Author Topic: Paying off Mortgage Early How bad is it for your FI Date?  (Read 198469 times)

tomsang

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Paying off Mortgage Early How bad is it for your FI Date?
« on: March 18, 2013, 05:35:01 PM »
Wife and I were considering paying down the mortgage in short order, for the psychological wellbeing of having a paid off house.  Then I started questioning how much does it hurt us financially and how much does it slow us down towards our quest for Financial Independence to have those un-Mustachian warm and fuzzies. If the math on paying down a mortgage is flat out bad, can I reset our psychology to reflect reality so that we feel psychologically better by having a mortgage and a larger portfolio. I  think we all intuitively know that with mortgage rates as low as they are, it makes more sense to have a 30 year mortgage and invest in building our portfolio, but we excuse this behavior by letting emotions rule over math. Sounds very un-Mustachian to let emotions overrule math, but it happens all the time.  So with that being said, I need some help in creating the model to do the math.       
   
Has anyone done the math to show the impact if you pay down/pay off  your mortgage v.s. investing the money into mutual funds or other investments?  Is there a calculator that shows your FI years and how many years it adds to your FI point if you pay off your mortgage vs. investing?

For an example I was looking at a fictitious $300,000 mortgage at 3.5% interest rate and $1,500,000 portfolio vs. a paid off house with a $1,200,000 portfolio.

In Firecalc, I was trying to come up with the two scenarios. 

1)   Scenario 1:  House paid off, yearly expenses of $50,000, Portfolio of $1,200,000
2)   Scenario 2:  $300,000 mortgage, interest 1st year of $10,500, tax savings of $1,000; therefore yearly expenses of $59,500 and Portfolio of $1,500,000

Scenario 1 Firecalc Results: 92.8% success rate for 30 years:  Average Portfolio $1,954,019
Scenario 2: Firecalc Results:96.4% success rate for 30 years: Average Portfolio  $2,688,299

Scenario 2:  $10,500 of interest paid at 3.5% x $300,000, $1,000 tax benefit for interest so $9,500 greater yearly expense.  Obviously interest will go down as well as the tax benefit at some point in time.

Variables that I was thinking about related to:

1)   Part of mortgage payment is going to principal which is adding to your net worth
2)   Tax benefits of the mortgage for  the first x number of years.  Used $1,000 tax benefit(($10,500 interest, $3,500 taxes, $1,500 charitable/state-$11,900 standard deduction married filing jointly)*.28 tax rate
3)   The bigger the house loan the bigger the benefit for taxes, FI, etc. Not mustachian, but if you are going to live in a $700,000 house, better to have a large mortgage and large portfolio.
4)   The mortgage is a great hedge against inflation as the interest and payment are locked in for 30 years. 
5)   The extra $300,000 of your portfolio would follow inflation as well, and would typically do better than inflation.
6)   Interest rates are being subsided by the government, so might as well lock it in for 30 years.  IE.  With the SWR of somewhere between 3% and 4%, if inflation/market does not increase by that amount then Early FI would be in greater jeopardy than whether you have a mortgage or not.  Therefore, interest is free or close to it under the current environment.
7)   Did not take into account SS, Pensions, etc.
8)   Tax benefit probably goes away once you retire as income drops.
9)   How to create the model, with a person investing x number of dollars either in a portfolio or part portfolio and part mortgage on a monthly basis.
10)   Cashflow issues, etc. if market is tanking and yet the mortgage payment is due.  I think that is covered in Firecalc, except for the principal 

With all the engineers and other math geniuses in MMM land, I figured someone has figured out how detrimental it is to pay off the mortgage vs. the psychology of being debt free.  I think that would be a cool spreadsheet if someone could put that together or point me to where it is located.  What else am I missing?  I know there are a number of people with houses that are paid off,  this would show them the math behind what it is costing them in years to FI, Firecalc confidence levels, ROI, etc.  Time to get a mortgage?  Maybe the psychology of having a paid off house outweighs the financial cost to FI, but at least it would be quantified.

Thanks for your help,

Tom

englyn

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #1 on: March 18, 2013, 08:46:17 PM »
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

Tyler

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #2 on: March 18, 2013, 09:55:49 PM »
Hi Tom.  Lots of points there -- let me focus on just a few.

I think you have an error in your Firecalc simulation.  In scenario 2, you only include mortgage interest in your additional spending, so from what I can tell you're not accounting for the fact that you still must sell stocks every year to pay for your principal.  While paying principal does not change your net worth, it does reduce your investment account (an important distinction because you won't be able to sell 4% of your house every year to pay bills).  Assuming a 30-year retirement (matching a 30 year mortgage) and the default Firecalc investment assumptions, your real scenario looks like:

Scenario 1:  House paid off, yearly expenses of $50,000, Portfolio of $1,200,000  >>> 92.8% success
Scenario 2: $300,000 mortgage, yearly expenses of $66,000 ($16k in house payments removed from investments every year), Portfolio of $1,500,000 >>> 86.5% success

Note that I ignored the mortage interest deduction because the interest is less than the standard deduction for a couple filing jointly.  YMMV based on your tax situation.

All that said... regardless of the theoretical success rates, I personally prefer to have no mortgage at all in retirement so that I can maintain my financial flexibility to do what Firecalc does not -- minimize my drawdown in down market years to make my portfolio more resilient and all but guarantee a 100% success rate.  And it's way less stressful to get a part time job to cover a bit of spending money than it is to also cover a mortgage.   

But at some point it comes down to personality.  I know some others here like the idea of arbitraging interest rates to make more money off their mortgage just because they can.  Personally, I like being debt-free and am perfectly happy letting go of a few potential (theoretical) future dollars because what the hell do I care -- I'll be happily retired already!

Finally, regarding your initial question of how a mortgage affects your FI date, that depends more on your personal situation -- like how large your stache already is and how far you are from FI.  All of the Firecalc calculations above assume you take out a 30 year mortgage the day you retire, but a mortgage in the accumulation phase is a different situation.  A mortgage can make good sense earlier in your savings journey to stay liquid and get those investments growing.

« Last Edit: March 18, 2013, 10:07:01 PM by Tyler »

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #3 on: March 18, 2013, 10:19:35 PM »
This is an oft discussed topic on the e-r.org forums.

So rather than recreate the wheel, here's plenty of reading for you.

You'll find people arguing both sides.  Since I prefer the keep a mortgage option (mainly due to inflation risk - holding the mortgage is an amazing inflation hedge, as your payment stays fixed while your portfolio can grow - and inflation is the #1 enemy to retirement, especially an early retirement that lasts a long time), I'll cherry pick some quotes to support that. ;)

Quote
FIRECalc simulations confirm that holding a low interest, long-term mortgage increases portfolio survivability. The reason is easy to understand. After a bad bear market, a portfolio survives if it has enough dollars left to grow in the recovery that follows. The more portfolio left to grow, the greater the chance for survival. A mortgage holder will have more money left to grow since the starting portfolio was not reduced by a mortgage payoff.

You have to run your own specific numbers in FIRECalc, but historically, paying off a mortgage has often resulted in greater portfolio risk -- not less. 

Quote
run the numbers and you will see -- for balanced portfolios, ~6.25% mortgage rates or lower, remaining time on loans >~10 years, the financial advantage has historically been with keeping the mortgage. Paying off the mortgage actually increases the risk of running out of money in retirement.

That is, not only should you not pay it off early as it will delay your ER, you shouldn't pay it off at ALL when you ER!  Keep the larger portfolio and the mortgage.

I support paying off the mortgage for people who don't have the discipline to invest the money otherwise.  That shouldn't describe a Mustachian, however.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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Kazimieras

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #4 on: March 18, 2013, 10:22:56 PM »
I'm a Canuk and we can't deduct mortgage interest (except in some special cases), but you do raise some good points. In short:

From a raw dollars perspective it is better not to pay off your mortgage and invest the money in the markets. The reason for being is mortgage rates are laughably low and the market is returning some very good returns right now (and hopefully will continue to do so). The math centers around what gives you a better rate of return. Once you've paid off the house you earn 0, since the equity is tied up in the unit. Money in stocks or bonds will typically be giving a return greater than 0. So the answer isn't rocket science.

One thing to take into account is the risk you're putting yourself in though. If you pay off your house and the market explodes, you still have your house. Owning your house fully makes your costs very predictable and you don't need to suddenly worry about interest rates rising. Anything you have in the markets, unless they are all insured GICs have the risk of going poof (look at Cyprus or Greece as examples). Also consider if your portfolio dips one year, you still are required to sell parts of it to pay for your mortgage. So imagine 2008, where you'd have to sell off a good chunk, which rebounded very nicely a year or two later, at a huge loss, just to cover your everyday costs.

ed

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #5 on: March 19, 2013, 11:54:48 AM »
On the psychological front, you could consider a blending approach - you don't have to chose between full-speed towards FI or full-speed towards zeroing the mortgage.  We did the maths ourselves and realised that ending the mortgage as soon as possible wasn't financially optimal.   We opted to pay it off early, but not nearly so early as we could have.  We got the warm and fuzzy collapsing-debt feeling, while our more rational selves admired that oh-so-rationally invested portofolio (well, mostly!). 

The blending approach works well for other rational-but-psychologically troubling decisions like moving investments from individual share holdings to index-tracking ETFs.  We found that doing it piecemeal was a lot easier - leaving a few % of the portfolio somewhere thrilling was the small price our inner Spocks paid to do the logical thing with the vast bulk.

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #6 on: March 19, 2013, 02:55:01 PM »
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

That is crazy high interest rates.  Do you know what is causing them?  Is there huge inflation expected in the near term?  Weak dollar?  For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate.  Seems like an opportunity to invest in mortgage notes.  Is there a market for that in Australia?

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #7 on: March 19, 2013, 03:06:47 PM »
Hi Tom.  Lots of points there -- let me focus on just a few.

I think you have an error in your Firecalc simulation.  In scenario 2, you only include mortgage interest in your additional spending, so from what I can tell you're not accounting for the fact that you still must sell stocks every year to pay for your principal.  While paying principal does not change your net worth, it does reduce your investment account (an important distinction because you won't be able to sell 4% of your house every year to pay bills).  Assuming a 30-year retirement (matching a 30 year mortgage) and the default Firecalc investment assumptions, your real scenario looks like:

Scenario 1:  House paid off, yearly expenses of $50,000, Portfolio of $1,200,000  >>> 92.8% success
Scenario 2: $300,000 mortgage, yearly expenses of $66,000 ($16k in house payments removed from investments every year), Portfolio of $1,500,000 >>> 86.5% success

That is why it would be cool to create a calculator that figured this out.  Your principal payments are an investment that pays out at your mortgage rate.  The way you have it set up, is that it is household expenses that went up, which obviously would hurt your success rate.  This is not what is happening when you pay down your mortgage.  You are buying an investment that pays out at your mortgage rate.  If you are liquidating investments that pay out at the level, it would not hurt your yield at all.  IE take from your bonds vs your equities as you are buying a bond that pays out at 3.5% or your mortgage rate. 

The tax savings were calculated in the first post at $1,008.  I used $1,000 for simple rounding.  Interest, taxes, charitable, and state taxes were at $15,500 while the standard is $11,900 for Married Filing Joint.  Take that at 28% or whatever your bracket is to come up with the benefit.  I don't think the taxes sways the calc much though.  Obviously if you have a house worth more than $300,000 then it becomes a bigger benefit while working.   

BYUvol

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #8 on: March 19, 2013, 03:07:08 PM »
   
Has anyone done the math to show the impact if you pay down/pay off  your mortgage v.s. investing the money into mutual funds or other investments?  Is there a calculator that shows your FI years and how many years it adds to your FI point if you pay off your mortgage vs. investing?

It's impossible to do this math with any level of certainty. The second you try to plug in numbers, you will be making assumptions about the future that will ultimately prove inaccurate, perhaps wildly so.

I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #9 on: March 19, 2013, 03:11:25 PM »

Quote
run the numbers and you will see -- for balanced portfolios, ~6.25% mortgage rates or lower, remaining time on loans >~10 years, the financial advantage has historically been with keeping the mortgage. Paying off the mortgage actually increases the risk of running out of money in retirement.

That is, not only should you not pay it off early as it will delay your ER, you shouldn't pay it off at ALL when you ER!  Keep the larger portfolio and the mortgage.

I support paying off the mortgage for people who don't have the discipline to invest the money otherwise.  That shouldn't describe a Mustachian, however.

Did those that came up with the 6.25% come up with a calculation, model, etc.  I think, that would go well with the surprising simple math to retirement, firecalc, and the other models out there.  If Firecalc has been proven to work, then figuring out exactly how much paying off your mortgage effects your FI and your years to FI seems like it could be boiled down to math vs. opinions on what is safer, better, etc. 

BYUvol

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #10 on: March 19, 2013, 03:17:00 PM »

The tax savings were calculated in the first post at $1,008.  I used $1,000 for simple rounding.  Interest, taxes, charitable, and state taxes were at $15,500 while the standard is $11,900 for Married Filing Joint.  Take that at 28% or whatever your bracket is to come up with the benefit.  I don't think the taxes sways the calc much though.  Obviously if you have a house worth more than $300,000 then it becomes a bigger benefit while working.

If you are dead set on this, you would also need to calculate what your other deductions are, because for most people, if Mortgage interest (and property tax) is your only deduction, you won't exceed your standard deduction. To gain the full benefit, your itemized deductions would need to match the standard deduction.

Then you need to make assumptions based on future tax code, like how much they will increase the standard deduction by, every year, whether they continue the mortgage interest deduction, if LTCG and dividend rates and brackets stay as they currently are, etc. Making educated guesses on these things in the near term (<5 years) is a challenge, I can't imagine trying to guess out past 15 years. Who would have guessed when Bush Sr was in office, that in 10 years, his son would be President invading Iraq again.

englyn

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #11 on: March 19, 2013, 07:01:09 PM »
That is crazy high interest rates.  Do you know what is causing them?  Is there huge inflation expected in the near term?  Weak dollar?  For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate.  Seems like an opportunity to invest in mortgage notes.  Is there a market for that in Australia?

No, 17% is crazy high interest rates ;) they were up there for a brief period in the 80's for reasons I don't understand. 6% is low for Aus. Few years ago they were 8.5%. Dollar is strong and the reserve bank has been cutting the rates to try to stimulate retail spending, trying to avoid stagflation.
The banks say they have to keep the rates up there because of their own high borrowing costs on the international market. Partly influenced by our overvalued dollar I expect. But otherwise, HMMMM, given the rates in other countries. Suspect they're charging whatever people will pay.
Mortgage notes?? never heard of them! Will investigate.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #12 on: March 19, 2013, 07:34:35 PM »
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

That is crazy high interest rates.  Do you know what is causing them?  Is there huge inflation expected in the near term?  Weak dollar?  For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate.  Seems like an opportunity to invest in mortgage notes.  Is there a market for that in Australia?

Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life. 
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Self-employed-swami

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #13 on: March 19, 2013, 08:00:19 PM »
I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.

That is how I look at it.  It is being saved somewhere.

Tyler

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #14 on: March 19, 2013, 10:00:03 PM »
I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.

Well said.

Mike

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #15 on: March 20, 2013, 01:55:16 AM »
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.


tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #16 on: March 20, 2013, 10:13:44 AM »
It's impossible to do this math with any level of certainty. The second you try to plug in numbers, you will be making assumptions about the future that will ultimately prove inaccurate, perhaps wildly so.

This is a math issue.  If you use Firecalc, then you are making assumptions.  My main question is, can you create a model like Firecalc or use Firecalc in a manner that will show the impact of paying off your mortgage.  You can have it include tax benefits or not include them.  Like Firecalc with SS. 

If you think that investments will earn less than mortgage rates over the next 30 years, then again we can calculate the Safe Withdrawal Rate, which I would bet would be much lower than 3%.  Most likely closer to 1%.  At those rates, then the Safe Withdrawal rates are based off of life expectancy vs. returns.

I understand the over-thinking aspect of it, but since it applies to virtually everyone who owns a house and who wants to retire in the world, it seems like a topic to invest some mental energy.  Maybe the person that was looking for their thesis topic could team up with the owner of Firecalc.  This would be a mainstream topic and could highlight the calculated approach of retirement, the MMM community, and Firecalc.     
 

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #17 on: March 20, 2013, 10:21:32 AM »
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

I have had mortgages with rates above 6%.  It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years.  Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates. 

Tyler

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #18 on: March 20, 2013, 10:29:03 AM »

That is why it would be cool to create a calculator that figured this out.  Your principal payments are an investment that pays out at your mortgage rate.  The way you have it set up, is that it is household expenses that went up, which obviously would hurt your success rate.  This is not what is happening when you pay down your mortgage.  You are buying an investment that pays out at your mortgage rate.  If you are liquidating investments that pay out at the level, it would not hurt your yield at all.  IE take from your bonds vs your equities as you are buying a bond that pays out at 3.5% or your mortgage rate. 


Firecalc doesn't think that way. For the purposes of living off your portfolio, a house is an expense, not an investment. The "investment" payout of paying off a house from a Firecalc perspective is baked into the reduced expenses.

It sounds like you need to get familiar with Excel and build your own tool. 

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #19 on: March 20, 2013, 11:32:38 AM »
I have had mortgages with rates above 6%.

My original mortgage on the house I'm living in was IIRC 7.25%, and that was only like 12 or 13 years ago.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #20 on: March 20, 2013, 11:51:42 AM »
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

I have had mortgages with rates above 6%.  It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years.  Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates.

Aus, like Canada, is resource-and-finance. We are, probably, heading into a secular bear market for natural resources.

The AU$ and CAD$ are both, historically, really strong right now. Mortgage rates are, historically, really low right now.

What is "normal" at the moment will almost certainly NOT be normal in 5 years, 10 years.

So: Chances of US$ gaining more than 3% p/a vs the AU$ for 5 years? Certainly possible.

capital

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #21 on: March 22, 2013, 09:31:52 AM »
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

I have had mortgages with rates above 6%.  It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years.  Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates.
The current historically-low rates in the United States are an attempt by the Federal Reserve to put money into the hands of consumers in order to encourage spending to drive economic recovery. Since the housing collapse, people have mostly been paying down debt or saving money, and decreased housing prices and incomes have driven down state government spending.

Australia's economy is pretty healthy due to resource exports and other factors-- it apparently hasn't been in recession since the early 1990s-- so their central bank has kept rates higher with the goal of keeping inflation lower, as allowing too much credit (and thus too much money) chasing after limited resources drives prices up.

clifp

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #22 on: March 24, 2013, 05:10:08 AM »
This is an oft discussed topic on the e-r.org forums.

So rather than recreate the wheel, here's plenty of reading for you.

You'll find people arguing both sides.  Since I prefer the keep a mortgage option (mainly due to inflation risk - holding the mortgage is an amazing inflation hedge, as your payment stays fixed while your portfolio can grow - and inflation is the #1 enemy to retirement, especially an early retirement that lasts a long time), I'll cherry pick some quotes to support that. ;)



Having been part of these discussion on various retirement boards, including E-R.org let me throw my $.27 (inflation) in.
First, the math generally support keeping a mortgage in retirement, but the numbers are generally close and are highly dependent on income and tax levels.
For folks in the accumulation phase,  most models show you come out pretty far ahead with mortgage, as long as you can take advantage of most of the mortgage interest deduction and you are comfortable with high equity allocation.  Look at this way the dividend yield on the S&P 500 is around 2.1% dividends and are very likely to exceed inflation, with a 3.5% loan you only need a 1.4% annual increase in stock prices over 30 years. This means an  S&P of 2360 or above and you come out ahead,. It is entirely possible that might happen in the next 5 to 7 years.

But the math is still fairly close and so the psychological factors matter a lot.  I paid off my mortgage, an ARM, around 1993 when I was in my early 30s. It did feel great to be debt free at the age.
On the other hand I assumed mortgage in retirement, in my 40s and was fine with it.  I paid it off a few years later, when I felt like there wasn't any great investment opportunities.  During the 2008 meltdown part of me was glad I didn't have mortgage payments, but part of me was upset that I didn't have cash to buy cheap stocks.  I took out a HELCO to purchase investment properties in Vegas. Right now I am in the process of getting 15 year mortgage, since the interest rate are so crazy low. I'll pay off my higher interest HELCO, do some real home improvements, buy an expensive car, and probably purchase another property in Vegas.  But partly I'll be borrowing the money because rates are so low.  One of the possible mortgage vendors is PenFed, and I will take great psychological pleasure  in looking at the 2.75% interest I am paying them and comparing it to the 5% interest I am getting for some 10 year CDs with them. I like knowing that if interest rates raise dramatically I can roll over my 10 year CDs and get higher interest rate but the mortgage (actually Fannie Mae) is stuck with my pay 2.75% for 15 years.

Like so many other financial things, a mortgage can viewed two ways, as a debt which burdens you, or an financial opportunity.  At today's rates I view it as an opportunity.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #23 on: March 24, 2013, 07:42:08 AM »
Right now I am in the process of getting 15 year mortgage, since the interest rate are so crazy low. I'll pay off my higher interest HELCO, do some real home improvements, buy an expensive car, and probably purchase another property in Vegas.  But partly I'll be borrowing the money because rates are so low.  One of the possible mortgage vendors is PenFed, and I will take great psychological pleasure  in looking at the 2.75% interest I am paying them and comparing it to the 5% interest I am getting for some 10 year CDs with them. I like knowing that if interest rates raise dramatically I can roll over my 10 year CDs and get higher interest rate but the mortgage (actually Fannie Mae) is stuck with my pay 2.75% for 15 years.

Interesting to hear your strategy.  Another successful retiree (besides Nords) getting a mortgage in retirement.  Thanks for sharing.

Also Vegas may not be the best place to invest in a rental at the moment, IMO.  (I myself am looking at a few other places outside Nevada). We should talk next time you're in town.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #24 on: March 28, 2013, 12:52:53 AM »
Interesting to hear your strategy.  Another successful retiree (besides Nords) getting a mortgage in retirement.  Thanks for sharing.
The lenders only care about cash flow:  pension income, rental property income, dividends/interest income.  Assets and unrealized capital gains don't count.

From their perspective, a stupidly risky junk-bond fund paying a 10% dividend is more desirable than the same amount of cash in Berkshire Hathaway stock.  They won't even consider your future pension income (for example, a military veteran who's retired from the Reserves/National Guard but whose pension starts at age 60) and they won't consider any assets.  Social Security would count if you were actually collecting it, but not if you were merely eligible.

On our last refinance I even had to obtain military retiree statements that "proved" my military pension would be paid next year.  Maybe the lender trusted me, but they seemed pretty skeptical about the government's ability to pay my pension.

Nobody cared whether the word was "retired" or "chronically unemployed".

The second page of the standard form had a huge continuation sheet.  I'd seen it before but I'd never understood its purpose.  The processor mentioned that it was for people to list all of their debts:  car loans, credit card balances, student debt, personal loans, alimony/child support...

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #25 on: March 28, 2013, 08:25:23 AM »
Actually getting the mortgage while FIRE'd does seem to be a tough nut to crack.  Clif's getting the HELOC is probably the simplest option, but of course doesn't lock you into a 30-year fixed, which may be desirable.

Ah well, I'm figuring in a few years when all of us on these forums want to be ERing anyways we'll be locked into rates lower than the going rate at the time, so getting a new one won't be an issue (aside from, perhaps, wanting to unwrap some equity for dry powder - again a time where a HELOC may be useful).
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #26 on: April 18, 2013, 01:55:05 PM »
Not the most academic article, but it shows that at these rates one has to start asking whether it makes sense to make extra payments to the mortgage.

http://homes.yahoo.com/news/why-paying-off-your-mortgage-early-is-actually-dumb-174007929.html

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #27 on: April 18, 2013, 09:01:01 PM »
Quote
Aus, like Canada, is resource-and-finance. We are, probably, heading into a secular bear market for natural resources.

The AU$ and CAD$ are both, historically, really strong right now. Mortgage rates are, historically, really low right now.

What is "normal" at the moment will almost certainly NOT be normal in 5 years, 10 years.

Good point. Particularly on the "normal" front!

Oz = great place to save $, not so good for a mortgage. Oz banks have tighter lending laws than in the US. That, combined with higher interest rates and demand for its natural resources from China, helped the country avoid much of the latest recession that the US/Europe have gone through.

We were looking at buying a house when we moved there in '09, but decided against it after reading about 'negative gearing' as the norm where we lived (Sydney). http://en.wikipedia.org/wiki/Negative_gearing_(Australia)

Edit: bloody Mac autocorrect typos
« Last Edit: April 18, 2013, 09:02:51 PM by expatartist »

leaderscorp

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #28 on: May 08, 2013, 12:20:28 AM »
You should consider the stability of your job and your monthly budget before deciding whether you will get a 15 year fixed mortgage or 30 year. Your FI will not be affected if you get the right computation for sure.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #29 on: May 10, 2013, 08:17:38 AM »
You should consider the stability of your job and your monthly budget before deciding whether you will get a 15 year fixed mortgage or 30 year. Your FI will not be affected if you get the right computation for sure.

Based on the 15 or 30 year fixed mortgage rates you could be retired and have a mortgage, which would increase your firecalc success percentage. Having assets in a semi liquid investment portfolio form is safer than having them tied up in your house. If you are building your net worth then having a mortgage and an investment portfolio will speed up your FI date. A fixed rate mortgage is one of the greatest inflation hedges out there. If your portfolio can't beat 3.5% over the next 30 years, then your SWR is probably close to 1% unless we go into a long term deflationary environment. With all countries printing money to fire up the economy this does not appear to be a problem in the next decade.

 

leaderscorp

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #30 on: May 10, 2013, 09:06:13 PM »
So you are suggesting not to take fixed rate mortgage?

Alex in Virginia

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #31 on: May 11, 2013, 06:09:43 AM »
Hi, All...

So far in this discussion, there's been no consideration of how the availability of reverse mortgages affects how one can look at a mortgage payoff.  Notwithstanding the high fees associated with negotiating a reverse mortgage, it still remains that -- past age 60? -- such a mortgage would enable one to cash back out home equity without incurring an increase in one's monthly expenses.  To me, that option helps make a mortgage payoff much more palatable, because it means that I'll still have fairly ready access to that payoff money in the future while significantly -- and permanently -- reducing my present FI basic living expenses.

And, yes, I'm paying off my mortgage.

Alex in Virginia

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #32 on: May 11, 2013, 06:55:24 AM »
I'm with Alex - I plan on buying next (smaller) home outright. (Arebelspy is right: it's very difficult to get a mortgage once you really are ER'd. I'd strongly consider a mortgage at these rates, but without wageslave-type income, it's very hard to qualify.)

Like Alex, I view a mortgage-free property as the financial backstop in the unlikely event we outlive assets. We would either sell to move to assisted living or take a reverse mortgage.

(I should add that we're not concerned about leaving an estate of zero. If you want to leave children or other bennies some legacy, a reverse mortgage may not be the right backstop for you.)

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #33 on: May 11, 2013, 07:23:37 AM »
So you are suggesting not to take fixed rate mortgage?

No a 30 year fixed rate loan is a gift from the government.  If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.

If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #34 on: May 11, 2013, 07:29:39 AM »
So you are suggesting not to take fixed rate mortgage?

No a 30 year fixed rate loan is a gift from the government.  If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.

If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.

And if anyone doesn't understand any of this (especially the first paragraph, re: how it relates to one's SWR), ask questions!

This is so crucial, and I think anyone fully understanding it will be much more prepared for FIRE (not just the mortgage part, perhaps you're renting, but the concepts behind it, regarding SWR and inflation), despite what they decide about their mortgage (though I think most understanding it will choose to keep the mortgage, at today's rates.. In the 5-6%s it's more debatable).

Great post tomsang.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #35 on: May 13, 2013, 10:12:42 PM »
So you are suggesting not to take fixed rate mortgage?

No a 30 year fixed rate loan is a gift from the government.  If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.

If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.

I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #36 on: May 14, 2013, 12:14:55 AM »
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.

I disagree with both of these (the latter if you're ER'd, the former in most cases).
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #37 on: May 14, 2013, 03:03:03 PM »
So you are suggesting not to take fixed rate mortgage?

No a 30 year fixed rate loan is a gift from the government.  If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.

If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.

+1000

leaderscorp

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #38 on: May 14, 2013, 09:37:20 PM »
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.

I disagree with both of these (the latter if you're ER'd, the former in most cases).

Can you elaborate this?

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #39 on: May 14, 2013, 10:13:29 PM »
Regarding the first, having a mortgage is a credit boost as it is a different credit type than most (credit cards, etc.). Paying it off won't help your credit score and could, in fact, lower it slightly.

Regarding the second, if you are ER'd, you have no w2 income, and it will be very difficult to get a mortgage, even owning a free and clear house.  They don't care about assets, they care about cash flow.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #40 on: May 15, 2013, 12:05:52 AM »
I am pretty sure that you will not be having a hard time obtaining another mortgage.
As Arebelspy says, I've done a half-dozen refinancings since ER and every one of them has depended on cash flow.  Pension, rental income, dividends, interest, good.  Lenders care about those.  Assets, capital gains, bad.  Lenders don't care about those.

For one refi I had to show two years of 1099-Rs (to verify pension income) and then I had to supply a third statement from the Dept of Defense finance office that affirmed the federal government would be paying my pension next year as well.  Luckily they only needed one year of that coverage despite our application for a 30-year mortgage.

Once when we were filling out the standard application form, the second page was blank.  I asked the mortgage broker what it was for.  She replied "It's the continuation sheet for people's listing of their debts.  Is this really all the credit cards you have?!?" 


leaderscorp

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #41 on: May 15, 2013, 09:37:56 PM »
I understand now. But, I don't see any problem in paying the mortgage early.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #42 on: May 15, 2013, 09:56:49 PM »
There's no problem with it persay, it's just not optimal. See tomsang's post above.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #43 on: May 15, 2013, 11:22:27 PM »
I understand now. But, I don't see any problem in paying the mortgage early.
It's a perpetual debate.

However before you retire you should maximize your opportunities to borrow money.  I'd say that (at a minimum) a homeowner should arrange for a home-equity line of credit at no closing costs, even if it's just for emergency use.  For some of us (like me) it's also a homeowner mortgage and a rental mortgage.  Loans are a lot easier to get it while you're working, and a lot harder to get it when you've retired.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #44 on: May 16, 2013, 09:59:17 AM »
I understand now. But, I don't see any problem in paying the mortgage early.
It's a perpetual debate.

However before you retire you should maximize your opportunities to borrow money.  I'd say that (at a minimum) a homeowner should arrange for a home-equity line of credit at no closing costs, even if it's just for emergency use.  For some of us (like me) it's also a homeowner mortgage and a rental mortgage.  Loans are a lot easier to get it while you're working, and a lot harder to get it when you've retired.

That's a key learning from this thread -  get your 30 fixed mortgage before you stop working, on a property that you'll keep to live in or rent out. Once you're FIRE I can understand how you won't get a loan.

3.5%  fixed for 30 years is the biggest bargain ever. But you must offset the debt with equity invested elsewhere...

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #45 on: May 19, 2013, 06:17:05 PM »
All, having followed most of the thread but still risking missing something, how about the following scenario for a near-retirement age working individual in the US whose current full-time IT consulting work is subject to the vagaries of the market and considerable downward pressure on billing rates:

Does it not make sense to pay down as quickly as possible one's residential mortgage and credit card debt while still maintaining a reduced, modest monthly contribution to 401k and other retirement accounts? Ideally, I will still have some earning years ahead of me after all is paid off to continue to supplement retirement accounts or other savings options yet in the worst case scenario that income dries up at least I won't be saddled with a hefty monthly mortgage and property tax bill (in NJ this is a killer) at a time when retirement is looming and SS and retirement accounts are my only income source.
Any thoughts about taking this sprint to the finish line?

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #46 on: May 19, 2013, 06:27:03 PM »
And if your income dries up, I'd much rather have that amount liquid, able to pay your mortgage (or not), rather than not have a mortgage and have lower expenses, but be unable to pay them because so much of your money is locked up in an inaccessible form of home equity.

YMMV.

[edit: autocorrect typo]
« Last Edit: May 19, 2013, 07:18:06 PM by arebelspy »
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #47 on: May 19, 2013, 06:47:15 PM »
Arebelspy--
Your point is well taken. Maybe a few more facts may help:
I receive disposable income averaging $11000 per month after taxes, SS, withholding, etc., of which $2200 goes straight to 401k.
I intend to have all CCs paid off in 6 months(I am now paying about $3k/month). My $200k mortgage now costs me about $900/month--P&I (5/5 arm, 2.75%). My intent was to pay off the mortgage before the 5th year interest rate reset, i.e., about $40k/year in principal (=$3.5k/month). Interest on this mortgage is averaging about $450/month. I don't know how I would manage if in 3 or 4 years from now my income is drastically reduced and I have still to pay off a large mortgage balance. I would be able to dip into retirement savings for this (with no early withdrawal penalty as I am 62 yo) but it would have major impact on quality of life in my retirement years. It seems to me the sooner I can rid myself of the mortgage burden the better. Thoughts about this? Thanks

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #48 on: May 19, 2013, 10:21:35 PM »
I want to pay mine off for cash-flow reasons, so yes, not financially optimal.  However, I do have other leveraged investments, so I'm not totally losing out on the low interest rates.

I want to quit working, and have reduced monthly expenses, so I can stay home with our future munchkins, while my husband keeps working. 

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #49 on: May 30, 2013, 07:41:16 PM »
Arebelspy--
Your point is well taken. Maybe a few more facts may help:
I receive disposable income averaging $11000 per month after taxes, SS, withholding, etc., of which $2200 goes straight to 401k.
I intend to have all CCs paid off in 6 months(I am now paying about $3k/month). My $200k mortgage now costs me about $900/month--P&I (5/5 arm, 2.75%). My intent was to pay off the mortgage before the 5th year interest rate reset, i.e., about $40k/year in principal (=$3.5k/month). Interest on this mortgage is averaging about $450/month. I don't know how I would manage if in 3 or 4 years from now my income is drastically reduced and I have still to pay off a large mortgage balance. I would be able to dip into retirement savings for this (with no early withdrawal penalty as I am 62 yo) but it would have major impact on quality of life in my retirement years. It seems to me the sooner I can rid myself of the mortgage burden the better. Thoughts about this? Thanks

Paying off the mortgage does not increase your net worth if the money is coming out of investments. If you are diverting assets from your investments to pay down the mortgage, you are saying that your best investment yield is lower than your mortgage rate. If you believe this then you need to reduce your Safe Withdrawal Rate as all the history has been with yields greater than 3.5% over a 30 year period.

If you lose your job, you have more flexibility having money in marketable investments than in your house. If you have an ARM, then you are giving up the inflation hedge that a 30 year mortgage provides.