Author Topic: Paying off Mortgage Early How bad is it for your FI Date?  (Read 226215 times)

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #150 on: March 04, 2014, 03:19:58 PM »
Keeping my mortgage outstanding post ER also makes it more complicated for me to determine how much I need to retire.  I had been using a number equal to 25x my annual expenses excluding my mortgage payments (on the assumption that my mortgage would be fully paid off at the time I declare FIRE), plus a cushion.  Any thoughts on the best way to calculate the number needed if the mortgage will remain outstanding?  One way to think about it would be to use the same number I used previously, plus additional investments in an amount equal to the remaining balance of the mortgage.

That's probably the easiest way.  The other way is to calculate your expenses with the mortgage payment, but then, like you said, it'll have to cover the whole payment, and that might lengthen your time to FI.

It'll be a much more secure FI, however, because it doesn't purposefully draw down any of that "extra" principal you had that you didn't use to pay off the mortgage.  Use the former method you suggested if you're comfortable with "bucketing" your portfolio like that, and drawing down on that part, otherwise the latter portion will be safer, but take longer.

If you want the same time to FI, but with likely more money at the end, do your method, or do the refi thing.
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brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #151 on: March 04, 2014, 03:45:22 PM »
Keeping my mortgage outstanding post ER also makes it more complicated for me to determine how much I need to retire.  I had been using a number equal to 25x my annual expenses excluding my mortgage payments (on the assumption that my mortgage would be fully paid off at the time I declare FIRE), plus a cushion.  Any thoughts on the best way to calculate the number needed if the mortgage will remain outstanding?  One way to think about it would be to use the same number I used previously, plus additional investments in an amount equal to the remaining balance of the mortgage.

That's probably the easiest way.  The other way is to calculate your expenses with the mortgage payment, but then, like you said, it'll have to cover the whole payment, and that might lengthen your time to FI.

It'll be a much more secure FI, however, because it doesn't purposefully draw down any of that "extra" principal you had that you didn't use to pay off the mortgage.  Use the former method you suggested if you're comfortable with "bucketing" your portfolio like that, and drawing down on that part, otherwise the latter portion will be safer, but take longer.

If you want the same time to FI, but with likely more money at the end, do your method, or do the refi thing.

Thanks, that all makes sense.  But it also highlights another way that not paying off the mortgage could delay FI:  even if I use my "bucketing" method, which in theory should allow me to retire at the same time as if I paid off the mortgage, if the markets go down in the next several years it will delay my early retirement (whereas if i directed all those payments to mortgage principal I would have attained FIRE sooner). 

I think these are all the reasons I've been splitting my after-tax savings between vanguard investments and mortgage principal over the past few years to hedge my bets.  But I've never really fleshed out the rationale and the pros and cons as well as this discussion has done for me.  I am now reevaluating my approach, but I may ultimately decide to continue with it.

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #152 on: March 04, 2014, 04:21:37 PM »
Using the outstanding balance is  conservative.  In reality you only need assets that will grow enough to pay off the mortgage. For example using you 100k/477 month example, you would need 80k earning 6% to pay off the mortgage. See you just cut 20k off the amount you need to save for retirement. It should be pointed out there are all sorts of tax and ACA things that can factor into this math also. You would have to evaluate them.

Yes if the market crashes, you are better off with a paid of mortgage. And if the markets soar, you are retiring years earlier. That is market risk.  Paying off the mortgage in 2007 saved you from a 40k loss. Paying it off in 2009 cost you a 200k gain. Which one delays your FIRE date more? No one can say. This last crash was incredibly short. The experience out of 2000-2002 was a bit different


Keeping my mortgage outstanding post ER also makes it more complicated for me to determine how much I need to retire.  I had been using a number equal to 25x my annual expenses excluding my mortgage payments (on the assumption that my mortgage would be fully paid off at the time I declare FIRE), plus a cushion.  Any thoughts on the best way to calculate the number needed if the mortgage will remain outstanding?  One way to think about it would be to use the same number I used previously, plus additional investments in an amount equal to the remaining balance of the mortgage.

That's probably the easiest way.  The other way is to calculate your expenses with the mortgage payment, but then, like you said, it'll have to cover the whole payment, and that might lengthen your time to FI.

It'll be a much more secure FI, however, because it doesn't purposefully draw down any of that "extra" principal you had that you didn't use to pay off the mortgage.  Use the former method you suggested if you're comfortable with "bucketing" your portfolio like that, and drawing down on that part, otherwise the latter portion will be safer, but take longer.

If you want the same time to FI, but with likely more money at the end, do your method, or do the refi thing.

Thanks, that all makes sense.  But it also highlights another way that not paying off the mortgage could delay FI:  even if I use my "bucketing" method, which in theory should allow me to retire at the same time as if I paid off the mortgage, if the markets go down in the next several years it will delay my early retirement (whereas if i directed all those payments to mortgage principal I would have attained FIRE sooner). 

I think these are all the reasons I've been splitting my after-tax savings between vanguard investments and mortgage principal over the past few years to hedge my bets.  But I've never really fleshed out the rationale and the pros and cons as well as this discussion has done for me.  I am now reevaluating my approach, but I may ultimately decide to continue with it.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #153 on: March 04, 2014, 04:46:56 PM »
Using the outstanding balance is  conservative.  In reality you only need assets that will grow enough to pay off the mortgage. For example using you 100k/477 month example, you would need 80k earning 6% to pay off the mortgage. See you just cut 20k off the amount you need to save for retirement. It should be pointed out there are all sorts of tax and ACA things that can factor into this math also. You would have to evaluate them.

Yes if the market crashes, you are better off with a paid of mortgage. And if the markets soar, you are retiring years earlier. That is market risk.  Paying off the mortgage in 2007 saved you from a 40k loss. Paying it off in 2009 cost you a 200k gain. Which one delays your FIRE date more? No one can say. This last crash was incredibly short. The experience out of 2000-2002 was a bit different

Great point foobar.  And since, in general, the markets go up over time, you're more likely to have it rise than crash.

Again, play the odds that you're comfortable with, but historically the odds have heavily been on the side of invest over mortgage payoff.
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foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #154 on: March 04, 2014, 06:33:08 PM »
Technically historically the odds have been probably more in a favor of paying of your mortgage.  But the 8.5 in 1990s (or the 12% of the early 80s) is not the same as a 4.0 of today.  The 4% SWR rate depends on 6%+ returns over 30 years. If you believe in that, you should worry about mortgages that cost less than that. If you start talking about 2% SWR then yeah pay off the mortgage.


Using the outstanding balance is  conservative.  In reality you only need assets that will grow enough to pay off the mortgage. For example using you 100k/477 month example, you would need 80k earning 6% to pay off the mortgage. See you just cut 20k off the amount you need to save for retirement. It should be pointed out there are all sorts of tax and ACA things that can factor into this math also. You would have to evaluate them.

Yes if the market crashes, you are better off with a paid of mortgage. And if the markets soar, you are retiring years earlier. That is market risk.  Paying off the mortgage in 2007 saved you from a 40k loss. Paying it off in 2009 cost you a 200k gain. Which one delays your FIRE date more? No one can say. This last crash was incredibly short. The experience out of 2000-2002 was a bit different

Great point foobar.  And since, in general, the markets go up over time, you're more likely to have it rise than crash.

Again, play the odds that you're comfortable with, but historically the odds have heavily been on the side of invest over mortgage payoff.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #155 on: March 07, 2014, 07:34:41 PM »
There are a few seperate factors at play, and we all will have our own take on the various assumptions. Thats ok. As long as you do the math,  and at the same time surface and accept the assumptions,  cool.

consider:
- interest rates and your underlying assumptions about cost of and return on capital. A SWR of 4% assumes a nominal pretax CAGR of your investment portfolio of around 9%. But thats over 30++ years. In the usa we can borrow at 30 year fixed nominal rates of 4.5%. YMMV

- tax and government allowances can severly distort the effective tax rate at lowish incomes. A mortgage paid house is like free undeclared income when it comes for applying for means tested benefits, like health care. Imagine you own a sweet 300k house that would cost about 2k a month to rent. Thats like adding 30k per year to your effective income pretax. A lot of benefits dissappear between say 30k and 60 k per year indeclarable  income. A cheap house in a rich area could give lots of other tax free benefits,  like good schools, nice parks, efficient police, etc.

- quality of life. If you own the land and the house and you can do what you want. You cant get kicked out easily, build, etc. Peace of mind. Worth a lot. But remember you never really own it freehold, unless you want to live in the middle of nowhere. Property taxes. Can be huge. Dont pay, and you loose your property.

- real estate is a great investment, wrt the land value. Location location. Opportunities for capital gains are huge. Tax free if you live there more than 2 years in the usa.

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #156 on: March 07, 2014, 08:12:02 PM »
300k house = 240k mortgage = 1100 a month. Call it 14k/yr. Does that mean your income needs to go up by 14k? Nope. 1k would be a reasonable high guess.

Owning  a home versus renting has advantages and disadvantages. They have nothing to do with having a mortgage. Real estate is a good investment because of leverage. Get rid of that and it averages about 1% above inflation (some areas to a lot better. Some do worse).


There are a few seperate factors at play, and we all will have our own take on the various assumptions. Thats ok. As long as you do the math,  and at the same time surface and accept the assumptions,  cool.

consider:
- interest rates and your underlying assumptions about cost of and return on capital. A SWR of 4% assumes a nominal pretax CAGR of your investment portfolio of around 9%. But thats over 30++ years. In the usa we can borrow at 30 year fixed nominal rates of 4.5%. YMMV

- tax and government allowances can severly distort the effective tax rate at lowish incomes. A mortgage paid house is like free undeclared income when it comes for applying for means tested benefits, like health care. Imagine you own a sweet 300k house that would cost about 2k a month to rent. Thats like adding 30k per year to your effective income pretax. A lot of benefits dissappear between say 30k and 60 k per year indeclarable  income. A cheap house in a rich area could give lots of other tax free benefits,  like good schools, nice parks, efficient police, etc.

- quality of life. If you own the land and the house and you can do what you want. You cant get kicked out easily, build, etc. Peace of mind. Worth a lot. But remember you never really own it freehold, unless you want to live in the middle of nowhere. Property taxes. Can be huge. Dont pay, and you loose your property.

- real estate is a great investment, wrt the land value. Location location. Opportunities for capital gains are huge. Tax free if you live there more than 2 years in the usa.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #157 on: March 08, 2014, 02:11:36 PM »
300k house = 240k mortgage = 1100 a month. Call it 14k/yr. Does that mean your income needs to go up by 14k? Nope. 1k would be a reasonable high guess.

Owning  a home versus renting has advantages and disadvantages. They have nothing to do with having a mortgage. Real estate is a good investment because of leverage. Get rid of that and it averages about 1% above inflation (some areas to a lot better. Some do worse).

The comparison wasn't between owning and renting, it was between paying off your mortgage and keeping it outstanding.  Keeping the balance on a 240k mortgage outstanding (and invested) will generate a lot more than 1k in income, and it will count against eligibility for means tested gov't benefits (ACA tax credits being the most salient in my mind).

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #158 on: March 10, 2014, 02:55:18 PM »
Exactly. Thanks brooklynguy!

ACA is exactly one example. I could try to work a specific example...

imagine 2 FIRE couples. The first own their own 300k house. The second own the same house next door, but have an 80% mortgage, at 5%.

Both have a portfolio delivering 10% nominal returns. The Owners portfolio is 350k, generating 35k in mixed dividend and capital gains. Tax of 4200 less health subsidy of 2.5k leaves income of 33k.

The Borrowers have a 240k mortgage and a portfolio of 590k, thus generating 59k in mixed income. Plus a yearly mortgage payment of 12k in interest. Federate tax is 13%, 7700. Health care subsidy would be zero. Total income after tax, interest and healthcare, 39300. From that they would be saving 6k a year towards repayment,  so end up with 33k.

it looks like a wash assuming 10% returns.


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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #159 on: March 10, 2014, 03:39:40 PM »
Lets go with your example. (note I think the 10% is crazy high but it will really show how much money your tossing away by paying off your mortgage in low interest rate environments, I did the math with 7% and put it in parens ). Assuming 3% inflation
couple a spends 20k year
couple b spends 32k/yr
a) has 1.9 million dollars in 30 years (12k)
b) has 3.7 million dollars in 30 years (262k). This is actually understanding the case as I inflated the whole 32k instead of just the 24k to keep the math simple.

Now you say I am ignoring taxes.  But when you in the 0% tax bracket, you can ignore federal taxes.

What about ACA? Well the second person is going to have 10-15k of income (capital gains are not income until realized). Guess what? That still gets you the full ACA credit. Sure in 30 some years he is going to have a very low cost basis portfolio but who cares. You will be in medicare land by then.  Heck if you worried about that situation, give up the credit every couple of years and realize 90k of capital gains.

Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.

Exactly. Thanks brooklynguy!

ACA is exactly one example. I could try to work a specific example...

imagine 2 FIRE couples. The first own their own 300k house. The second own the same house next door, but have an 80% mortgage, at 5%.

Both have a portfolio delivering 10% nominal returns. The Owners portfolio is 350k, generating 35k in mixed dividend and capital gains. Tax of 4200 less health subsidy of 2.5k leaves income of 33k.

The Borrowers have a 240k mortgage and a portfolio of 590k, thus generating 59k in mixed income. Plus a yearly mortgage payment of 12k in interest. Federate tax is 13%, 7700. Health care subsidy would be zero. Total income after tax, interest and healthcare, 39300. From that they would be saving 6k a year towards repayment,  so end up with 33k.

it looks like a wash assuming 10% returns.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #160 on: March 10, 2014, 07:35:16 PM »
Quote
Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.

Only if you actually invest it. I know a lot of people who have huge mortgages, but then also have 6 figures in cash earning 0%.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #161 on: March 10, 2014, 08:07:09 PM »
Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.

With the "in most cases" qualification, I agree.  But it's worth being cognizant of these issues and running the numbers to see if this applies in one's own individual case.  There's a handy ACA subsidy estimator available at http://kff.org/interactive/subsidy-calculator/

In my situation, if I keep my mortgage balance outstanding (and assume it will generate a nominal return of 7%), that additional income will disqualify me for annual subsidies having a value equal to 1% of the mortgage balance.  (And that's looking only at ACA subsidies, putting aside any other means-tested tax benefits I might lose out on.)  So there will be circumstances where the math justifies paying off the mortgage, primarily at the higher end of the "low" mortgage rate spectrum.

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #162 on: March 10, 2014, 09:46:17 PM »
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.  If you end up needing more money sell every 7 years and skip 1 year of ACA subsidy. Even paying 15% in taxes you will come out ahead if your getting 7% returns. My goal in life isn't to max out government benefits and minimize taxes. It is to have enough money to do what I want. Paying less in taxes and getting ACA support is a means to an end not an end.

Obviously this situation really only exists because of the current low mortgage rates. 3.5% for 30 years means you almost assured of being a winner and the 4% rule  is in real trouble if your not:). 8.0% for 30 years (you know like the ancient history of 2000) is a whole different ball game where unless you have some 12% bonds laying around, you might struggle to make much.


Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.

With the "in most cases" qualification, I agree.  But it's worth being cognizant of these issues and running the numbers to see if this applies in one's own individual case.  There's a handy ACA subsidy estimator available at http://kff.org/interactive/subsidy-calculator/

In my situation, if I keep my mortgage balance outstanding (and assume it will generate a nominal return of 7%), that additional income will disqualify me for annual subsidies having a value equal to 1% of the mortgage balance.  (And that's looking only at ACA subsidies, putting aside any other means-tested tax benefits I might lose out on.)  So there will be circumstances where the math justifies paying off the mortgage, primarily at the higher end of the "low" mortgage rate spectrum.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #163 on: March 11, 2014, 08:52:32 AM »
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.  If you end up needing more money sell every 7 years and skip 1 year of ACA subsidy. Even paying 15% in taxes you will come out ahead if your getting 7% returns. My goal in life isn't to max out government benefits and minimize taxes. It is to have enough money to do what I want. Paying less in taxes and getting ACA support is a means to an end not an end.

Obviously this situation really only exists because of the current low mortgage rates. 3.5% for 30 years means you almost assured of being a winner and the 4% rule  is in real trouble if your not:). 8.0% for 30 years (you know like the ancient history of 2000) is a whole different ball game where unless you have some 12% bonds laying around, you might struggle to make much.

You're right, you don't have to realize the full amount of the nominal return.  But you do need to realize an amount sufficient to cover the mortgage payments plus the portion of health insurance premiums that otherwise would have been covered by ACA subsidies (and any other tax credits/avoidance, etc., that otherwise would have been obtained).  I think you've convinced me that in the overwhelming majority of cases, if the mortgage rate is low enough, the math will justify keeping the mortgage outstanding even in light of these types of considerations.  But these factors should still be taken into account when determining the optimal strategy--the determination isn't as simple as "if the expected market return exceeds the mortgage rate, don't pay off the mortgage, period."

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #164 on: March 11, 2014, 08:55:12 AM »
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #165 on: March 11, 2014, 09:02:25 AM »
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?

The overriding question on that would be "what assumptions would go into it?"

It's easiest to roll your own based on your assumptions.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #166 on: March 11, 2014, 09:14:52 AM »
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?

The overriding question on that would be "what assumptions would go into it?"

It's easiest to roll your own based on your assumptions.

I'm currently working on one for my own situation, but I figured someone had already made one for this general situation.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #167 on: March 11, 2014, 10:08:48 AM »
I'd keep it simple. Unless you are a very experienced investor/trader/real estate guy who KNOWS they can beat current interest rates with their returns...just pay off the mortgage early. Holding stock index funds ASSUMING that they will return 5%+ over the lifetime of your mortgage is foolish. You have no idea if they will. Nobody does.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #168 on: March 11, 2014, 10:55:04 AM »
You don't need to realize income to pay your bills. Lets look at how much the mortgage person needs to realize in additional income
200k of stock that goes up 10%
You want 12k so you sell  some  stock.
How much income did you realize? A bit under 1200 dollars. The other 10800 dollars is return of principal

  Now your income will drift up slowly over the years as your cost basis decreases (depends a lot on returns and your opportunities to tax loss harvest) so eventually your income will get you over the subsidy line but for a person expecting to live on 20k/yr with a 1.2 million dollar portfolio, that is going to take 30+ years.


Yes ACA complicated things but not by much. The person without a mortgage still needs to balance keeping income low and while making sure future income isn't high (to avoid taxing SS and medicare) and figuring out that balance isn't easy. Their only "advantage" is they have a lot less money to deal with.


You're right, you don't have to realize the full amount of the nominal return.  But you do need to realize an amount sufficient to cover the mortgage payments plus the portion of health insurance premiums that otherwise would have been covered by ACA subsidies (and any other tax credits/avoidance, etc., that otherwise would have been obtained).  I think you've convinced me that in the overwhelming majority of cases, if the mortgage rate is low enough, the math will justify keeping the mortgage outstanding even in light of these types of considerations.  But these factors should still be taken into account when determining the optimal strategy--the determination isn't as simple as "if the expected market return exceeds the mortgage rate, don't pay off the mortgage, period."

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #169 on: March 11, 2014, 11:07:48 AM »
Retiring before 70 is also foolish by this logic. What if after you retire you get 0% investment returns and you out of money in 20 years? If you believe in the 4% rule, you expect to be making ~7% for the next 30+ years. Maybe we are in a bad period where the rules break down but the odds are against it.

I'd keep it simple. Unless you are a very experienced investor/trader/real estate guy who KNOWS they can beat current interest rates with their returns...just pay off the mortgage early. Holding stock index funds ASSUMING that they will return 5%+ over the lifetime of your mortgage is foolish. You have no idea if they will. Nobody does.

hodedofome

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #170 on: March 11, 2014, 02:20:02 PM »
Retiring before 70 is also foolish by this logic. What if after you retire you get 0% investment returns and you out of money in 20 years? If you believe in the 4% rule, you expect to be making ~7% for the next 30+ years. Maybe we are in a bad period where the rules break down but the odds are against it.

I would never recommend someone retire early unless they can live off of stable income for perhaps a significant period of time or have a way to bring in extra income if they need it.

Nobody can know what will happen, but I think it's foolish to assume markets always have to go up, just because we need them to in order to fund our retirements. Which is why there's diversification. Diversify globally, diversify asset classes. 100% buy and hold allocation to US stock index funds for an early retirement is retarded IMO. You are taking unlimited risk on that bet. You are assuming that because it's worked before, it will continue to work. Past performance is not indicative of future results.

This book should be required reading for those on this board recommending a 100% US stock allocation strategy http://www.amazon.com/Triumph-Optimists-Global-Investment-Returns/dp/0691091943
« Last Edit: March 11, 2014, 02:42:34 PM by hodedofome »

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #171 on: March 11, 2014, 08:10:08 PM »
What is stable income? It sure isn't rentals (what happens when you can't rent for 6 months), bonds (interest rate risks), stocks, and so on. At best your looking at tips. With a .2% real return, you need to save like 50x of expenses if you want to retire at 45. Or you can take reasonable risks and retire with 25x assets at any age. There is nothing wrong with being super conservative. You just have to realize the costs (and benefits) of doing it.

Is it foolish to think that markets always go up? Sure. But make a list of the markets that have had 30 year losing periods and it is a very small list. Heck even Japan is just one good 5 year stretch from being break even:)

Retiring before 70 is also foolish by this logic. What if after you retire you get 0% investment returns and you out of money in 20 years? If you believe in the 4% rule, you expect to be making ~7% for the next 30+ years. Maybe we are in a bad period where the rules break down but the odds are against it.

I would never recommend someone retire early unless they can live off of stable income for perhaps a significant period of time or have a way to bring in extra income if they need it.

Nobody can know what will happen, but I think it's foolish to assume markets always have to go up, just because we need them to in order to fund our retirements. Which is why there's diversification. Diversify globally, diversify asset classes. 100% buy and hold allocation to US stock index funds for an early retirement is retarded IMO. You are taking unlimited risk on that bet. You are assuming that because it's worked before, it will continue to work. Past performance is not indicative of future results.

This book should be required reading for those on this board recommending a 100% US stock allocation strategy http://www.amazon.com/Triumph-Optimists-Global-Investment-Returns/dp/0691091943

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #172 on: March 11, 2014, 08:14:52 PM »
What is stable income? It sure isn't rentals (what happens when you can't rent for 6 months)

Rentals can be quite stable.  In decent areas, vacancy is close to 0%.  If you can't rent it for 6 months, you're doing something way wrong - your asking price is wrong.  Everything will rent (or sell) at the right price.  If you're in an area where an eviction takes three weeks or so, your worst case scenario is around a month total vacancy, with proper management.

I've never heard of a competent landlord or management not being able to rent something for 6 months.
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foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #173 on: March 11, 2014, 09:08:23 PM »
 I lived in a desirable area. We went from 0 vacancy to  just under 10% in about 18 months. My rent dropped 30% in that time period. That isn't stable income.  Imagine if instead of just a little bubble we had a full 10 year deflation cycle. Are rentals relatively low risk investments? Sure. But they are not no risk. You have to give up a ton of return in order to get to the no risk world.

But lets say you believe in rentals and not stocks and bonds. That doesn't change anything.  No one is saying you need to invest your "mortgage pay off money" in the stock market. Buy a couple rental units with the cash. If you can't get 5% off your investment, you picked bad units.



What is stable income? It sure isn't rentals (what happens when you can't rent for 6 months)

Rentals can be quite stable.  In decent areas, vacancy is close to 0%.  If you can't rent it for 6 months, you're doing something way wrong - your asking price is wrong.  Everything will rent (or sell) at the right price.  If you're in an area where an eviction takes three weeks or so, your worst case scenario is around a month total vacancy, with proper management.

I've never heard of a competent landlord or management not being able to rent something for 6 months.

hodedofome

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #174 on: March 11, 2014, 09:32:50 PM »
Bonds can be stable income if you are the holder of the bond. Bond funds are a bet on the direction of Interest Rates. If you hold the bond then you'll get the interest payments. Annuities are mostly stable. Life insurance is stable. Rents can be stable but can fluctuate. Key is diversification, unless you know a particular area very well.

I disagree that nobody is saying invest your mortgage payoff money in the stock market. That advice is rampant in this forum. And that is the specific advice I am adressing. It's the only thing I really disagree with Dave Ramsey about as well.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #175 on: March 11, 2014, 09:39:12 PM »
I disagree that nobody is saying invest your mortgage payoff money in the stock market. That advice is rampant in this forum. And that is the specific advice I am adressing. It's the only thing I really disagree with Dave Ramsey about as well.

Indeed.

I would absolutely advocate for someone holding a sub-4% mortgage to direct extra funds towards investments in equities to hold long term before paying down that debt, yes.

Only someone comfortable with the risks and who understood all the scenarios.

But that person would have come out ahead historically nearly every time.  That's the smart play, IMO.

You don't like it for yourself personally, fine.  But to say that no one should do it (when you don't know their risk tolerance levels, goals, etc.) isn't a credible position, IMO.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #176 on: March 12, 2014, 08:38:42 AM »
It is not generic advice.

But in the USA especially many of us feel that long term interest rates are artificially low, certainly last year when they were 3.5%, but even now at 4.5%, fixed at nominal rates for 30 years.

Now, no matter what your personal investment portfolio is, whatever your allocation between stock, bonds, real estate,  tulips, .. if you are planning to FIRE there will be an assumption on SWR. MMM recommends 4%, not out of line with generally accepted rules of thumb and historic performances of investments.

But anything similar, even 3% SWR, inherently projects long term average CAGR nominal growth in your portfolio of about 7 - 9 %

so borrowing long term at these low rates as long as you can handle the cashflow implications and volatile portfolio ups and downs, tax implications too, seems a solid investment.

This must be considered in line with your overall portfolio gearing ratio  - which should be low, and preferably only comprise this kind of long term fixed deal.

In other countries, interest rates are much higher, and usually floating. Fixed rates can be more expensive and only available for a few years. In these cases especially paying off that mortgage sounds like a great idea, because relative to your portfolio the risked returns are better, or at least comparable,  in paying off the mortgage.

Note though that putting all your money and savings into 1 asset, your house, is also pretty crazy and very high risk.


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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #177 on: March 12, 2014, 09:45:36 AM »
It is not generic advice.

But in the USA especially many of us feel that long term interest rates are artificially low, certainly last year when they were 3.5%, but even now at 4.5%, fixed at nominal rates for 30 years.

Now, no matter what your personal investment portfolio is, whatever your allocation between stock, bonds, real estate,  tulips, .. if you are planning to FIRE there will be an assumption on SWR. MMM recommends 4%, not out of line with generally accepted rules of thumb and historic performances of investments.

But anything similar, even 3% SWR, inherently projects long term average CAGR nominal growth in your portfolio of about 7 - 9 %

so borrowing long term at these low rates as long as you can handle the cashflow implications and volatile portfolio ups and downs, tax implications too, seems a solid investment.

This must be considered in line with your overall portfolio gearing ratio  - which should be low, and preferably only comprise this kind of long term fixed deal.

In other countries, interest rates are much higher, and usually floating. Fixed rates can be more expensive and only available for a few years. In these cases especially paying off that mortgage sounds like a great idea, because relative to your portfolio the risked returns are better, or at least comparable,  in paying off the mortgage.

Note though that putting all your money and savings into 1 asset, your house, is also pretty crazy and very high risk.

I think that almost any advice can become dangerous or useless if taken as generic.  Blindly following any course of action without taking your personal situation into account can lead you astray.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #178 on: March 12, 2014, 11:14:36 AM »
Already editing my first post.

It's my first post after months of lurking.  But we followed arebelspy's advice and did our own spreadsheet. 

We considered a couple of scenarios since we have approximately 1k of money to invest after maxing out all tax advantaged accounts.  We have a 15 year 3.5% mortgage.

All scenarios assumed a 7% nominal return in the market.  Time Horizon was 15 years, then 30 years.

Scenario 1) Invest 1k in stock index fund each month and pay off mortgage in 15 years.
Scenario 2) Invest 1k in additional principal payments each month (pay off in 6+ years), then invest mortgage payment +1k in stock index fund.
Scenario 3) Look for optimal state that maximizes total gains by paying some extra on mortgage (paying it off early 8+ years), then once we paid it off early, invest the mortgage payment +1k in savings.

At the end of the 15 years, Scenario 3 had slightly less invested in the market then in scenario 1 and we owned our house free and clear.  However, we reduced the maximal amount of interest paid throughout the mortgage, while still taking advantage of most of the mortgage interest deduction.  It put us ahead financially and we get to "feel good" since we pay off the mortgage early.  This is the method we are choosing.

We also looked at different market scenarios.  Scenario 3 beat Scenario 1 if historic rates of growth over the long term continue or if rates are lower.  It is only a less optimal choice if the market does better than the historic rate of return over the long term.

As some other poster said, however, we are sure happy to be able to have all of these options to choose from.
« Last Edit: March 12, 2014, 11:36:46 AM by mobyrocket »

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #179 on: March 12, 2014, 11:39:10 AM »
Mobyrocket!  Welcome-

Can you elaborate on your quote:

We also looked at different market scenarios.  Scenario 3 beat Scenario 1 if historic rates of growth over the long term continue or if rates are lower.  It is only a less optimal choice if the market does better than the historic rate of return over the long term.

Market averages are in excess of 8%, you are paying a mortgage at 3.5%, I can't see how you would not be better off under scenario 1 if you are using those rates in your fact pattern.

Are you taking into account that you can liquidate a portion of your portfolio in year 8, pay off your mortgage and still have more left over?  I think something is missing or not calculating correctly.

I would love to see your spreadsheet.

Welcome to the forum!

Tom

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #180 on: March 12, 2014, 12:06:27 PM »
Tomsang,

Thanks for the reply.  As I stated we used the long term return of 7% as our top rate of return not 8%.    So I think our math is right, but it seems like you are challenging our assumptions.  Always a good thing from a data perspective.  As I said, we are making a sub-optimal choice if the market returns more than 7%.  And it has over the long term, but the spread is quite large.

I've learned a lot in the forum and from the MM family collectively, so we may change our current plan as we learn more but we wanted to at least take ourselves through some different scenarios and think about the value of our emotional and financial motivations.

I can give you some of our other assumptions - we want to retire early, we don't count the value of our home in our net worth or retirement projections, we subscribe to index investing (my partner invests in target retirement funds, I go all in for a 5 fund portfolio and re-balance semi-annually), we are somewhat risk averse so all of our projections are based on the lower end of the curve for market returns to calculate our early retirement date.  The mortgage payoff question is one of a number of steps we are taking to build our financial future.  We fully fund our tax advantage accounts and are currently looking at decreasing our emergency fund (told you we are risk averse) and make all those little Benjamin Franklins work harder for us.  Oh and we are constantly looking for our own anti-mustachian behaviors and giving them a face punch and telling them to skedaddle.

I think I attached the spreadsheet correctly.

« Last Edit: March 12, 2014, 12:12:31 PM by mobyrocket »

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #181 on: March 12, 2014, 05:50:47 PM »
Mobyrocket - Thanks for your spreadsheet. I put together a spreadsheet to show the impact of paying off your mortgage at various rates, etc.  Play around with it, let me know what should be changed, etc.  I have been meaning to create a spreadsheet for sometime as this topic comes up and I feel like we are all talking about different things.  Hopefully, this will clarify the concepts if not let me know so I can improve the spreadsheet.

I am looking forward to your involvement on the boards.


Tom
« Last Edit: March 14, 2014, 03:49:51 PM by tomsang »

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #182 on: March 12, 2014, 08:20:48 PM »
Thanks everyone, love hearing both sides of it.  After much consideration I am switching sides.

I am locked in at 3.875% with 28 years scheduled, probably 26 years after the extra payments and I will probably live here another 3-5 years (trying to move west).

I was sending in an extra $300-$600 a month to the bank, now going to split it into 3 funds (VTSAX, VDIGX, VCVLX). 

One reason, worst case, I can't make a payment, the bank does not care that I paid extra for years, they want the next check.  If the market goes down, I will still have enough to make a few payments. 

The biggest reason, if after 3-5 years of buying stocks every month they should do better than 3.875%, and I will have the added benefit of the tax savings paying more into the interest along the way.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #183 on: March 12, 2014, 08:50:55 PM »
He isn't better off financially.  He feels better saving 100 dollars instead of making 150 and paying 100 (made up numbers).  Hedging like that is often a very good strategy when you have mixed feelings about a choice.  Now 15 years is a lot different than 30. The risk factor goes up and the benefit goes down to investing. That being said I am gambling that over 7 years I can earn more than 2.5%. So far up big but there is still a lot of time to revert to the mean. I am also gambling that we will be moving in the next 7 years:)


Mobyrocket!  Welcome-

Can you elaborate on your quote:

We also looked at different market scenarios.  Scenario 3 beat Scenario 1 if historic rates of growth over the long term continue or if rates are lower.  It is only a less optimal choice if the market does better than the historic rate of return over the long term.

Market averages are in excess of 8%, you are paying a mortgage at 3.5%, I can't see how you would not be better off under scenario 1 if you are using those rates in your fact pattern.

Are you taking into account that you can liquidate a portion of your portfolio in year 8, pay off your mortgage and still have more left over?  I think something is missing or not calculating correctly.

I would love to see your spreadsheet.

Welcome to the forum!

Tom

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #184 on: March 13, 2014, 01:03:26 AM »
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.


...because the majority here are stashing money in tax deferred investments, not taxexempt investments. In the USA , mostly stashing in a 401(k) - and you realize income when the money is taken out.

Additionally for the "Refi/Take out a loan" crowd - when you take out that $300,000 loan, you are paying perhaps $5,000* for origination fee, title search, et cetera.You aren't getting $300,000 to invest - you are getting $295,000

Does it dramatically change the equation? No. Just another nibble, like needing to pay taxes on the gains you are using to pay the mortgage, and tax incentive phaseouts due to higher income.

Does a 4% mortgage for 30 years and investing the rest make sense in the USA? In lots of cases - yes. But you cannot overlook all of the additional costs.

Personally, I have 7.5 years left on a mortgage @ 2.5% - I am not planning to pay it down, but I'm not planning to refi anytime soon either.

*YMMV, of course. $5,000 is just an example number.
« Last Edit: March 13, 2014, 01:05:14 AM by TomTX »

mobyrocket

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #185 on: March 13, 2014, 10:55:23 AM »
Tom,

FYI to foobar, I'm a she : )

The spreadsheet is really great, much more elegant than our scenario analysis.  I have a couple of questions.  I didn't see where you factored in the interest payment avoidance.  As you could tell from my analysis, I discounted each ending balance by the interest paid over the lifetime of the loan.  Do you feel this is a bad assumption on my part in comparing the scenarios?  I understand that you did not factor in mortgage interest deduction, but the cost avoidance seems like it's not chump change.

Also, once we pay off the loan we immediately moved the mortgage payment and the excess principle into the stock market.  So under the scenario where I don't pay off my mortgage early, I don't increase investments into the stock market until year 15, but under the paying early scenarios, I increase my yearly stash into the stock market at year 6 or 8.  Under my analysis, this would reduce the difference in gains between paying nothing extra versus paying extra.   I looked at the math tab and your analysis looks just at investing the extra over the 30 year period of time.   Could you explain your thought process in leaving this out?  It makes intuitive sense that investing 1k a month for 30 years at 7% gets me farther ahead than 1k at 3.5% for 7 years + 1k at 7% for 7 years.  However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments. 

Great discussion and thank you for engaging with me.

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #186 on: March 13, 2014, 12:15:45 PM »
You are changing the problem from
a) I have 200k laying around should I invest it or pay off my mortgage
to
b) Do I take extra 260k out of my 401(k) (Probably be more as you will be paying 33% on the money you take out for you living expenses ) or would I be better off taking an extra 14k/yr out of my 401(k).

I haven't done the math on the second one but I would be surprised if paying an extra 58k in taxes up front works out for some one planning on living on 40-50k/yr. Sure you would lose ~1k/yr of ACA support but having to pay taxes at lower rate would be a big win and being able to keep 60k more invested is really nice.

Obviously their are a ton more cases out there (pay the loan off over 5 years instead of 1, roll the money to a roth instead of paying off the house,...) that you would need to think about.  Picking the right one would require thinking about your situation for the next 20 years and making a lot of guesses.




Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.


...because the majority here are stashing money in tax deferred investments, not taxexempt investments. In the USA , mostly stashing in a 401(k) - and you realize income when the money is taken out.

Additionally for the "Refi/Take out a loan" crowd - when you take out that $300,000 loan, you are paying perhaps $5,000* for origination fee, title search, et cetera.You aren't getting $300,000 to invest - you are getting $295,000

Does it dramatically change the equation? No. Just another nibble, like needing to pay taxes on the gains you are using to pay the mortgage, and tax incentive phaseouts due to higher income.

Does a 4% mortgage for 30 years and investing the rest make sense in the USA? In lots of cases - yes. But you cannot overlook all of the additional costs.

Personally, I have 7.5 years left on a mortgage @ 2.5% - I am not planning to pay it down, but I'm not planning to refi anytime soon either.

*YMMV, of course. $5,000 is just an example number.

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #187 on: March 13, 2014, 12:54:13 PM »
I have a couple of questions.  I didn't see where you factored in the interest payment avoidance.  As you could tell from my analysis, I discounted each ending balance by the interest paid over the lifetime of the loan.  Do you feel this is a bad assumption on my part in comparing the scenarios?  I understand that you did not factor in mortgage interest deduction, but the cost avoidance seems like it's not chump change.

Mobyrocket- I think you hit on a major hurdle for people when you talk about Interest Payment Avoidance.  The typical reply is that by paying XYZ Debt vs. investing that I avoid paying interest.  My spreadsheet does take this into account.  Under the Math Tab, Column A - We are required to make the full mortgage payment to term.  Therefore, we don't have the money to invest.  So this is accounting for the interest avoidance.  It is basically saying that we are ok with paying interest if we can get a better yield in Columb B (Investment) 


Also, once we pay off the loan we immediately moved the mortgage payment and the excess principle into the stock market.  So under the scenario where I don't pay off my mortgage early, I don't increase investments into the stock market until year 15, but under the paying early scenarios, I increase my yearly stash into the stock market at year 6 or 8.  Under my analysis, this would reduce the difference in gains between paying nothing extra versus paying extra.   I looked at the math tab and your analysis looks just at investing the extra over the 30 year period of time.   Could you explain your thought process in leaving this out?  It makes intuitive sense that investing 1k a month for 30 years at 7% gets me farther ahead than 1k at 3.5% for 7 years + 1k at 7% for 7 years.  However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments.

Under my previous calculator once you paid off your mortgage the remaining payments were going into an investment account and earning the equivalent to the mortgage rate.  I updated the calc to be earning the investment yield when your mortgage is paid off.  Under the Math Tab, under the Mortgage Paydown Extra Payment calc you will see that the mortgage starts off as a positive number in column T.  Once your mortgage is paid off it becomes a negative number.  That negative number represents your investment account growing. The formula that I created says that if the mortgage balance is a positive number the interest is calculated using the mortgage rate.  If it is a negative number than the interest is calculated using the investment rate.  So if you have a 30 year mortgage you can go to the last row and see the investment account balance, the paid off mortgage early investment account and see the difference.  I captured that on the Input sheet in 5 year increments, but you can capture it by year if you want.  I just wanted to keep it simple.  If you see a negative in Column F or Column H on the Input Sheet that is indicating investments or investments exceeding the loan.         


sherr

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #188 on: March 13, 2014, 01:03:01 PM »
The spreadsheet is really great, much more elegant than our scenario analysis.  I have a couple of questions.  I didn't see where you factored in the interest payment avoidance.  As you could tell from my analysis, I discounted each ending balance by the interest paid over the lifetime of the loan.  Do you feel this is a bad assumption on my part in comparing the scenarios?  I understand that you did not factor in mortgage interest deduction, but the cost avoidance seems like it's not chump change.

Hi Moby,

This is wrong, but in a very subtle way. I'll do my best at explaining.

You were already accounting for paying the mortgage interest in each of your scenarios with the off-the-books aspect of your spreadsheet. In your spreadsheet you don't account for the money you're spending on the mortgage in any of the scenarios, you just start adding it in in later once the mortgage is paid off. So in scenario 1 say it looks like for the first 15 years you're paying $13,528 every year on mortgage repayments, and $12k a year on investing. But you are paying for the mortgage interest as part of that ~$13k per year; it's both paying the interest and the principle of your mortgage. So by subtracting the mortgage interest on line 19 you are double-counting the mortgage interest; once when you paid it as a fraction of your mortgage payment that you did not invest, and once when you explicitly subtract it on line 19. The double-counting incorrectly makes the scenarios that pay more mortgage interest look worse than they are; in order to have a correct comparison you need to delete line 19 altogether.

In case that's not clear I'll try explaining another way. You need to stick to accounting for the money either entirely physically or entirely theoretically. By "entirely physically" I mean that you have to keep track of where all your physical money goes; you made a payment here on such-and-such date, invested so-and-so here on such-and-such date, etc. This is mostly what your spreadsheet is, except for line 19. The other way you could go, which is also entirely valid and will wind up with the same answers, is entirely theoretically; if you have X amount of money to invest each month you could either a) pre-pay your mortgage and save X in theoretical interest that you would otherwise have had to pay or b) invest it and receive X in interest that you would otherwise have not earned. In the theoretical case it's perfectly valid to have the "lifetime mortgage interest accrued" counted as a negative when you're comparing scenarios, but you would also have to have the "opportunity cost of not having invested that money" to counter-balance it.

Make sense? It's entirely valid to consider the mortgage interest as a drag on your gain in net worth, but in your spreadsheet you are implicitly accounting for that by not investing the mortgage payments. Implicitly accounting for it and then explicitly accounting for it is wrong, you need to do just one or the other.
« Last Edit: March 13, 2014, 01:06:36 PM by sherr »

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #189 on: March 13, 2014, 01:04:44 PM »
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments. 

Another great topic that is discussed!!! People focus on what they are paying vs. what they are receiving or the net of what they are paying netted with their investment returns. Your cashflow is vastly better off having a huge stache!  Under the input sheet you can see your Stache under B (Column D).  This is your cash flow.  You have all of this money to pay bills, spend, invest, etc.  At some point the return kicking off of this is greater than your mortgage payment.  Therefore your cash flow is positive even though you still have a mortgage payment.   

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #190 on: March 13, 2014, 01:10:30 PM »
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments. 

Another great topic that is discussed!!! People focus on what they are paying vs. what they are receiving or the net of what they are paying netted with their investment returns. Your cashflow is vastly better off having a huge stache!  Under the input sheet you can see your Stache under B (Column D).  This is your cash flow.  You have all of this money to pay bills, spend, invest, etc.  At some point the return kicking off of this is greater than your mortgage payment.  Therefore your cash flow is positive even though you still have a mortgage payment.   

+1.  EXCEPT in the case brooklynguy wrote about earlier, when you have a ton of trapped equity so your payment is high and the invested amount that covers the balance doesn't kick off enough for the high P&I payment.  In that case, you may need to Refi.

But in general, having the amount liquid and earning more will net you more cash flow at the end of the day, aside from more overall money.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #191 on: March 13, 2014, 02:07:17 PM »
Brain currently on overload trying to remember back to finance and accounting classes and digesting all these really thoughtful explanations . . .   Thanks to all of you for working through this.  I'll plug away at refining our scenarios based on tomsang's excellent tool.  The additional explanation on how the math tab works is super helpful.  I'm taking all the feedback home to walk through this with my partner.  Seems like we may be optimizing our strategy a bit more.

I can feel the bristles on our staches growing right now : )

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #192 on: March 13, 2014, 03:10:03 PM »
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments. 

Another great topic that is discussed!!! People focus on what they are paying vs. what they are receiving or the net of what they are paying netted with their investment returns. Your cashflow is vastly better off having a huge stache!  Under the input sheet you can see your Stache under B (Column D).  This is your cash flow.  You have all of this money to pay bills, spend, invest, etc.  At some point the return kicking off of this is greater than your mortgage payment.  Therefore your cash flow is positive even though you still have a mortgage payment.   

+1.  EXCEPT in the case brooklynguy wrote about earlier, when you have a ton of trapped equity so your payment is high and the invested amount that covers the balance doesn't kick off enough for the high P&I payment.  In that case, you may need to Refi.

But in general, having the amount liquid and earning more will net you more cash flow at the end of the day, aside from more overall money.

Arebelspy, you and others have convinced me that even in that situation, in most cases it's still better to defer paying off and just draw down on the invested principal for cash flow, as long as the time horizon until mortgage maturity is long enough (which, of course, will be inversely correlated with the amount of trapped equity).

Edit:  I meant better than the alternative of paying off the mortgage, not the alternative of refinancing.  I'm specifically thinking of my own situation.  I had been paying down aggressively for a while but I still have about 90% of the original principal balance outstanding and 24 years until maturity.  Keeping my mortgage balance outstanding seems like my best bet for optimization.  My plan is now to cease all mortgage prepayments in favor of investing those amounts in the markets.
« Last Edit: March 13, 2014, 04:01:58 PM by brooklynguy »

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #193 on: March 13, 2014, 03:59:18 PM »
Arebelspy, you and others have convinced me that even in that situation, in most cases it's still better not to pay off and draw down on the invested principal for cash flow, as long as the time horizon until mortgage maturity is long enough (which, of course, will be inversely correlated with the amount of trapped equity).

Wow, neat.  It's rare someone has an open mind and changes their opinion based on internet discussions.  :)

Yeah, I think that's the best way to go, draw down on the principal of the "payoff" funds, but others may be uncomfortable with that idea because they can't see past the idea of "drawing down principal = bad" (even though if they pay off the mortgage they're drawing down from principal to do so, or will have a lower portfolio amount).
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TomTX

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #194 on: March 13, 2014, 05:17:16 PM »
You are changing the problem from
a) I have 200k laying around should I invest it or pay off my mortgage
to
b) Do I take extra 260k out of my 401(k) (Probably be more as you will be paying 33% on the money you take out for you living expenses ) or would I be better off taking an extra 14k/yr out of my 401(k).


No, I'm not. I am countering your position, which you also stated thusly: "You don't need to realize income to pay your bills. "

For most people here, a significant fraction of their 'stache is inside a 401(k)* - in order to pay bills in retirement, they have to get money out of the 401(k). When they get money out of the 401(k) - ALL of that money is income. They have realized income. They have to pay taxes on it.

My understanding of your assumption (which I disagree with**) is that most of the assets are already outside the 401(k) and you will only pay taxes (realize income) on the gain.


*Or rolled over to a Traditional IRA. Whatever. Irrelevant to the point.

**For most people here, obviously not all.

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #195 on: March 13, 2014, 06:16:03 PM »
And how do you plan on paying off the mortgage with that tax advantaged money?  After you take the money out to pay off the mortgage, are you not back to where we started with 200k that you can either pay off the mortgage or invest? And in this case the investment works out even better because you can roll that 200k into a Roth (yeah you have to work around with the 5 year rule) and generate no income forever. Wasting that tax space on paying off your mortgage early would be sad.


You are changing the problem from
a) I have 200k laying around should I invest it or pay off my mortgage
to
b) Do I take extra 260k out of my 401(k) (Probably be more as you will be paying 33% on the money you take out for you living expenses ) or would I be better off taking an extra 14k/yr out of my 401(k).


No, I'm not. I am countering your position, which you also stated thusly: "You don't need to realize income to pay your bills. "

For most people here, a significant fraction of their 'stache is inside a 401(k)* - in order to pay bills in retirement, they have to get money out of the 401(k). When they get money out of the 401(k) - ALL of that money is income. They have realized income. They have to pay taxes on it.

My understanding of your assumption (which I disagree with**) is that most of the assets are already outside the 401(k) and you will only pay taxes (realize income) on the gain.


*Or rolled over to a Traditional IRA. Whatever. Irrelevant to the point.

**For most people here, obviously not all.
« Last Edit: March 13, 2014, 09:00:04 PM by foobar »

PeteD01

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #196 on: March 16, 2014, 07:24:47 AM »
Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.

http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/

Peter

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #197 on: March 16, 2014, 02:51:54 PM »
Are you aware of any place that will offer me a 30 year fixed rate margin loan at <4% that will not be called if the asset drops 50%? They aren't remotely the same product.


Yes leverage adds risk but it also adds return. In this case the added return drastically outweighs the risk due to the extended time period. Imagine you shove all the money in to an S&P 500 fund (lets assume no taxes to keep it real easy and this is NOT how I would invest money I didn't need for 30 years) during the worst 30 year period ever. Hmm that's an 8% return.  Maybe we are starting a new worst 30 year period that will only return 2%. Its possible. But I wouldn't want to bet on it.

Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.

http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/

Peter

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #198 on: March 16, 2014, 04:20:56 PM »
Are you aware of any place that will offer me a 30 year fixed rate margin loan at <4% that will not be called if the asset drops 50%? They aren't remotely the same product.


Yes leverage adds risk but it also adds return. In this case the added return drastically outweighs the risk due to the extended time period. Imagine you shove all the money in to an S&P 500 fund (lets assume no taxes to keep it real easy and this is NOT how I would invest money I didn't need for 30 years) during the worst 30 year period ever. Hmm that's an 8% return.  Maybe we are starting a new worst 30 year period that will only return 2%. Its possible. But I wouldn't want to bet on it.

Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.

http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/

Peter

There is no question that a young person with little invested and a 30 years low rate mortgage should continue investing in tax advantaged accounts and defer paying off the mortgage. There's really not much choice in the matter.

There is also no question that borrowing on margin is different because of the possibility of a margin call, although I would look at what happened to many people with underwater mortgages and job loss a few years ago as somewhat of a margin call equivalent. The fact remains that leveraged investments can turn ugly in a hurry.

What I am having trouble understanding is that many people have not only mortgage debt but also significant investments in bonds. I have never had more than 10% in bonds ( ok, had another 5% in TREA which I believed at the time to be bond-like, well it isn't but I was able to time it in 2009).
The reason is probably that asset allocation is often looked at as something happening just within the investment portfolio. So one hears that someone has an AA of 30/70 but then learns that the same person has a mortgage balance as large as their investment portfolio. That makes no sense at all.
In reality, this person is facing volatility risk of way more than a 100% stock allocation (referenced to all investable assets of course) with the bond investments only limiting upside potential. And upside potential is clearly all what counts for an investor with such a high stock allocation and that is all what a young person with good future earning potential and low net worth should be worrying about.

I think it is important to note that by considering carrying debt to be similar to holding negative bonds, the AA becomes more realistic in terms of real world consequences of volatility risk - that is the effect on net asset worth. I really do not care about how my investment portfolio is doing in isolation. I do care about net invested asset worth increase over time.

Stock market investments have the highest return potential but unfortunately also have the greatest dispersion of portfolio end value. The way to deal with this is asset allocation. Look at your AA with your debts figured in as negative bonds and see what you need to do to get to your desired AA (30/70, 40/60 or whatever).

If you don't look at debts as negative bonds you may end up not knowing the actual risk you are taking as a young person and you may end up way too conservative when you are older.

By the way, I am about one year away from FIRE and my current AA is way over 100% stock market but buying back my mortgage debt will get me to about 15% bonds within the year. This excludes real estate equity and annuities.

Peter







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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #199 on: March 16, 2014, 05:36:59 PM »
Peter,

I like that approach, viewing a mortgage as an inverse or negative bond.

but make sure you're comparing apples and apples.

a fixed 30 year nominal in us$ mortgage,  at say 4.5%, for someone in solid accumulation mode, seems to be a no brainer. As long as they instead of putting equity into the house they put extra equity into the rest of the portfolio. This represents a counter play to buying a 30 yr treasury. A fixed nominal 30yr mortgage is effectively an inflation hedge., plus should return well on the leveraged equity elsewhere ( ie I expect my portfolio of stock to average 9% nominal over 30 years, pre tax.)

But my bond portfolio is not in corresponding 30 yr treasuries, but mid duration (1 - 7 yr) mid rating bonds, yielding more than 3% and the rate will roll up if rates go up.