Author Topic: Paying off Mortgage Early How bad is it for your FI Date?  (Read 226314 times)

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #250 on: September 15, 2014, 11:39:42 AM »
Interesting article on whether to payoff your mortgage. I think it says that if you are mustachian that you should keep your mortgage. If you buy high and sell low than you should pay off your mortgage.

http://www.fool.com/how-to-invest/personal-finance/credit/2014/09/14/should-you-pay-off-a-mortgage-early-the-answer-may.aspx

That's actually not a bad point - the average investor has earned 2.5%, so most people should pay off their homes, as they'll have mortgages higher than that.  A buy and hold indexer, however, should probably expect quite a bit better than that.


I am a bit suspect of the 2.5% number (can't find the report where it comes from). It looks like the number that a financial asset management firm would through out to encourage you to invest with them. And if JP Morgan clients are only making 2.5%, I don't think they would be advertising that:)

http://www.businessinsider.com/typical-investor-returns-20-years-2014-8

Read the small print under the chart for how they calculated average asset allocation investor return.

As I thought this is one of those BS numbers that is used to sell financial products. They are comparing a dollar cost averaging return to fixed sum asset returns.  The low return of the 00s (when investor had the most money after the run up in the 90s) lowers the average quite a bit compared to the opposite (low returns for a decade when money is being poured in and then high returns when you have a bunch of money invested).

Kevin Aster Tin Obin

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #251 on: September 30, 2014, 07:05:18 AM »
But let's assume you take that 165k you could use to pay off the rental and instead put them as down payments on 4 other rentals at ~40k each that cash flow $4800 each annually after expenses and debt service (say, purchase price of 160k each, putting down 25%, 120k loan at 4.4%, gross rents 1800/mo, net 1000 after expenses minus P&I of $600/mo = 400/mo cash flow = 4800 annually).

Option 1: Use 165k to pay off mortgage.  Gain $830/mo to your cash flow due to not having P&I any more.

Option 2: You use the 165k to buy 4 properties as described.  Gain 1600 to your monthly cash flow (and you get all the extra appreciation benefits, depreciation tax benefits, principal paydown, etc. that you don't get in scenario 1 that I'm completely ignoring but also makes it WAY better).

Gaining 1600/mo rather than 830/mo will let you FIRE way sooner. In fact, if we put that in your spreadsheet, let's see what you get.

If we change "holding mortgage" to "buying more", stache amount is 85k, adjusted spending after rental income is now (original 18.6k - new 4800 x 4 = 19200 negative.  I.e. You're already FIRE!  (You spend 36k annually, bring in 17400 from your rental 1, bring in 19.2k from the new rentals, and you don't need any more income, you use the 85k you have left as cash reserves).

In option 2 you are much more leveraged, which adds risk, you have more properties to manage, etc. etc.  There are certainly downsides to scenario 2.

But my point wasn't to address leverage versus not, but just your math that paying off a mortgage reduces your time to FIRE.  It doesn't, if you have a better place for that money.  If you want FIRE as fast as possible, paying off low interest mortgages is not the way to go.  Cheap leverage is, especially if it's on something that cash flows well and so you don't need to worry too much if the paper value dips.

Arebelspy, thanks for looking at this and reaffirming me I need to buy more rentals!  Makes sense!  Now to find a property...


medinaj2160

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #252 on: October 02, 2014, 04:33:04 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.


ender

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #253 on: October 02, 2014, 04:47:32 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Only 2.2%?

What is your 401k in? Mine this year is double yours, at 4.4%.

medinaj2160

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #254 on: October 02, 2014, 05:28:07 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Only 2.2%?

What is your 401k in? Mine this year is double yours, at 4.4%.

Vanguard 500 Index Signal (VIFSX) 67%
Vanguard Total Intl Stock Index Signal (VTSGX) 20%
Vanguard Total Bond Market Index Signal (VBTSX) 13%

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #255 on: October 03, 2014, 07:37:18 AM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

medinaj2160

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #256 on: October 03, 2014, 10:52:46 AM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #257 on: October 03, 2014, 11:00:13 AM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.

medinaj2160

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #258 on: October 03, 2014, 12:05:16 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.

How are you getting a 30k return in 16 months from investing 54k gradually.


VirginiaBob

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #259 on: October 03, 2014, 01:01:30 PM »
The other reason why I can see keeping a mortgage is if you live in a hurricane prone area.  Usually when the whole area is hit, homeowners insurance companies go bankrupt leaving the homeowners to foot the bills.  If you don't actually own much of the home, you lower your risk.  Your credit will take a hit, but oh well.

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #260 on: October 04, 2014, 01:53:26 PM »
Medinaj2160. If you would be open it would be interesting to use your case as a real life example of how paying off your mortgage early effects your stock portfolio, net worth and your financial independence date.

To calculate. We would need to know.

House cost
Down payment
Date of purchase
How much extra you paid each month
Any large extra payments. Amount and date.
Do you itemize for your taxes or take the standard deduction
If itimize. What tax rate.

We have your mortgage interest rate, your investment allocation. So we can calculate the returns of the funds and the interest that you would have paid.

medinaj2160

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #261 on: October 05, 2014, 07:35:24 PM »
Medinaj2160. If you would be open it would be interesting to use your case as a real life example of how paying off your mortgage early effects your stock portfolio, net worth and your financial independence date.

To calculate. We would need to know.

House cost 122k
Down payment 3.5k
Date of purchase June 2012
How much extra you paid each month as much as I could... december 2013 balance was 64k. Todays balance is 10550.
Any large extra payments. Amount and date.
Do you itemize for your taxes or take the standard deduction I was barely able to itemize last year
If itimize. What tax rate.

We have your mortgage interest rate, your investment allocation. So we can calculate the returns of the funds and the interest that you would have paid.

Our income is 121k. We spend 20k a year + the house payment $835. We have no debt other then the 10,550 on the mortgage and 5k on some zero interest credit cards. This year is the first time we both max out our 401k's and traditional IRA's. FI money would be 20k per year, FIRE money would be around 700k on the low side or 1M on the high side and no mortgage.
« Last Edit: October 05, 2014, 07:38:00 PM by medinaj2160 »

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #262 on: October 05, 2014, 08:20:13 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.

How are you getting a 30k return in 16 months from investing 54k gradually.

Thats the hand waving part given I don't know exactly when your money showed up. Given TSM is still up over 6% for the year(and the previous 20 months were even better), it is hard to come up with case where paying off early works out. And no you don't invest money like this in bonds.  And 2.4 years is a lot more than 16 months last time I checked:)

medinaj2160

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #263 on: October 06, 2014, 04:02:03 AM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.

How are you getting a 30k return in 16 months from investing 54k gradually.

Thats the hand waving part given I don't know exactly when your money showed up. Given TSM is still up over 6% for the year(and the previous 20 months were even better), it is hard to come up with case where paying off early works out. And no you don't invest money like this in bonds.  And 2.4 years is a lot more than 16 months last time I checked:)

By 16 months I meant the good months since my return for this year is only 1.9% ;).

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #264 on: January 02, 2015, 12:24:18 PM »
2014 was fruitful with the various markets doing very well.  By not paying off the 3.875% mortgages and diverting dollars to equities has pushed up my FI Date. It will be interesting to see what 2015 brings. 

S&P up 11.4%, Dow Industrial up 7.5%, NASDAQ up 13.4%, international exposure brought down my returns, but overall I still cleared a 9.38% return in 2014.   

defenestrate

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #265 on: January 27, 2015, 10:16:42 PM »
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.

Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of  annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.

No way, my beginning balance was 120k. In december 2013 it was 64k...

Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.

How are you getting a 30k return in 16 months from investing 54k gradually.

Thats the hand waving part given I don't know exactly when your money showed up. Given TSM is still up over 6% for the year(and the previous 20 months were even better), it is hard to come up with case where paying off early works out. And no you don't invest money like this in bonds.  And 2.4 years is a lot more than 16 months last time I checked:)

By 16 months I meant the good months since my return for this year is only 1.9% ;).

I believe you should pay off your mortgage based on the term of the mortgage, and you should choose the mortgage with the lower interest rate. The 15 year is an excellent choice now with sub 3% rates, usually between .6-.8% from the 30 year. Now it is true that you spend more on the 15, and you could divert that cash into investments, however, in the early years, the hurdle rate is fairly high. Including a tax shield of 25% and an opportunity cost of 10%, you would still be better off for the first 30 payments, which would be the inflection point at which the stock investment would begin to outperform, and your stock portfolio would break even at around 55 payments.

this has to do with the spread between the 30 year and the 15 year, and the principal amount applied to that spread. My example takes a $230,000 mortgage. Another way to think about this is looking at the first year, where you give up ~$6000 in extra payments, but in return reap $2000 savings in interest payments--that is a 33% return in that year. However, by year four this advantage disappears. However, the faster payoff is a much better deal than many would make it seem, and so many here are not properly looking at the short term returns of such a move, instead only focusing on the long-term.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #266 on: January 28, 2015, 08:00:42 AM »
I believe you should pay off your mortgage based on the term of the mortgage, and you should choose the mortgage with the lower interest rate. The 15 year is an excellent choice now with sub 3% rates, usually between .6-.8% from the 30 year. Now it is true that you spend more on the 15, and you could divert that cash into investments, however, in the early years, the hurdle rate is fairly high. Including a tax shield of 25% and an opportunity cost of 10%, you would still be better off for the first 30 payments, which would be the inflection point at which the stock investment would begin to outperform, and your stock portfolio would break even at around 55 payments.

this has to do with the spread between the 30 year and the 15 year, and the principal amount applied to that spread. My example takes a $230,000 mortgage. Another way to think about this is looking at the first year, where you give up ~$6000 in extra payments, but in return reap $2000 savings in interest payments--that is a 33% return in that year. However, by year four this advantage disappears. However, the faster payoff is a much better deal than many would make it seem, and so many here are not properly looking at the short term returns of such a move, instead only focusing on the long-term.

I wasn't able to follow exactly what you were trying to say, but you seem to be confused.  The only way a 15 year mortgage can effectively generate a 33% "return" as compared to a 30 year mortgage is if the interest rate were 33 percentage points lower.  The "return" on prepaying your mortgage is equal to the interest rate on your mortgage--that doesn't change based on the fact that a mortgage's repayment schedule backloads the repayment of principal.  And the tax deduction for mortgage interest (for those who can take advantage of it) weighs in favor of investing and keeping the mortgage outstanding, not the other way around.

Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #267 on: March 22, 2015, 12:05:22 AM »
I wasn't able to follow exactly what you were trying to say, but you seem to be confused.  The only way a 15 year mortgage can effectively generate a 33% "return" as compared to a 30 year mortgage is if the interest rate were 33 percentage points lower.  The "return" on prepaying your mortgage is equal to the interest rate on your mortgage--that doesn't change based on the fact that a mortgage's repayment schedule backloads the repayment of principal.  And the tax deduction for mortgage interest (for those who can take advantage of it) weighs in favor of investing and keeping the mortgage outstanding, not the other way around.

1) Mortgage payments are ALWAYS paid with post-tax money.
2) After paying off the mortgage (at possibly your highest earnings point in life), you lower your tax burden by contributing as much as possible pre-tax to savings. More % "return" on the prepayment.
3) For people 50 years old or more, losing your job with a mortgage is a high risk proposition.
4) Medicare can take your investments if you get sick, they can't take your house.

I find the focus on only the interest rate to be silly and short-sighted. Mortgages are capitalized up-front, investments are capitalized "late". Did you win if you die before earning your investment returns?

MDM

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #268 on: March 22, 2015, 12:49:36 AM »
2) After paying off the mortgage (at possibly your highest earnings point in life), you lower your tax burden by contributing as much as possible pre-tax to savings. More % "return" on the prepayment.
Or you could have been lowering your tax burden all along by contributing as much as possible pre-tax to savings, while paying only the minimum mortgage payment.

Quote
3) For people 50 years old or more, losing your job with a mortgage is a high risk proposition.
Maybe.  One can also make the case that having liquid assets is preferable to illiquid assets.  Depends on what one assumes about the performance of the liquid assets at the time coinciding with the job loss.

Quote
Mortgages are capitalized up-front, investments are capitalized "late".
Don't understand - could you elaborate?

Quote
Did you win if you die before earning your investment returns?
One might say that dying is a losing proposition no matter where one put one's money.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #269 on: March 22, 2015, 08:16:41 AM »
Quote
Mortgages are capitalized up-front, investments are capitalized "late".
Don't understand - could you elaborate?

You don't understand because it's a fundamental misunderstanding.

People look at mortgage amortization charts and think because you pay more interest up front, it makes sense to pay off some of those early years, not understanding that the interest you're paying is just a function of the amount owed and the interest rate and payment size, and of course later more goes to principal because you're paying the same payment amount but the amount owed at that point is a lot less.

But they say that it's "capitalized up front" like you have to pay more interest up front.  You're still paying the same rate though.

(And an investment would be capitalized "late" because you earn more money "late" - well duh, that's when you have more invested.)

It's not true if you understand the math, so don't sweat trying to wrap your head around the misunderstanding, MDM.  :)
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #270 on: March 22, 2015, 12:09:36 PM »
Quote
Mortgages are capitalized up-front, investments are capitalized "late".
Don't understand - could you elaborate?

You don't understand because it's a fundamental misunderstanding.

People look at mortgage amortization charts and think because you pay more interest up front, it makes sense to pay off some of those early years, not understanding that the interest you're paying is just a function of the amount owed and the interest rate and payment size, and of course later more goes to principal because you're paying the same payment amount but the amount owed at that point is a lot less.

But they say that it's "capitalized up front" like you have to pay more interest up front.  You're still paying the same rate though.

(And an investment would be capitalized "late" because you earn more money "late" - well duh, that's when you have more invested.)

It's not true if you understand the math, so don't sweat trying to wrap your head around the misunderstanding, MDM.  :)

Hey arebelspy, it's not MDM that doesn't understand. MDM was quoting my comment, it's me saying "capitalized up front" so it's me who is not understanding.

Look, this stuff isn't religion to me, it's math, just like you said.

Accelerating FIRE is important, yes. Will my employment stay healthy and robust until I can FIRE? NO idea, but I deal with that as it comes.

If I'm misunderstanding, how can I get past it? Should I plug all my data into FIREcalc, comparing several scenarios, then act accordingly?

And what-the-hell are these awesome pre-tax investments I'm missing out on besides:
- 401k (Buying Vanguard but it's Fidelity. It has a contribution cap and .15% fees)
- HSA, which I dived into when it became available to me 3 months ago which I think has zero yields.

Post-tax I'm using Betterment.

I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?
« Last Edit: March 22, 2015, 12:12:50 PM by mefla »

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #271 on: March 22, 2015, 12:38:24 PM »
I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?

Just noticed that you are parallel posting in this thread as well as the one I responded to in the general discussion subforum.  Yes, post your numbers (mortgage interest rate and remaining life to maturity being the most relevant).  I think it would be most helpful to do it in this on-topic thread for continuity for anyone following along.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #272 on: March 22, 2015, 01:23:48 PM »
I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?

Just noticed that you are parallel posting in this thread as well as the one I responded to in the general discussion subforum.  Yes, post your numbers (mortgage interest rate and remaining life to maturity being the most relevant).  I think it would be most helpful to do it in this on-topic thread for continuity for anyone following along.

Yeah, there's two discussions going on and I'm hooting and hollering in both - and it's making me tired. I want to get to the meat of it and move on.  You want me to do my own case study here in this thread? I'll do it either way - here, or start a new thread, don't matta.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #273 on: March 22, 2015, 01:35:54 PM »
Another way to think about the topic:

Getting to FIRE ASAP often entails minimizing ongoing expenses in perpetuity (based on the ridiculously simple math)

The interest portion of a mortgage is considered an expense (along with insurance and taxes)

The principal portion of the mortgage payment is typically not considered an expense but a form of savings as it increases the asset side of the balance sheet

When you pay down your mortgage early you are effectively decreasing your interest expense every year going forward (and the effect increases over time), albeit potentially at the expense of growing your assets or income growing potential by diverting that cash flow towards other investments which can appreciate or earn income in perpetuity

I find the discussion between paying down principal (and effectively decreasing future interest expense) similar to the debate about cutting spending vs simply increasing wage income: I think unless the mortgage rate is in the low 3s and the interest deduction is meaningful (i.e. the homeowner is in a very high income tax bracket) paying down principal is a more stable road towards financial independence and decreases the chances of "making a catastrophic mistake" with one's asset allocation or investment portfolio (buying high and selling low) which is not a trivial risk for 95% of the population

Note that my interpretation of expense mainly applies to primary residence and household budgets when trying to FIRE ASAP, not real estate as a business as arebelspy may be referring to

Additionally note that in practice I chose not to pay down principal early but instead divert excess cash flow and savings to investments (equities), but that was a personal decision based on my view of the market as well as a judgment call on the stability of my earning potential as a waged employee


brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #274 on: March 22, 2015, 02:59:46 PM »
Yeah, there's two discussions going on and I'm hooting and hollering in both - and it's making me tired. I want to get to the meat of it and move on.  You want me to do my own case study here in this thread? I'll do it either way - here, or start a new thread, don't matta.

The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying.  With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.

If you want to start a case study with detailed information for your specific situation (which you should probably do in a new thread), I would be willing to provide an analysis and I'm sure others would be too.  But the short answer is:  if your interest rate is low, and your remaining life to maturity is long, you can probably do better by investing in lieu of prepaying (and, if you're not in that boat, you can get yourself into it by refinancing, if you wish to).

I think unless the mortgage rate is in the low 3s and the interest deduction is meaningful (i.e. the homeowner is in a very high income tax bracket) paying down principal is a more stable road towards financial independence and decreases the chances of "making a catastrophic mistake" with one's asset allocation or investment portfolio (buying high and selling low) which is not a trivial risk for 95% of the population

I'd draw this line somewhere higher than "low 3s with a meaningful tax deduction."  A portfolio with a reasonable allocation of stock and bond index funds has a very high likelihood of outperforming a 4% mortgage (even with no tax deduction) over the next 30 years, and if it doesn't then just about all of our retirement plans are in a lot of trouble.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #275 on: March 22, 2015, 03:24:56 PM »
I think unless the mortgage rate is in the low 3s and the interest deduction is meaningful (i.e. the homeowner is in a very high income tax bracket) paying down principal is a more stable road towards financial independence and decreases the chances of "making a catastrophic mistake" with one's asset allocation or investment portfolio (buying high and selling low) which is not a trivial risk for 95% of the population

I'd draw this line somewhere higher than "low 3s with a meaningful tax deduction."  A portfolio with a reasonable allocation of stock and bond index funds has a very high likelihood of outperforming a 4% mortgage (even with no tax deduction) over the next 30 years, and if it doesn't then just about all of our retirement plans are in a lot of trouble.

Bonds are pricing in negative real rates (nominal rates lower than expected inflation).  Stocks are priced for low forward returns (until valuations normalize, which would ultimately result in negative or stagnant returns for decades). 

I would say betting on substantially more than 4% for the next 10-15yrs for a portfolio of stocks/bonds (60/40, 80/20 pick whatever allocation you want) is not a great proposition.  We are not talking about this year or next year or even the next 3-5 years, but decades from now: history has shown that asset returns are almost impossible to predict in the short run, but very predictable in the medium to long run based on traditional measures of valuation due to mean reversion in financial asset returns.  Buffett, Gross, Bernstein, Shiller, Jesse Livermore (from Philosophical Economics) - all the investing greats are in agreement that medium to long term returns going forward will be significantly lower than what we have seen the last 20-30yrs.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #276 on: March 22, 2015, 04:46:24 PM »
I would say betting on substantially more than 4% for the next 10-15yrs for a portfolio of stocks/bonds (60/40, 80/20 pick whatever allocation you want) is not a great proposition.  We are not talking about this year or next year or even the next 3-5 years, but decades from now: history has shown that asset returns are almost impossible to predict in the short run, but very predictable in the medium to long run based on traditional measures of valuation due to mean reversion in financial asset returns.  Buffett, Gross, Bernstein, Shiller, Jesse Livermore (from Philosophical Economics) - all the investing greats are in agreement that medium to long term returns going forward will be significantly lower than what we have seen the last 20-30yrs.

Fair enough, and I don't disagree with any of that.  With a 10 or 15 year period until maturity I would probably choose to pay down a 4% mortgage today.  But over a 30-year period, prepaying a 4% mortgage would have put you ahead less than 5% of the time historically (assuming you invested in a portfolio with at least a 50% stock allocation).  I would probably choose to invest today with a 4% mortgage rate, but reasonable minds can differ on the advisability of that approach -- perhaps we are currently in a situation closer to one of the 5% failure cases.  My mortgage rate is 3.875% with about 24 years remaining until maturity, and I'm choosing not to make prepayments.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #277 on: March 22, 2015, 05:04:12 PM »
I would say betting on substantially more than 4% for the next 10-15yrs for a portfolio of stocks/bonds (60/40, 80/20 pick whatever allocation you want) is not a great proposition.  We are not talking about this year or next year or even the next 3-5 years, but decades from now: history has shown that asset returns are almost impossible to predict in the short run, but very predictable in the medium to long run based on traditional measures of valuation due to mean reversion in financial asset returns.  Buffett, Gross, Bernstein, Shiller, Jesse Livermore (from Philosophical Economics) - all the investing greats are in agreement that medium to long term returns going forward will be significantly lower than what we have seen the last 20-30yrs.

Fair enough, and I don't disagree with any of that.  With a 10 or 15 year period until maturity I would probably choose to pay down a 4% mortgage today. But over a 30-year period, prepaying a 4% mortgage would have put you ahead less than 5% of the time historically (assuming you invested in a portfolio with at least a 50% stock allocation).  I would probably choose to invest today with a 4% mortgage rate, but reasonable minds can differ on the advisability of that approach -- perhaps we are currently in a situation closer to one of the 5% failure cases.  My mortgage rate is 3.875% with about 24 years remaining until maturity, and I'm choosing not to make prepayments.

And I would be refinancing to a 30-year term and investing as much as I can.  Rates won't stay low forever, and low interest fixed debt is such a good inflation hedge.  But to each his own.  Lots of paths to FIRE.  :)
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #278 on: March 22, 2015, 06:54:34 PM »
Quote
The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying.  With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.

I definitely disagree with this point.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #279 on: March 22, 2015, 07:06:51 PM »
Quote
The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying.  With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.

I definitely disagree with this point.

How so?  The first part is axiomatically true, so you must mean the second sentence... So you think the next 30 years will be a sub 3% nominal return (i.e. a negative real return)?

Please clarify.
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Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #280 on: March 22, 2015, 10:49:08 PM »
Quote
The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying.  With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.

I definitely disagree with this point.

How so?  The first part is axiomatically true, so you must mean the second sentence... So you think the next 30 years will be a sub 3% nominal return (i.e. a negative real return)?

Please clarify.

First:
I have never, ever had an investment that acts like a mortgage. The interest rate or percentage yield has never been something constant - it goes up, it goes down, it goes negative, it goes positive. So my disbelief in the statement is really a disbelief that there's an investment out there that acts as consistently positive as a mortgage such that the final $$ yield exceeds that of my mortgage.

The one investment I have that "acts" like a mortgage is my bank savings account, and I get a whopping 1% there. Now, if I could find a savings account that would pay me >% than my mortgage, I'd be all over that.

Second:
My timeframe for paying off the mortgage is five years, not 30 years. If I'm mortgage-free after five years, then I push that same money into investments and I've lost only the initial five years, not a total 30 years of investment returns.

There's further complication, in that as I pay down, I refi at certain points so that I'm not paying against a very high initial borrow. When I get at-or-under $100k owed, I'll refi to a shorter 10 year term, drop my monthly payment and then push until I'm done there also

As soon as I'm done, 100% of what I was putting toward the mortgage goes into investing. So I start racing to catch up with that guy, smarter than I am, who didn't pay off his mortgage.

Now, let's suppose me and "Smarter Guy" work for the same employer and that company goes belly up, or lays off both of us.

Neither one of us has money to invest, so higher yield investments are meaningless.
I keep my house, he loses his house, or burns through his 401k to keep it.

As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.

Now, here's the rub: my "what if" scenario I cite above is not made up - it's happened to several of my good friends and co-workers.

My last buddy who found himself in this situation had to quit because he was losing his eyesight. But guess what? He kept his house because he'd paid it off by then.

For me, the elements of personal risk matter because they have already happened and could happen again before I can FIRE. When these things do happen, there's no more ability to invest, so investment return is only meaningful on past money, not present or future money.

Saying it's only a matter of comparing % interest rates is (to me) like saying one car is cheaper than the other because the monthly payment is lower.

You guys keep arguing this teeny, tiny little sterile factoid that I've never seen happen in reality. I'm arguing from the perspective of things that I've seen happen before and I expect will happen again.
« Last Edit: March 22, 2015, 11:12:37 PM by mefla »

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #281 on: March 22, 2015, 11:03:15 PM »
Quote
The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying.  With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.

I definitely disagree with this point.

How so?  The first part is axiomatically true, so you must mean the second sentence... So you think the next 30 years will be a sub 3% nominal return (i.e. a negative real return)?

Please clarify.

First:
I have never, ever had an investment that acts like a mortgage. The interest rate or percentage yield has never been something constant - it goes up, it goes down, it goes negative, it goes positive. So my disbelief in the statement is really a disbelief that there's an investment out there that acts as consistently positive as a mortgage such that the final $$ yield exceeds that of my mortgage.

It doesn't matter if it acts like a mortgage, or what it looks like on a short time scale; it matters what it looks like at the end of the time period.  And his statement - that at the end of 30 years if the CAGR you got on your investment is higher than the mortgage interest rate, you'll end up mathematically ahead having invested.  The bumpiness of the ride along the way isn't relevant to comparing the ending value.

The one investment I have that "acts" like a mortgage is my bank savings account, and I get a whopping 1% there. Now, if I could find a savings account that would pay me >% than my mortgage, I'd be all over that.

And have interest rates (bank account, CD, whatever) always been that low?  No, of course not. There will very likely be a point in which a CD rate is higher than your interest rate, if you had a 30 year mortgage, and paying down the mortgage will be quite silly.

Second:
My timeframe for paying off the mortgage is five years, not 30 years.

We weren't talking about five years.  Read his statement, that you quoted and disagreed with.  It was on a 30-year time scale.  Why would you quote and disagree with a statement about a 30-year time scale and then come back and reply later with "my timeframe is 5 years"?

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Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #282 on: March 22, 2015, 11:22:47 PM »
Quote
We weren't talking about five years.  Read his statement, that you quoted and disagreed with.  It was on a 30-year time scale.  Why would you quote and disagree with a statement about a 30-year time scale and then come back and reply later with "my timeframe is 5 years"?

I know you weren't talking about five years...I was talking about five years. I never even said I had a 30 year mortgage, I've not had one for many years now. I'm at 15 and trying to switch down to a 10 ASAP.

You guys keep talking in generalities, saying these things like they are natural laws. Maybe they are true in the abstract sense, but there's nothing abstract about the premise of this thread. It really works only if you are much younger than 50 and you have a 30 year mortgage. It's absolutely terrible advice if you are over 50 and have a much-less-than-30 year mortgage.

But who in their right mind has a 30 year mortgage in this day and age? Haven't you overbought, badly, if you MUST have a 30 year mortgage?

matchewed

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #283 on: March 23, 2015, 05:56:28 AM »
But who in their right mind has a 30 year mortgage in this day and age? Haven't you overbought, badly, if you MUST have a 30 year mortgage?

Lots of people and for the reasons listed in this thread. It seems like you're just ignoring what people have said at this point. Speaking of speaking in generalities, even at 50+ where you can easily see another 30 years of life a 30 year mortgage is a perfectly reasonable decision if the interest rate is lower than your expected CAGR. But then as I pointed out it's already been said. Your investment timeline doesn't end at your 5 year mark, it keeps going for the rest of your investment life.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #284 on: March 23, 2015, 06:28:10 AM »

Now, let's suppose me and "Smarter Guy" work for the same employer and that company goes belly up, or lays off both of us.

Neither one of us has money to invest, so higher yield investments are meaningless.
I keep my house, he loses his house, or burns through his 401k to keep it.

As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.

Now, here's the rub: my "what if" scenario I cite above is not made up - it's happened to several of my good friends and co-workers.

This is completely apples and oranges. If you and "smart guy" had exactly the same monthly payments, to either a mortgage or investments, and you have paid off your house then the smart guy will have enough liquid investments to pay off his house too the day he lost his job. What people here are arguing is that he'd (historically) have more left than you do. You'd have a paid off house and no liquid assets, he'd have the money to either pay off his house or buy food.

Mortgage vs bank account does not make any sense for the same reason. A bank account is liquid, your house is pretty much as illiquid as it gets. A half paid off house does you no good if you loose your job, and you can't eat your house.

TheNewNormal2015

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #285 on: March 23, 2015, 06:53:41 AM »

Now, let's suppose me and "Smarter Guy" work for the same employer and that company goes belly up, or lays off both of us.

Neither one of us has money to invest, so higher yield investments are meaningless.
I keep my house, he loses his house, or burns through his 401k to keep it.

As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.

Now, here's the rub: my "what if" scenario I cite above is not made up - it's happened to several of my good friends and co-workers.

This is completely apples and oranges. If you and "smart guy" had exactly the same monthly payments, to either a mortgage or investments, and you have paid off your house then the smart guy will have enough liquid investments to pay off his house too the day he lost his job. What people here are arguing is that he'd (historically) have more left than you do. You'd have a paid off house and no liquid assets, he'd have the money to either pay off his house or buy food.

Mortgage vs bank account does not make any sense for the same reason. A bank account is liquid, your house is pretty much as illiquid as it gets. A half paid off house does you no good if you loose your job, and you can't eat your house.

I'm guessing the examples mefla mentions were during the financial crisis, when stocks (and home prices) crashed at the same time that a lot of ppl lost their jobs (and had an extremely hard time finding another one)

A lot of ppl fail to realize that employment security and asset prices are often very highly correlated - bull mkts tend to make ppl complacent I guess

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #286 on: March 23, 2015, 07:29:56 AM »
I'm guessing the examples mefla mentions were during the financial crisis, when stocks (and home prices) crashed at the same time that a lot of ppl lost their jobs (and had an extremely hard time finding another one)

A lot of ppl fail to realize that employment security and asset prices are often very highly correlated - bull mkts tend to make ppl complacent I guess

As I pointed out  to mefla in the parallel discussion in the other thread, if flexibility in light of job insecurity is a primary concern, that's an even stronger reason not to prepay your mortgage.  Monthly amortization is fixed, so if you lose your job midway through an aggressive prepayment plan, you're now stuck owing the same monthly payment with no employment income to cover it and no liquid investments to cover it.  And if you lose your job after already having paid off the mortgage in full, you're in no better position than the person who invested in lieu of prepaying and now has a big pile of investments to service the mortgage payments.

People like mefla talk about investing in lieu of prepaying as if it's taking some huge gamble, but in my view, unless you've already grossly oversaved for retirement (such that you already have more than enough beyond any reasonable doubt), taking out a fixed rate, low interest 30 year loan and investing the proceeds is the more prudent course.  Not doing so is gambling that your investment returns will outpace inflation by a sufficient margin to cover your expenses without the benefit of the inflation hedge provided by the mortgage.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #287 on: March 23, 2015, 08:41:06 AM »
You guys keep talking in generalities, saying these things like they are natural laws. Maybe they are true in the abstract sense, but there's nothing abstract about the premise of this thread.

No, we're talking math. 

But who in their right mind has a 30 year mortgage in this day and age? Haven't you overbought, badly, if you MUST have a 30 year mortgage?

Who said one MUST have a 30-year mortgage?  I could afford the payments on a 15, or 10, or 5.  Actually, to be honest, I could pay off my mortgage with cash in the bank.  No thanks.  As noted in the thread title and all the discussion, that's bad for my FI date.

It appears you didn't read any of the discussion that occurred, just came blazing in with opinions.  We aren't attacking your choices, so you don't need to defend them.  We're talking about optimization.  If you want to be sub-optimal because it makes you happy, do it!  That's the right choice for you.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #288 on: March 23, 2015, 09:02:00 AM »
I guess my biggest mistake was attacking the primary assertion as untenable. That caused all of you to make assumptions about what I'm doing for myself that don't apply to me.

I'll stop arguing that point, which as arebelspy likes to point out, is "just math". For that simple case, that particular assertion really is "just math".

I'm tired, and you guys have beat me down.

But some will use the phrase "it depends", and I've learned that the phrase is actually wisdom - it isn't a cop-out or a smart-ass remark, it's true: What you need to be doing with your money, after accepting and practicing certain fundamentals (which I know we do all agree on), can be a strong function of your personal situation.

And BTW: My example I cited above, is my brother-in-law. His scenario occurred last September. However, from the 2008 timeframe I do know about a dozen people affected in the housing bubble in the way you speak of.

In my case, "regional opportunity" dominates my thinking. In times past, this area has had very large companies go belly-up and dump thousands (at one point, local business press estimated over 8000 people when Nortel and Sony Ericsson both closed operations). I am totally bewildered when I talk to folks from the west coast who have never been without a job.

That difference really changes your perspective on risk management. You work and invest against disaster rather than for possible gains.
« Last Edit: March 23, 2015, 09:03:49 AM by mefla »

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #289 on: March 23, 2015, 09:14:09 AM »
You are not just attacking the primary assertion as untenable; you are making claims that reflect a misunderstanding of the math behind mortgage loans and investments and therefore also reflect a misunderstanding of why we are saying that prepaying long term, low interest, fixed rate debt is suboptimal.

How is it that your brother-in-law and other victims of regional economic hardship are worse off by not having prepaid their mortgages?  If you would read and respond to the points we are making in our posts, I think you would see that they would be better off by investing instead of prepaying.  Prepaying your mortgage leaves you in a worse spot if you unexpectedly find yourself without a job; you are left with less options to pay that mortgage payment that the bank is still going to be expecting every month.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #290 on: March 23, 2015, 09:26:42 AM »
There's further complication, in that as I pay down, I refi at certain points so that I'm not paying against a very high initial borrow. When I get at-or-under $100k owed, I'll refi to a shorter 10 year term, drop my monthly payment and then push until I'm done there also

This will cost money. It only makes sense if the rate reduction is significant enough, or you gain cash flow (but that's moot for you since you're prepaying)

As soon as I'm done, 100% of what I was putting toward the mortgage goes into investing. So I start racing to catch up with that guy, smarter than I am, who didn't pay off his mortgage.

Unless during your 5 year aggressive paydown the market has a horrible run returning less than your mortgage rate, you will NEVER catch up. Or unless you are investing in different funds and yours earn substantially higher returns than smarter guy, but that's not apples to apples.

As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.

Again not apples to apples. Why does his luck get worse while yours remains stable?

I think you need to run some numbers in a spreadsheet or cfiresim. It's just math. If the investment averages a ROR higher than the mortgage rate, it will win the race.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #291 on: March 23, 2015, 09:46:52 AM »
Since mefla has asked for hard figures to make the abstract concrete, here is a way to easily see the probable suboptimal effect of prepaying your mortgage using cfiresim (though mefla seems to have made up his/her mind without bothering to try to understand what we are all saying, so this may be more for the benefit of others reading along):

You can use cfiresim to compare the "prepay vs. invest" options and see how each path would have fared historically using your own specific figures.

As an example, let's look at someone with no mortgage who is about to enter retirement.  One option is to continue along with a paid-off house (and no mortgage expense), and another option is to take out a new 30-year mortgage of $200k with a 4% rate.  To isolate the "investments vs. mortgage" comparison, you need to run the cfiresim analysis looking only at the mortgage balance and associated mortgage payments to get the cost-benefit analysis of taking out the mortgage.  So you need to leave the retirement period set at 30 years, with a starting portfolio value of $200k, yearly spending of $11,457.96 (which represents the annual principal + interest payments (954.83 x 12)) and make sure to set the yearly spending at NOT inflation adjusted (because mortgage payments aren't adjusted for inflation, which is the beauty of mortgage loans), and set the investment allocation details to match how the loan proceeds will be invested (for this example, we'll leave them at cfiresim's default settings of 75/25 stock bond, 0.18% expense ratio).

In this example, cfiresim tells us that, historically, the mortgage option came out ahead 95.65% of the time.  How far ahead?  Cfiresim tells us the median portfolio ending value at the end of 30 years was $532k (in inflation-adjusted dollars) -- which means that, half of the time, the person who didn't take the mortgage option left at least $532 THOUSAND DOLLARS on the table (two and a half times the principal amount of the mortgage itself!).

Altering the variables produces corresponding changes to the results.  Bigger mortgage amount?  Even more money left on the table.  Lower mortgage rate?  Ditto.

And this example was analyzing the lump sum "payoff" (really the decision not to take the mortgage in the first place) vs. investment.  Most people making the "prepayment vs. investment" decision are doing so in the accumulation phase, when they would be slowing prepaying the mortgage over time (at the opportunity cost of making additional investments), when it is more likely that the tax benefits of carrying a mortgage come into play to make carrying the mortgage an even more attractive option.  You can model this in cfiresim as well, using your own specific numbers, and see how likely you would have been to come out ahead or behind (and by how much you would have come out ahead or behind) based on historical data.

bacchi

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #292 on: March 23, 2015, 10:01:25 AM »
And BTW: My example I cited above, is my brother-in-law. His scenario occurred last September. However, from the 2008 timeframe I do know about a dozen people affected in the housing bubble in the way you speak of.

What was your BIL (or any of those people) doing with the prepayment cash if not investing it?

It seems like the other person in all of these scenarios never actually saves what the mortgage prepayer puts toward the mortgage.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #293 on: March 23, 2015, 04:37:30 PM »
Has anyone done a calculation to see if refinancing to a 15 year mortgage is worth it or not?  We decided to refinance to a 15 year mortgage before I found MMM since we could go down from a rate of 4.375% to 2.875% so we would save a lot of money on interest and pay off the mortgage faster.  However, we still have not closed on the refinance yet and reading this is making me rethink about going from a 30 year to a 15 year.  If we refinanced it to another 30 year, the interest rate would only go down now to 3.875%.  Is it worth "prepaying" the mortgage by going to a 15 year term to save 1% in the interest rate?  Since we haven't closed on the refinance yet, there's still a chance we could make this change last minute.

Some of the tangible benefits of "prepaying" the mortgage was the idea that it's kind of forced savings in a way.  It's hard to be as disciplined to put the extra money towards investing and not making bad decisions when the market is down.  Also, I think when we are ready to retire, having lower expenses with a paid off house would help us be in a lower tax bracket right?  Our mortgage is about half of our expenses.  I like the idea of instead of making extra mortgage payments to invest the difference but when you are ready to retire, take the extra money you made in your investments and paying off the mortgage at that time.  This idea seems more in the middle, so you could still move forward your FIRE date but when you do FIRE, you have the peace of mind of a paid off house. 

The Happy Philosopher

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #294 on: March 23, 2015, 05:28:56 PM »
This is a long thread, and maybe this question is best posted in a new thread but I will fire away. Let's say someone uses 100% capital gains in retirement (taxable account). We all know that up to a certain point these will be free from federal taxes. Let's say a mortgage forced you to realize additional capital gains which would be fully taxed. Would it be worth it in this case to pay off the mortgage before retirement with w2 income already being taxed to avoid the federal taxes in retirement? I know it will depend on interest rate, return assumptions, etc. but what do people better at math than I think about this scenario? Sorry if this has been addressed.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #295 on: March 23, 2015, 05:42:21 PM »
This is a long thread, and maybe this question is best posted in a new thread but I will fire away. Let's say someone uses 100% capital gains in retirement (taxable account). We all know that up to a certain point these will be free from federal taxes. Let's say a mortgage forced you to realize additional capital gains which would be fully taxed. Would it be worth it in this case to pay off the mortgage before retirement with w2 income already being taxed to avoid the federal taxes in retirement? I know it will depend on interest rate, return assumptions, etc. but what do people better at math than I think about this scenario? Sorry if this has been addressed.

If your long term rate of return is greater than (mortgage rate)/(1 - CG tax rates), then investing will come out ahead in your scenario. For example,

Mortgage rate = 4%
CG tax rates = 20%

The investment rate of return should be greater than 0.04/(1-0.20) or 5%  for you to come out ahead when investing.

BTW, I would say that this is a good problem to have for me. My total expenses in retirement (early) including capital gains  and dividends would have to be almost $90K for your  scenario described above to occur. I assume MFJ tax status. 

Faraday

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #296 on: March 24, 2015, 08:29:38 AM »
You are not just attacking the primary assertion as untenable; you are making claims that reflect a misunderstanding of the math behind mortgage loans and investments and therefore also reflect a misunderstanding of why we are saying that prepaying long term, low interest, fixed rate debt is suboptimal.

Lord have mercy. You guys are gonna have me drooling and dragging my arms on the ground before we're done here.

I get the math. I don't argue with the math - I'm using said "math" myself for my own savings. I'm not saving zero and only paying the mortgage...my own personal approach is blended. Please stop claiming I don't understand the math and let's get to my real questions... [/i]

My problem is with real world practice of the assertion, one way or another. It's a black-and-white assertion. It's an either/or assertion. What I am not sure about...and what I AM asking you big brains, is...

1) Who keeps a mortgage for 30 years any more when you save so much money with a 15 or 10 year? OK, a 30 year mortgage is a "lesser investment" than...investment. I get that. But I refi'ed to 15 ages ago and am trying to refi $100k (or less) to 10 years to save even more money. (And if the answer is "run FIREcalc to figure this out for yourself, that's OK, I can do that.)

2) WHAT investments are best for outstripping that terrible 30 year mortgage?  I offered examples of savings instruments that CANNOT outstrip my mortgage: My credit union's CD's, savings accounts and mutual funds. They have pathetic yields far less than my mortgage's % rate.

3) What happens when you sell the house and buy another with a new mortgage, especially if the property has increased in value and you make money off the sale?

4) What happens when your investments crash and you lose 50% and it takes time for things to recover? I thought the prevailing wisdom is that you never recover the time value of the cash lost during the downturn? (This happened to me in a 401k and in a plain stock purchase, so don't give me any crap like "that doesn't happen". Ask folks who bought stock in the "Old GM"...)

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How is it that your brother-in-law and other victims of regional economic hardship are worse off by not having prepaid their mortgages?  If you would read and respond to the points we are making in our posts, I think you would see that they would be better off by investing instead of prepaying.  Prepaying your mortgage leaves you in a worse spot if you unexpectedly find yourself without a job; you are left with less options to pay that mortgage payment that the bank is still going to be expecting every month.

You are better off only after you've made it beyond what I'll call "the zone of risk", when your investments are not only large enough to support paying the mortgage, but large enough so that you don't deplete them. What is that, 12 years? 15 years?

In other words, with an SWR of 4% and let's say a mortgage of $2k/month and living expenses of, say, $1k/month ($3k/month total, $36,000 a year), you need $900,000.

But, oh no, he's lost his job with only, say, $100,000 in savings/investments and he's got to have $3k/month to live on . He's no longer contributing to the investments, so that gets stuck at $100,000 save for the yields.

He depletes his savings in less than four years. If he's not found a job in four years, he loses house, investments, etc.

He'd be better off walking away from the house the moment he loses his job, moving in with dear old mom and dad and trying to drop his monthly cash needs as low as possible, until he finds a new job.

Right?



brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #297 on: March 24, 2015, 09:02:21 AM »
1) Who keeps a mortgage for 30 years any more when you save so much money with a 15 or 10 year? OK, a 30 year mortgage is a "lesser investment" than...investment. I get that. But I refi'ed to 15 ages ago and am trying to refi $100k (or less) to 10 years to save even more money. (And if the answer is "run FIREcalc to figure this out for yourself, that's OK, I can do that.)

I am keeping a mortgage for 30 years.  Lots of other people participating in this thread are keeping a mortgage for 30 years.  The entire point we are making is that you (almost certainly) do not "save so much money" with a 15 year, or a 10 year, or a 0 year (i.e., no mortgage), if you invest the proceeds in investments with a higher CAGR than the mortgage rate.  Yes, if you take the loan proceeds and stick them under your mattress, you will save money by taking a 15 year instead of a 30 year, or by prepaying your mortgage of any maturity length.  But if you invest the proceeds, you make money by carrying the longer-term debt.  Which leads us to your next question...

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2) WHAT investments are best for outstripping that terrible 30 year mortgage?  I offered examples of savings instruments that CANNOT outstrip my mortgage: My credit union's CD's, savings accounts and mutual funds. They have pathetic yields far less than my mortgage's % rate.

The investment option you are most likely to hear about here is a reasonable mix of stock and bond index funds.  Historically, if you use any allocation consisting of at least 50% stocks, you would have come out ahead over 95% of the time by borrowing a 30 year mortgage loan and investing all of the proceeds in such a portfolio (and using that portfolio to pay off the loan according to its amortization schedule) (scroll up and read reply # 292 for details).  Today, you won't be able to outperform current mortgage rates by sticking the loan proceeds in a bank account; however, as arebelspy noted, there's a good chance you might be able to do so later on during the life of the loan.


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3) What happens when you sell the house and buy another with a new mortgage, especially if the property has increased in value and you make money off the sale?

Now you have hit on a legitimate reason to consider prepaying instead of investing.  One of the assumptions behind the argument to invest instead of prepay is that you will hold mortgage for the long-term; if there is a chance you might sell the house (and therefore have to pay off the mortgage) in the short-term, that would be a valid reason not to invest the loan proceeds in any volatile asset class (like stocks).

The increase (or decrease) in the value of the house is irrelevant to this consideration, though.

Quote
4) What happens when your investments crash and you lose 50% and it takes time for things to recover? I thought the prevailing wisdom is that you never recover the time value of the cash lost during the downturn? (This happened to me in a 401k and in a plain stock purchase, so don't give me any crap like "that doesn't happen". Ask folks who bought stock in the "Old GM"...)

Again, over a 30 year time horizon, with mortgage rates like those available today, investment performance would have failed to enable you to pay off the mortgage in accordance with its scheduled amortization and still have a pot of money left over at the end of the 30 year period less than 5% of the time (which includes all the recessions, depressions, market crashes, bear markets, etc., in the history of the markets).

Quote

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How is it that your brother-in-law and other victims of regional economic hardship are worse off by not having prepaid their mortgages?  If you would read and respond to the points we are making in our posts, I think you would see that they would be better off by investing instead of prepaying.  Prepaying your mortgage leaves you in a worse spot if you unexpectedly find yourself without a job; you are left with less options to pay that mortgage payment that the bank is still going to be expecting every month.

You are better off only after you've made it beyond what I'll call "the zone of risk", when your investments are not only large enough to support paying the mortgage, but large enough so that you don't deplete them. What is that, 12 years? 15 years?

In other words, with an SWR of 4% and let's say a mortgage of $2k/month and living expenses of, say, $1k/month ($3k/month total, $36,000 a year), you need $900,000.

But, oh no, he's lost his job with only, say, $100,000 in savings/investments and he's got to have $3k/month to live on . He's no longer contributing to the investments, so that gets stuck at $100,000 save for the yields.

He depletes his savings in less than four years. If he's not found a job in four years, he loses house, investments, etc.

He'd be better off walking away from the house the moment he loses his job, moving in with dear old mom and dad and trying to drop his monthly cash needs as low as possible, until he finds a new job.

Right?

Again, see the cfiresim analysis.  If the time horizon is 30 years, over 95% of the time in the past you would have been able to march through any market crash or bear market, keep paying down the mortgage out of the pot of investments, and still come out ahead.

In your example, the guy who lost his job with $100k in investments is still better off than the guy who has been aggressively prepaying his mortgage and therefore has $0 in investments.  Either of these guys might be better off moving in with dear old mom and dad, but one of them has a $100k pile of investments while the other one has an extra $100k of equity trapped in the house.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #298 on: March 24, 2015, 09:41:00 AM »
1) You save more with the 15-year, but end up with less in the end.  Many of us keep it for 30 years in order to maximize our portfolio size and thus chances of ER success.

2) Equities, over a long enough timeframe.  (And "terrible"?  It's 4% or less right now.  That's amazing.)

3) Lather, rinse, repeat?  Extra proceeds can be invested as per your AA and IPS.

4) You wait it out.  Typically it takes a few years, at most.  You only lose when you sell.  That's not the plan with these funds.  As long as the CAGR at the end of the 30 years is > the mortgage rate, you came out ahead, regardless of any crashes along the way.  This has happened in every 30-year period in history, IIRC, compared to today's mortgage rates.

5) The guy investing who has funds liquid to keep paying the mortgage payment (which is lower on a 30-year) is in much better shape than the guy who has it all as trapped equity but still has the (larger 15-year) payment as well, even if the 15-year guy only has 5 years left and the 30-year guy has 25 left (because they've both had it for 5 years and the 15-year has been aggressively pre-paying).
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brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #299 on: March 24, 2015, 10:26:09 AM »
As long as the CAGR at the end of the 30 years is > the mortgage rate, you came out ahead, regardless of any crashes along the way.  This has happened in every 30-year period in history, IIRC, compared to today's mortgage rates.

Thankfully our powers of recollection are not necessary, because the internet can recall for us.  Cfiresim tells us that this failed to happen less than 5% of the time assuming a mortgage rate of 4%.  Unfortunately, cfiresim.com seems to be down at the moment (an unfortunate coincidence that detracts from my point about the internet's ability to substitute for our human recollection :-P), but when it's back up we can easily check whether this statement is true for any given mortgage rate.  For rates less than 3.5%, I think you are definitely correct.