Author Topic: Where do you find the balance between paying extra on mortgage and investing?  (Read 4273 times)

El Jacinto

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I have a very unmustachian house, which will certainly extend the time before I am financially independent. However, when one is married, one must compromise. With that said, I have the following dilemma.

I have a 30 year fixed mortgage at 4.375%. I can choose to put up to an extra $1,000/month towards the mortgage, starting in a few months, or I can add that to my 401(k), taking my monthly contribution from 15% (1,100/month) of gross household income to 27.5% (2,027/month).

In running the numbers, I can stay at minimum payments for the full term with the following results:

Payoff: June 2048
Total interest: $246,527
401(k) at June 2048: $3,548,244

If I put the extra towards the mortgage, I get the following:

Payoff: July 2032
Total interest paid: $105,554
401(k) at June 2048: $2,471,285

Essentially, while I double the time I spend paying on the mortgage, it results in a much larger nest egg. What is the price of the risk in this equation?

YoungGranny

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Over 30 years the risk of investing is much lower since you're not trying to time the market, you won't need access to the money for many years, and you will be making consistent contributions over time. It's a no-brainer to invest in your 401k instead of paying off the mortgage and actually paying off the mortgage and having that money locked into a house which can be quite illiquid can be just as risky if not more. You also have a much larger chance of ending up with a smaller nest egg by paying off your mortgage.  I made the mistake on my first house of paying more to the mortgage and then I wised up and listened to the math shown in the 'Don't Payoff Your Mortgage' thread. I now am close to being able to pay off my mortgage but I realize it's far better to have the investments instead.

frugaliknowit

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Do you hold any bonds or bond funds in your retirement stache?

mrteacher

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Posting to follow.

El Jacinto

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Do you hold any bonds or bond funds in your retirement stache?

No, it is split three ways with small, mid, & large cap mutual funds.

chasesfish

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I would recommend maximizing every single retirement account and tax deferred vehicle available to you before paying extra on the mortgage.

Paying extra on the mortgage - Been there, done that, regretted the investment gains I lost.   Once I got a decent amount saved outside of the retirement accounts, I decided there was zero emotional value to owning my home outright.

The answer is different for everyone and its a personal choice

ice1717

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The approach I like is:

Max tax advantaged accounts (401k, HSA, Roth IRA...) to save on taxes and to get the additional investment gains from the long time horizon. 

After that, invest any additional money in an investment account until it matches the value of your mortgage.  If you want to pay off the mortgage at this point, go for it.  You have peace of mind that you are moving toward/have the money to pay it off, but you don't risk needing the money that is tied up in your mortgage payoff. 

Risk goes both ways.  The market can go down or sideways for the next X years, but with dollar cost averaging into your 401k your gains/losses won't match those results due to when you are buying.  The other risk is needing or wanting the money you have put into paying off your mortgage.  It's possible, but not easy or free to get the money back out.

mm1970

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We are pre-paying the mortgage only because my husband goofed on the last refi, and we are too lazy to change it.

Fund the 401k.

Radagast

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Making extra payments is risky because in the event you are unable to make regular payments for a few months, you loose the extra payments (and regular payments and the house). Also you can't access the extra payments once made (well except with a home equity loan) so there is a liquidity problem too as you can't sell little bits of the house. Risk and illiquidity command premiums. ...So I'd be willing to make extra payments if:
1. I was already maxing out every tax-advantaged space available to me
2. I could not refinance to a better rate
3. The mortgage rate was higher than the 10-year treasury bond +3% (right now 3%+3%=6%, thanks MDM https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153)
4. The mortgage was also higher than 1/CAPE10+0.5%+inflation (right now 1/32+0.5+2.5= 6% also http://www.multpl.com/shiller-pe/)
...so right now about 6% would be my balance point. I think I'd keep the 6% mortgage but make extra payments on the 6.125%. Since my mortgage is at 3.0% the thought makes me hurt though.

I would be willing to pay off the mortgage in a single lump sum if it was both smaller and had a better yield than my allocation to bonds. I would pay for it by liquidating the bonds. I would also consider paying it off if I was about to swear off earning money for good, regardless of my bond allocation (consider being the word, not necessarily decide).

Taran Wanderer

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I really, really, really want to pay my house off, but I don’t. We first max out our 401k, 403b, and Roth IRA contributions. Then we contribute to the kids’ 529 plans. Then we have no car debt or any other debt besides real estate. Then we ensure our cash buffer is substantial. Then we go on vacation once in a while. Then, if I just can’t handle it anymore, I pay an extra principal payment on the mortgage. It makes me feel good, but I know my odds are better with the market.

You have done the math. You have demonstrated that the probable best course of action is to max your 401k. You can either trust the math and max out your retirement savings, or you can feel good by seeing your mortgage balance drop but then feel bad because you probably would have done better in the martlet.

Dicey

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The best explanation I have seen anywhere, ever, is the first chapter of RIC Edelman's "Ordinary People, Extraordinary Wealth". Get it from your library, read the first chapter, it's all you need. If it doesn't convince you, nothing will. I'm going to go out and play now while you kids figure it out. It took me a while when I was your age, but I got there and you can, too.

Dosclaimer: Applies to US-based, fixed rate, tax-deductible, affordable mortgages only. If these things do not describe you or your mortgage, I have no advice for you, only my best wishes as you work through the math.

MDM

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The best explanation I have seen anywhere, ever, is the first chapter of RIC Edelman's "Ordinary People, Extraordinary Wealth". Get it from your library, read the first chapter, it's all you need. If it doesn't convince you, nothing will. I'm going to go out and play now while you kids figure it out. It took me a while when I was your age, but I got there and you can, too.

Dosclaimer: Applies to US-based, fixed rate, tax-deductible, affordable mortgages only. If these things do not describe you or your mortgage, I have no advice for you, only my best wishes as you work through the math.
Ordinary People, Extraordinary Wealth: The 8 Secrets of How 5, 000 Ordinary Americans Became Successful Investors--and How You Can Too: Ric Edelman: 9780062736864: Amazon.com: Books allows reading at least part of the first chapter.

Fomerly known as something

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I round up my mortgage to an even $100 amount, otherwise everything else extra is invested.  If I want to pay off my mortgage in the future as others have said I will pay it off in full.  That will be a cash flow decision at FIRE.

LightStache

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0% mortgage, 100% investing. As you ran the numbers, in today's environment it just doesn't make sense to pay down a mortgage for purely financial reasons. As I approach FI, I like the idea of just having enough money in after-tax brokerage accounts to pay off the house if you feel like it. That would probably give me the best piece of mind -- not giving up the value of cheap leverage, but not risking losing the house.

gaja

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Are interest rates normally that high in your part of the world? It is almost 2x what we have on our mortgage.

kpd905

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I have only thrown extra at my mortgage after maxing out all tax-advantaged space.  And I am only throwing enough at my mortgage to get rid of PMI.  I have about $5,000 to go, then PMI will be gone.  At that point, I'll finally open up a taxable account and start putting the extra cash there.

TomTX

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By investing all of it.

nick663

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Are interest rates normally that high in your part of the world? It is almost 2x what we have on our mortgage.
When did you acquire it?  Mortgage rates have been steadily increasing in US.   Best I'm seeing with a quick search is 4.7% on a 30 year.

gaja

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Are interest rates normally that high in your part of the world? It is almost 2x what we have on our mortgage.
When did you acquire it?  Mortgage rates have been steadily increasing in US.   Best I'm seeing with a quick search is 4.7% on a 30 year.

Guess it is the 30 year thing that makes it different. We don't use that in Norway.

Another Reader

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My interest rate is 3.125 percent on a 30 year fixed rate mortgage with 24 years to go.  The loan servicer is Wells Fargo Bank, who coincidentally is offering a 3 year CD through the various brokers at 3.15 percent.  JP Morgan/Chase is at 3.20 percent.  Or I can buy a five year treasury at auction on Monday at 3.00 percent.  There is zero chance I am going to direct one extra penny at a tax advantaged mortgage loan, given that I can exceed the tax adjusted interest rate on the loan with any of these essentially risk free products.


ender

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I have a 30 year fixed mortgage at 4.375%. I can choose to put up to an extra $1,000/month towards the mortgage, starting in a few months, or I can add that to my 401(k), taking my monthly contribution from 15% (1,100/month) of gross household income to 27.5% (2,027/month).

Make sure you account for taxes on your income, too.

$1000 into a pretax 401k is not going to be $1000 after tax, for purposes of paying down the mortgage - with your income you very likely have marginal tax rates to consider here.


simplyjay

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im paying down the mortgage with 100% of all my savings per month and whatever else i can. why? because its an investment property that cashflows well and will do me even better when the payments are gone. plus you won't find peace of mind rolling around on the floor. this property will cash flow almost 2k once paid after all expenses... thats pretty good.

Another Reader

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im paying down the mortgage with 100% of all my savings per month and whatever else i can. why? because its an investment property that cashflows well and will do me even better when the payments are gone. plus you won't find peace of mind rolling around on the floor. this property will cash flow almost 2k once paid after all expenses... thats pretty good.

That's a different scenario.  I am paying off higher rate investment property mortgages as well, because the rates are significantly higher and stable, lower risk cash flow is the goal. 

TomTX

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im paying down the mortgage with 100% of all my savings per month and whatever else i can. why? because its an investment property that cashflows well and will do me even better when the payments are gone. plus you won't find peace of mind rolling around on the floor. this property will cash flow almost 2k once paid after all expenses... thats pretty good.

An alternative would be to find another property for sale which would also cash flow well, and use the extra money to acquire it (with a mortgage on that one as well)

AccidentialMustache

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Not that I wouldn't max the 401k first, but a paid off house lets you grab a heloc, which can be an advantage in cash-acquiring property, plus the interest against that can be deductible in some cases, should that be of interest to you.

Dicey

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Not that I wouldn't max the 401k first, but a paid off house lets you grab a heloc, which can be an advantage in cash-acquiring property, plus the interest against that can be deductible in some cases, should that be of interest to you.
A property does not have to be paid off to get a HELOC.

tralfamadorian

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Not that I wouldn't max the 401k first, but a paid off house lets you grab a heloc, which can be an advantage in cash-acquiring property, plus the interest against that can be deductible in some cases, should that be of interest to you.

So, paying off a fixed-rate, non-callable note to be able to borrow a higher rate, callable note in the future? What's the benefit of this over putting the extra payments in a taxable brokerage account then pulling the funds out later when you wanted to purchase another property?

maizefolk

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Not that I wouldn't max the 401k first, but a paid off house lets you grab a heloc, which can be an advantage in cash-acquiring property, plus the interest against that can be deductible in some cases, should that be of interest to you.

But isn't the interest on your primary mortgage also going to be tax deductible in the same situations the HELOC's interest would be? (As well as some others where the HELOC interest would not.)

Dicey

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Not that I wouldn't max the 401k first, but a paid off house lets you grab a heloc, which can be an advantage in cash-acquiring property, plus the interest against that can be deductible in some cases, should that be of interest to you.

But isn't the interest on your primary mortgage also going to be tax deductible in the same situations the HELOC's interest would be? (As well as some others where the HELOC interest would not.)
No. Different rules. Where's a good CPA when you need one?