Author Topic: The old pay down mortgage versus invest debate.. one aspect seems overlooked  (Read 17562 times)

boarder42

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I'd love to see someone bring a real life situation to this where someone lost their house b/c they lost their job then their e-fund ran out and they had no cash b/c they were pumping money into their mortgage.

If you want to pay off your house early go for it but the historically faster AND safer way to pay it off early is to put the extra money in a taxable account and them lump sum pay it off at once. 

neo von retorch

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I would not love for that to happen! Because I like when people succeed!

I think you're forgetting that it's not as black and white as the math. Not just "ooey gooey" emotional stuff, but also you don't know the rest of their story.

i.e. "Have $200k in investments; decided to pay off mortgage early" vs "Have $5k e-fund, $0 invested, paying off mortgage with no safety net."

Gerard

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I like the "invest it and when you have enough pay down the mortgage all at once" strategy, but I would point out that it won't work for most Canadian mortgages, which limit (sometimes drastically) the amount that you can pay down in any given year.

Of course, all the math is potentially different in Canada because mortgage payments aren't tax deductible, mortgages tend to have terms of five years or less, bla bla...


Cassie

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As someone else pointed out if you have a large mortgage and pay it off you can live on much less $ if something does happen.

Cycling Stache

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I know I should not respond, I know I should not respond.

I paid off my house in 2014.  I'm very happy to have done so.  I realize that mathmatically investing over the long term works better.  I'm nonetheless very happy to have done so.  Here's why.

(1)  House is paid off.  I often see the arguments (rational as they may be) that if you have X amount in an index fund, you can use that more easily to cover you in case you lose your job.  But the situation I worried about more was the long-term unemployed situation (how ever unlikely that may have been), and had the idea that if my by-far largest expense was removed, I could cut my other expenses to the bone and live a long time.  Again, all unlikely, but different than the I'll just use the funds I have available for the time being while looking for another job.

(2)  No debt.  Yes, yes, debt doesn't have to be a bad word.  But having no debt feels WAY better (to me) than having debt did.  I'm glad I'm there.

(3)  Short-term guaranteed returns.  This addresses OP's initial point.  I turned my situation into a short-term decision by paying off the house in a couple years.  At that point, it was a question whether I would take the guaranteed return of 3% versus the risk of 7% over a 2-year time horizon.  I'm not actually sure that's correct from an economic standpoint, but guaranteed rate of return over the short term was appealing to me.

(4)  I now invest like a champ.  Not only do I have a ridiuclous amount of overage coming in every 2 weeks, I consistently invest it in the market without any desire (barely) to try to time the market or worry about whether it's up or down.  Now that I know everything else is taken care of, I can finally be the completely rational market investor, which I found hard to do when I had a large amount in the market before paying off the house.

If I were starting over with a 30-year mortgage and were nowhere close to paying it off, I too would go with the rational approach of investing over paying extra toward the mortgage.  But for me, I turned it into a short-term decision, and I realized that paying it off would enable me to become the rational investor I (and I believe many others) struggle to be in real life.  For those who don't think they'll be affected by that irrationality, wait until you have $400k or $500k in the market that you're considering putting towards your house and wondering if a 10% or 20% drop is right around the corner.  Rationally, it doesn't matter, and for some, no problem.  For me, in real life?  It was tough.

One last point--targeting your mortgage (especially as you get closer) very well could encourage you to cut expenses and save more.  It did for me.  Having a very concrete target to attack was much more meaningful than my current approach of just watching investment account balances grow (or not, depending on the market).  Still nice, but not the same level of motivation at all, at least for me.

boarder42

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As someone else pointed out if you have a large mortgage and pay it off you can live on much less $ if something does happen.

so the money has to come from somewhere and go somewhere.

if you're assuming spend all you earn or pay down your mortgage of course that makes more sense.

But everyone has a limited amount they bring in whatever that number may be.  after you've maxed all retirement accounts you have a sum left over.  That sum is then spent on fixed expenses rent/mortgage, utilities, food, water money that has to go out.  then you hopefully still have a sum leftover. 

So now what do you do with that sum

Lets assume to identical twins make all the same choices up to this point and each have 10k annually left over

Twin 1. pays down house
Twin 2. invests

with 10k per year extra to the mortgage on a 200k house twin 1 pays his house off in 12 years.

Twin 2 invests.  at 8% return his money is worth 205,000 at the end of 12 years and he has a mortgage of 145,000

so yeah he is 60k ahead thats the easy math. 

So both Twins get laid off in the 12th year or later they are likely in the same boat with the caveat that twin 2 has extra capital if he needs it

But now lets explore the what if they get laid off in year 11 or earlier. 

We'll just use the mid point year 6

say they both have 6 months in an E fund but neither can find a job til a year later.  so they need to live and pay their mortgages for 6 more months.

Twin 2 is SOL

Twin 1 has earned -5% return on his 10k savings over the last 6 years (remember its been a bad market)  - and only has 50k of his 60k invested left.

but thats enough for him to keep making payments for the next 6 months. but for anyone here 50k should easily float you for 6 months esp. if you're jobless.


SO

what did we learn?  if you want to pay down your mortgage then you should probably at the very least invest it and pay it off in a lump sum you will have less risk.

Assumption 200k loan at 4% over 30 years. 

xclonexclonex

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I know I should not respond, I know I should not respond.

I paid off my house in 2014.  I'm very happy to have done so.  I realize that mathmatically investing over the long term works better.  I'm nonetheless very happy to have done so.  Here's why.

(1)  House is paid off.  I often see the arguments (rational as they may be) that if you have X amount in an index fund, you can use that more easily to cover you in case you lose your job.  But the situation I worried about more was the long-term unemployed situation (how ever unlikely that may have been), and had the idea that if my by-far largest expense was removed, I could cut my other expenses to the bone and live a long time.  Again, all unlikely, but different than the I'll just use the funds I have available for the time being while looking for another job.

(2)  No debt.  Yes, yes, debt doesn't have to be a bad word.  But having no debt feels WAY better (to me) than having debt did.  I'm glad I'm there.

(3)  Short-term guaranteed returns.  This addresses OP's initial point.  I turned my situation into a short-term decision by paying off the house in a couple years.  At that point, it was a question whether I would take the guaranteed return of 3% versus the risk of 7% over a 2-year time horizon.  I'm not actually sure that's correct from an economic standpoint, but guaranteed rate of return over the short term was appealing to me.

(4)  I now invest like a champ.  Not only do I have a ridiuclous amount of overage coming in every 2 weeks, I consistently invest it in the market without any desire (barely) to try to time the market or worry about whether it's up or down.  Now that I know everything else is taken care of, I can finally be the completely rational market investor, which I found hard to do when I had a large amount in the market before paying off the house.

If I were starting over with a 30-year mortgage and were nowhere close to paying it off, I too would go with the rational approach of investing over paying extra toward the mortgage.  But for me, I turned it into a short-term decision, and I realized that paying it off would enable me to become the rational investor I (and I believe many others) struggle to be in real life.  For those who don't think they'll be affected by that irrationality, wait until you have $400k or $500k in the market that you're considering putting towards your house and wondering if a 10% or 20% drop is right around the corner.  Rationally, it doesn't matter, and for some, no problem.  For me, in real life?  It was tough.

One last point--targeting your mortgage (especially as you get closer) very well could encourage you to cut expenses and save more.  It did for me.  Having a very concrete target to attack was much more meaningful than my current approach of just watching investment account balances grow (or not, depending on the market).  Still nice, but not the same level of motivation at all, at least for me.

I am very glad you decided to respond. I am definitely an irrational investor, so I think paying off the mortgage, and removing the stress would be a good idea.

Thanks for sharing this.

I'd love to see someone bring a real life situation to this where someone lost their house b/c they lost their job then their e-fund ran out and they had no cash b/c they were pumping money into their mortgage.

I think you make a very valid point. Pumping extra into the mortgage may not be as good of an idea as it is to pay it off in lump sum.

Mikila

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

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xclonexclonex

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I have $132000 left on my mortgage, and I am seriously considering paying it off in one go next month...

Cassie

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I agree that it is safest to pay off in one lump sum which is what we did.  Then with a job loss that person can live on unemployment much easier especially if a spouse is working,  etc.

boarder42

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

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math works the same regardless of price of home

green daisy

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We just refinanced for a lower rate.  We are at 2.75% for 15 years.  Initially we decided to pay it off in 10 years, but investing the extra money instead is compelling.  That said, what about just paying an extra lump sum in the beginning to knock down the principal? Paying extra in the beginning would save more in interest than paying that same amount later into the loan.  Although I guess the same logic applies that investing that same lump sum in the beginning gives it more time to grow. 

My husband is not a mustachian convert, but he will never spend more than we have and he likes the idea of a paid off mortgage.  If the money is inaccessible because it's been sent to the mortgage company, he wouldn't be able to spend it. 

NoraLenderbee

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

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math works the same regardless of price of home

FFS, everybody has acknowledged multiple times that mathematically it's better not to pay off early. Nobody claims they will end up with more money by paying it early. You are right. You won the argument about which is financially superior. People are talking about other factors that may enter in, not claiming that those factors subvert the math.

tobitonic

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

Sent from my XT1526 using Tapatalk

math works the same regardless of price of home

FFS, everybody has acknowledged multiple times that mathematically it's better not to pay off early. Nobody claims they will end up with more money by paying it early. You are right. You won the argument about which is financially superior. People are talking about other factors that may enter in, not claiming that those factors subvert the math.

: ^ )

Additionally, it would be even mathematically better to take out additional mortgages (as many as possible!) and pay them off as slowly as possible while investing every spare penny. Frankly, I see it as quite irrational to only have one outstanding mortgage at a time.

Mikila

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

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math works the same regardless of price of home
But not regardless of interest rate. 

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MDM

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math works the same regardless of price of home
But not regardless of interest rate. 

Assuming you meant "the answer can change if the mortgage interest or expected investment return rates change," then yes.

Otherwise please explain, because the math equations are the same regardless of the variable values.

powskier

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Just to go back to the OP's original premise, if you only have 3 years of mortgage payments left you are hardly paying any interest at all at that point. someone who is better at math can figure out the details or correct me, but it would appear that if your mortgage interest rate is say 4% over the life of the loan that if you could parse out ( for debate sake) the actual interest rate you are paying in the last 3 years it would be far less than that since so much of the payment at that time is principle.

To me this looks like it sways the argument in the first post back towards the invest camp.


MDM

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Just to go back to the OP's original premise, if you only have 3 years of mortgage payments left you are hardly paying any interest at all at that point. someone who is better at math can figure out the details or correct me, but it would appear that if your mortgage interest rate is say 4% over the life of the loan that if you could parse out ( for debate sake) the actual interest rate you are paying in the last 3 years it would be far less than that since so much of the payment at that time is principle.

To me this looks like it sways the argument in the first post back towards the invest camp.

In a conventional fixed-rate U.S. mortgage, you pay the stated interest rate on the remaining principal every month.  The actual interest rate never changes.  See https://en.wikipedia.org/wiki/Fixed-rate_mortgage.

ender

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I would suspect the majority of those arguing against paying off a home are in high dollar areas.  When your home costs you ~$60k, it makes more sense to pay off because a.) the interest rate is higher, and b.) the amount should be a negligible percentage of your portfolio. 

Sent from my XT1526 using Tapatalk

math works the same regardless of price of home

I agree to some extent, but if your home's value is 20% of your net worth vs 80% the actual implications on your life are more significant.

A small percentage of your total net worth being used as insurance of sorts by paying a mortgage off early has less impact and more benefit than the other way around.

If you consider paying your home off early to be a type of insurance, the "math is bad" decision doesn't work out as straightforward. Unless you are saying that you don't recommend any insurance at all? Mathematically for most people all insurance is a mathematically poor choice. Whether that is health insurance, homeowners insurance, or even an emergency fund. Using your same hardline analysis here would logically lead you to the conclusion to not pay for any insurance.

K-ice

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My husband is not a mustachian convert, but he will never spend more than we have and he likes the idea of a paid off mortgage.  If the money is inaccessible because it's been sent to the mortgage company, he wouldn't be able to spend it.

^^^ This. My SO is uncomfortable investing in anything other than realestate. However, it was easy to convince them to pay down the mortgage quickly.

Now that it is paid, it is harder to work towards a common goal. I am investing but it would be better to do it together.

There is hope. I just convinced them to invest like 2% of their net worth in an ETF. The rest is all tied up in realestate or sitting as cash.

powskier

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Just to go back to the OP's original premise, if you only have 3 years of mortgage payments left you are hardly paying any interest at all at that point. someone who is better at math can figure out the details or correct me, but it would appear that if your mortgage interest rate is say 4% over the life of the loan that if you could parse out ( for debate sake) the actual interest rate you are paying in the last 3 years it would be far less than that since so much of the payment at that time is principle.

To me this looks like it sways the argument in the first post back towards the invest camp.

In a conventional fixed-rate U.S. mortgage, you pay the stated interest rate on the remaining principal every month.  The actual interest rate never changes.  See https://en.wikipedia.org/wiki/Fixed-rate_mortgage.

Yes , I know this, I was trying to point out that in the last 3 years you are paying a small amount of interest and a large amount of principal, as if ( for the purpose of argument) the interest rate in the last few years was tiny. The point being that the last few years is the best part and the money you would use to pay off your mortgage in the last few years does way better invested.
i hope you can understand the concept I am trying to explain....consider it a thought experiment.