if I put that $140/month into a tIRA and let it grow for 18 years I'd have $50,000.

Wahoo. Yippee. If things go to plan I will have at least $993k invested by then with a yearly expenditure of around $35k (3.5% withdrawal rate).

Is that calculation cut and dry? Of course not. Is it likely to change? Of course. And I totally expect smarter people than me to post OMG YOU'RE WRONG CHECK OUT THIS CALCULATION.

But both my GF and I want our house paid off when I retire. Simple as that. Go ahead and show me a calculation that I'm losing out on $10 or $20k or whatever in possible gains. It doesn't matter to us.

One last thing, and it leads back to my first point: this community gets so lost in the tiny details that it completely loses track of how just doing the big things right puts you ahead of 90% of the pack. 50% savings rate, taking advantage of tax advantaged accounts, having an emergency fund, driving paid off used cars and living close to work, on and on--that means you're doing really good.

The small decisions of where the extra money after that goes is nothing more than the personal side of personal finance. And if someone else's small decisions (i.e., what to do with $140/month) makes you think they are dumb, you need to relax.
« Last Edit: December 10, 2015, 11:18:03 AM by ReadySetMillionaire »

nereo

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One last thing, and it leads back to my first point: this community gets so lost in the tiny details that it completely loses track of how just doing the big things right puts you ahead of 90% of the pack. 50% savings rate, taking advantage of tax advantaged accounts, having an emergency fund, driving paid off used cars and living close to work, on and on--that means you're doing really good.

True dat.  Kudos to anyone that's put them in the financial situation where they have to decide between paying down a mortgage really, really early or saving a very large chunk of their wealth each year.
Either choice puts you on firm financial footing and on the road to financial independence.

frugaliknowit

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To answer Westcoaster's question:  Yes, I do believe the length of time left on your mortgage should affect your decision making.  Yes, I believe the shorter the amount of time left, everything else being equal, the less potential opportunity cost to prepaying the mortgage.

In my case, if I don't prepay, my mortgage (4%, providing little, if any tax benefit) runs 10 years.  My employer no longer offers a 401K.  I've built up large cash reserves (don't need to add any more) and fully fund my Roth.  It only makes sense that I should throw a good chunk of savings at the mortgage, which if all goes well, will be gone in 5 years instead of 10.
« Last Edit: December 10, 2015, 11:15:05 AM by frugaliknowit »

maco

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Something else related that came up on another thread recently, is that my mortgage is at least half of my monthly spending. My FIRE number would be way lower if I paid off the mortgage, and the difference in FIRE numbers is larger than the balance of the mortgage.
If by "FIRE number" you mean "25 times (ongoing expenses that increase with inflation)" the mortgage payment does not belong inside the parentheses, for two reasons.  First, it isn't ongoing and second, it does not increase with inflation.

You might calculate your FIRE number as "25 times (ongoing expenses that increase with inflation) plus (remaining mortgage principal)" - how do things look if you go that route?
When I asked another friend who's into FIRE how she was going to handle her mortgage, her answer was that the mortgage is just part of ongoing expenses, and then 20 years into early retirement when the mortgage finally runs out, hey, great the available budget space increases a bunch.

I asked her because I was trying to figure out "well it'll take 8% withdrawals for 15 years then 4% after that, so what's that mean the starting number has to be?"

MDM

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I asked her because I was trying to figure out "well it'll take 8% withdrawals for 15 years then 4% after that, so what's that mean the starting number has to be?"
Good for you!  It appears you have a good instinct for getting past the generic rules of thumb and looking to understand better.

Quote
When I asked another friend who's into FIRE how she was going to handle her mortgage, her answer was that the mortgage is just part of ongoing expenses....
Except it really isn't.  Under certain circumstances (say, 29 years left on the mortgage and no inflation occurs in those 29 years) one can indeed treat the mortgage as "just part of ongoing expenses."  The shorter the time left on the mortgage and the more likely inflation will occur, however, the more that treatment is not correct.

One could even suggest calculating your FIRE number as "25 times (ongoing expenses that increase with inflation) plus (remaining mortgage principal)" is too conservative (because investments will return more than the cost of paying down the mortgage principal), but using the KISS principle the equation as stated seems reasonable.

See http://forum.mrmoneymustache.com/welcome-to-the-forum/trying-to-get-a-better-understanding-of-that-'25-times-annual-spending'-rule/ for more on this.
« Last Edit: December 10, 2015, 02:22:13 PM by MDM »

Rubic

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If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

100% agree.  I have a friend who's been overpaying his 3% mortgage every month for the past 2 years.  He's in good financial shape overall, but struggling now with short-term cash flow.  He regrets his decision.


slugline

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Aggressively paying down a low-interest mortgage is like a choice to concentrate your financial holdings in a single piece of real estate. I do understand the emotional appeal of owning one's place outright, but diversification helps me sleep better.  Liquidity helps me sleep better.

DividendMoney

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Aggressively paying down a low-interest mortgage is like a choice to concentrate your financial holdings in a single piece of real estate. I do understand the emotional appeal of owning one's place outright, but diversification helps me sleep better.  Liquidity helps me sleep better.

At least you know who the tenant is... and if they can afford the 'rent'. :)

maco

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I asked her because I was trying to figure out "well it'll take 8% withdrawals for 15 years then 4% after that, so what's that mean the starting number has to be?"
Good for you!  It appears you have a good instinct for getting past the generic rules of thumb and looking to understand better.

Quote
When I asked another friend who's into FIRE how she was going to handle her mortgage, her answer was that the mortgage is just part of ongoing expenses....
Except it really isn't.  Under certain circumstances (say, 29 years left on the mortgage and no inflation occurs in those 29 years) one can indeed treat the mortgage as "just part of ongoing expenses."  The shorter the time left on the mortgage and the more likely inflation will occur, however, the more that treatment is not correct.

One could even suggest calculating your FIRE number as "25 times (ongoing expenses that increase with inflation) plus (remaining mortgage principal)" is too conservative (because investments will return more than the cost of paying down the mortgage principal), but using the KISS principle the equation as stated seems reasonable.

See http://forum.mrmoneymustache.com/welcome-to-the-forum/trying-to-get-a-better-understanding-of-that-'25-times-annual-spending'-rule/ for more on this.
Thanks. That makes sense.

I'm only 2 years into my mortgage so it sure does seem ongoing at this point, though! (And that friend is looking at FIRE in about 5-7 years and bought her current house earlier this year) I have been making extra payments to knock off the PMI, so I think I've actually got 25 years left on the mortgage based on the extra I've paid.

MDM

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...I have been making extra payments to knock off the PMI
PMI is a different story.  Paying enough to get rid of PMI often satisfies both the mathematically and emotionally inclined - go for it!

RyanAtTanagra

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... You also discount the emotional and personal aspect of PERSONAL finance as if humans are supposed to be robotic calculators removed from emotion. They're not.

Take me, for example. My parents got divorced when I was 18 (ten years ago). They are now 60 and each have $125k left on their mortgages. Were (or are) they mustachian? No. But I've seen how the process of refinancing and taking out HELOCs has negatively affected them beyond description. They are both going to have to work until they are 70.

Meanwhile, my GF's parents have a paid off home. They paid it off about 5 years early by paying like $50 more per month. GF's dad is basically retired (does accounting on the side) and her mom still works because she loves her job.

I just wanted to back up this poster.  I've seen a similar thing with my parents (divorced and remarried when I was young).  My Dad got a 20yr mortgage which they paid off in 15, about the time he retired at 55.  My Mom got a 30yr and kept taking out equity as the value of the house tripled over the next 15 years, doing repairs and renovations, then got divorced, housing prices fell, can't sell the house, and will be working until 70 most likely, and not by choice.

Now obviously the mortgage choices weren't the only things going on financially, but it signified the overall relationship with money, and I can't imagine how much easier my Mom's life would be right now if that house was paid off instead of having taken out more and more equity.

I 100% understand the math behind it, but I still plan to time paying off my mortgage (though first I have to get one) at the same time I FIRE.  Like the poster above said, this is PERSONAL finance, and this is your HOME, not an investment property.  A home is somewhere you should feel happy, safe, and secure.  For some, that is hindered by having a mortgage hanging overhead.  It's not all about numbers.

boarder42

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^^^ what your mom did is not what the debate is over. Pulling money out of a house to renovate is not the debate. If she pulled it out and invested it. She likely could have walked away from it and been in a better place than before.

RyanAtTanagra

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^^^ what your mom did is not what the debate is over. Pulling money out of a house to renovate is not the debate. If she pulled it out and invested it. She likely could have walked away from it and been in a better place than before.

Agreed.  Unfortunately people rarely do that.  Just adding to ReadySetMillionare's explanation of why the early mortgage repayment decision isn't just about numbers.  It's like the SWR, asset allocation, and cash reserves questions.  We can talk about the math till the cows come home, but sometimes it's whatever makes you sleep best at night.  For a lot of people, a paid off house does that.

alsoknownasDean

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The view I've got, is that if I invest it into x, I have to pay tax on the proceeds. If I pay off the mortgage, I'd get a guaranteed 'return' of y% per annum.

$100,000 paid off a 4.5% mortgage is a guaranteed $4500 a year interest saving. $100,000 into an investment that generates a return of 7% would bring in $7000 a year, but one may have to pay income tax on that (or capital gains, depending on the investment). Depending on the marginal tax rate, it might be better off to pay the mortgage off, especially if the market isn't growing much.

Although, of course, there's CGT discounts and franking credits and the like which I haven't taken into account.

boarder42

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The view I've got, is that if I invest it into x, I have to pay tax on the proceeds. If I pay off the mortgage, I'd get a guaranteed 'return' of y% per annum.

$100,000 paid off a 4.5% mortgage is a guaranteed $4500 a year interest saving. $100,000 into an investment that generates a return of 7% would bring in $7000 a year, but one may have to pay income tax on that (or capital gains, depending on the investment). Depending on the marginal tax rate, it might be better off to pay the mortgage off, especially if the market isn't growing much.

Although, of course, there's CGT discounts and franking credits and the like which I haven't taken into account.

there are quite a few math issues here ... hopefully MDM can explain them but you can also look above to the explanation of why a 4% mortgage is actually close to a 1-2% real return on investment and in recent years has actually been negative due to super low inflation

MDM

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The view I've got, is that if I invest it into x, I have to pay tax on the proceeds. If I pay off the mortgage, I'd get a guaranteed 'return' of y% per annum.

$100,000 paid off a 4.5% mortgage is a guaranteed $4500 a year interest saving. $100,000 into an investment that generates a return of 7% would bring in $7000 a year, but one may have to pay income tax on that (or capital gains, depending on the investment). Depending on the marginal tax rate, it might be better off to pay the mortgage off, especially if the market isn't growing much.

Although, of course, there's CGT discounts and franking credits and the like which I haven't taken into account.

there are quite a few math issues here ... hopefully MDM can explain them but you can also look above to the explanation of why a 4% mortgage is actually close to a 1-2% real return on investment and in recent years has actually been negative due to super low inflation

Yes, math issues (including different tax laws among countries).  In the US, depending on income, marital status, and other itemizable deductions, the $4500 can be "worth" anywhere from the full $4500 (e.g., not itemizing at all) down to ~$2700 or so (e.g., losing the itemized deduction while paying ~40% marginal tax).  Similarly, the $7000 can be "worth" anywhere from the full $7000 (e.g., all LTCG & QD taxed at 0%) down to ~$4200 or so (e.g., paying that ~40% marginal tax).

The net values of each tend to move together.  It would be highly unusual, e.g., to not itemize (and save the full $4500) while paying 40% marginal tax on the $7000.  Likewise, if one is itemizing while paying 40% marginal tax, there will be also some tax on the $7000.

Thus each situation should be analyzed on its own merits.  For a first approximation, however, comparing the expected investment return rate to the mortgage interest rate and putting your money toward the higher one is a reasonable approach.  The closer the two rates are to each other, the less likely there will be any significant difference in outcome even when analyzed exactly.

Trimatty471

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

Where do you put your mortgage payoff fund?
If it is in your taxable account, How do you decrease the amount you owe in taxes?

Less

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Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.


I feel this bit is often glossed over. making good returns on any investment is usually dependent on having the luxury of being able to choose your exit time. If your forced to foreclose, or forced to sell shares in a down market you are going to loose.

boarder42

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And don't forget the "personal risk".. I.e what if you lost your job while you still had that mortgage outstanding.... Would that mean you'd lose your house?

Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.

This is precisely why I went after the mortgage first, sure, mathematically it wasn't the best, but heck as long as I could meet the $2000 a year RE tax payment I would at least not be on the street.

But your logic only applies if you pay of the mortgage in full. If you're hypothetically throwing $400 a month into a long mortgage, that money would serve you better in the market in the event of a job loss.

If you can't pay your mortgage, the bank isn't going to care one whit that you prepaid 10K over the past five years. They will still take your house. How much nicer would it be to have that 10K to pay your mortgage when you lose your job? That's the real security.

That's the reason to have a mortgage pay-off fund rather than prepaying.

Where do you put your mortgage payoff fund?
If it is in your taxable account, How do you decrease the amount you owe in taxes?

You save more tax money claiming the interest as a deductible than you would lose on the gains when you paid down your mortgage.

In the US at TODAYS mortgage rates it is

1 less safe to put money towards a mortgage vs taxable account
2 costs you a few years on your retirement.

No one has Mathematically proven safety or earlier retirement by choosing to pay down their mortgage based on the current US conditions. If you pay down your mortgage you're doing it to feel better but are actually worse off in the long run.

You get the "but what if the market doesn't perform like it has for the next 30 years" argument. But if that's how you feel you're in the wrong forum and likely won't retire early. If you believe this then the premise of retiring early makes no sense.

Then you'll get the real estate investors who say they don't rely on the stock market. Well if you're investing in real estate the correct way it would serve you better to invest that extra capital in more houses to rent than your own mortgage.

As justajane said the ONLY way paying down your mortgage MAY be safer would be a lump sum payoff.

You're going to be less safe by pumping money into a mortgage over time than the guy investing over the same time.

It's just logic. Read my above posts if you want more insight into it.

boarder42

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Specially bearing in mind that most job losses occur during recessions, the same time the market is in the toilet, so your investments may not pay off the mortgage to allow you to keep a roof over your head.


I feel this bit is often glossed over. making good returns on any investment is usually dependent on having the luxury of being able to choose your exit time. If your forced to foreclose, or forced to sell shares in a down market you are going to loose.

This too is pretty incorrect. You don't time market entry just like you don't time your exit. Market timing requires a crystal ball no one owns.

Regardless withdrawing money from a down market when laid off in a recession is better than having pumped that into your house NC the bank doesn't care if you made extra payments if you can't pay them now they will take it.

tobitonic

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We paid off our mortgage some 15 years ago.  The joy of no monthly payments, the knowledge that we own our home outright and certainty that loss of income would be a far smaller problem....PRICELESS (to borrow a  Mastercard ad).  No amount of calculation of opportunity cost on a spreadsheet compares to the feeling of waking up feeling secure.  You can't really put a price on peace of mind.

As for the opportunity cost of paying off the mortgage...  Well, nobody knows.  The next 20 years may be nothing like the last 20.  No amount of retrospective studying will guarantee you a ROI higher than the mortgage going forward.  You know for sure what your ROI is when you pay off that mortgage.

Truth. Paid ours off at the start of this year, and very happy with our decision. The path to happiness is different for everyone.

Mini-Mer

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This thread resurrected at the perfect time for me - I've been debating this (again) and the range of opinions is very helpful! 

Another factor: a more conservative investor may not get much financial advantage of keeping the money in investments vs. paying down the mortgage itself.

I started the investment account option - but am finding that my risk tolerance is lower for money allocated towards a specific existing debt.  You can work longer if retirement accounts go down, or buy a cheaper car if the car-replacement fund is low.  The mortgage is what it is, and it has a deadline.  I plan on trying to outperform my interest rate, of course, but lower-risk investments do have lower potential returns. 

ender

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I like the idea of having a separate account for mortgage "extra payments" at Vanguard and then if it's equal to the mortgage balance, paying it off in one shot. Probably do something more stable than 100% stocks but who knows.





trashmanz

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Can you guys not understand the simple simple math here. Even if your mortgage is half your expenses. Putting money towards principal doesn't help you fire any earlier. It make it later. Especially if you aren't maxing tax advantaged accounts.

It's purely emotional. If you want to pay it off pay it off but be truthful to yourself and know you're paying it off to give yourself a false feeling of comfort.

Basically you're just doing what TSA does at airports to yourself. Giving your self a false feeling of being safer. You're actually more unsafe.

Posters here frequently take complicated decisions and oversimplify them into black and white issues. It honestly feels like we're debating gun rights, abortion, healthcare, etc., when in fact, all of these issues require an extremely nuanced and detailed inspection of evidence and reason.

Instead of debating political issues on here, it's things like buy vs. rent, pay down mortgage or invest, have cable TV or don't, bike to work or you're an idiot, etc. This is all very complicated stuff and applies to each person individually. It's not black and white.

Thus, I get pretty agitated with condescending posts like the one quoted above. You have no idea what that person's financial situation is, you have no idea how they grew up, their family situation, etc. You also discount the emotional and personal aspect of PERSONAL finance as if humans are supposed to be robotic calculators removed from emotion. They're not.

Take me, for example. My parents got divorced when I was 18 (ten years ago). They are now 60 and each have $125k left on their mortgages. Were (or are) they mustachian? No. But I've seen how the process of refinancing and taking out HELOCs has negatively affected them beyond description. They are both going to have to work until they are 70.

Meanwhile, my GF's parents have a paid off home. They paid it off about 5 years early by paying like $50 more per month. GF's dad is basically retired (does accounting on the side) and her mom still works because she loves her job.

So my own personal observation of seeing my parents pay on a mortgage for the last 35 years has led me to strongly, strongly, strongly want a paid off home when I'm ready to retire. You can sit here all you want and say NUMBERS NUMBERS NUMBERS. I really don't care.

Now am I going to go crazy paying it off ? No. Tax refunds, bonuses, etc. are going to go in a tIRA, 529, or money market account of some type and thus increase our savings rate. We plan to just pay about an extra $140/month. That number is based on having the house paid off by the time I want to FIRE (45). Not having a mortgage payment means that my COL will be lower for retirement, thus meaning I don't need to save as much for retirement.

Sure, $140/month for 18 years is almost $30,000 cash. And if I put that $140/month into a tIRA and let it grow for 18 years I'd have $50,000.

Wahoo. Yippee. If things go to plan I will have at least $993k invested by then with a yearly expenditure of around $35k (3.5% withdrawal rate).

Is that calculation cut and dry? Of course not. Is it likely to change? Of course. And I totally expect smarter people than me to post OMG YOU'RE WRONG CHECK OUT THIS CALCULATION.

But both my GF and I want our house paid off when I retire. Simple as that. Go ahead and show me a calculation that I'm losing out on $10 or $20k or whatever in possible gains. It doesn't matter to us.

One last thing, and it leads back to my first point: this community gets so lost in the tiny details that it completely loses track of how just doing the big things right puts you ahead of 90% of the pack. 50% savings rate, taking advantage of tax advantaged accounts, having an emergency fund, driving paid off used cars and living close to work, on and on--that means you're doing really good.

The small decisions of where the extra money after that goes is nothing more than the personal side of personal finance. And if someone else's small decisions (i.e., what to do with $140/month) makes you think they are dumb, you need to relax.


I don't see what you wrote here as contradicting any of the post you quoted. You seem to admit that for some people it is an emotional rather than logical decision to pay down the mortgage. That is fine but doesn't change what is actually The less risky decision.

little_brown_dog

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One last thing, and it leads back to my first point: this community gets so lost in the tiny details that it completely loses track of how just doing the big things right puts you ahead of 90% of the pack. 50% savings rate, taking advantage of tax advantaged accounts, having an emergency fund, driving paid off used cars and living close to work, on and on--that means you're doing really good.

True dat.  Kudos to anyone that's put them in the financial situation where they have to decide between paying down a mortgage really, really early or saving a very large chunk of their wealth each year.
Either choice puts you on firm financial footing and on the road to financial independence.

This is so true. People here routinely say something like “we are maxing all our tax advantaged accounts, we have a 3-6mo efund, we have no debt, we have optimized our expenses, we are saving for college, and we still have EXTRA money – should we pay off our house before going for more investments?” And naturally we get into a discussion over it because that is what this forum is for, but when you think about it this question probably isn't that critical. People with this dilemma are in great shape. They clearly have a strong handle on their finances and know how to make good moves for their situation. Whatever they choose to do is probably a defensible position whichever way the math works out. In these circumstances, there isn't an obviously right answer or an obviously wrong one.
The much scarier questions are ones like "should we buy a house while my wife is pregnant and we have 100k in cc debt?". People with the ability to save for retirement, hold an efund, and pay off a mortgage in relatively short order are definitely not the ones to worry about.
« Last Edit: March 18, 2016, 09:03:28 AM by little_brown_dog »

xclonexclonex

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I am glad this thread got resurrected. I have been thinking about paying off the mortgage, and living on one income, while investing the rest into Vanguard funds...I see merits on both sides of the argument (the emotional argument vs. the logical argument).

I don't know what I will end up doing...