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Learning, Sharing, and Teaching => Investor Alley => Topic started by: tomsang on March 18, 2013, 05:35:01 PM

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

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

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

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

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

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

Variables that I was thinking about related to:

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

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

Thanks for your help,

Tom
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: englyn on March 18, 2013, 08:46:17 PM
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Tyler on March 18, 2013, 09:55:49 PM
Hi Tom.  Lots of points there -- let me focus on just a few.

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

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

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

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

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

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

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 18, 2013, 10:19:35 PM
This is an oft discussed topic on the e-r.org forums.

So rather than recreate the wheel, here's plenty of reading for you. (http://www.google.com/search?q=site%3Aearly-retirement.org+mortgage+invest+firecalc+simulation)

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

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

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

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

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

I support paying off the mortgage for people who don't have the discipline to invest the money otherwise.  That shouldn't describe a Mustachian, however.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Kazimieras on March 18, 2013, 10:22:56 PM
I'm a Canuk and we can't deduct mortgage interest (except in some special cases), but you do raise some good points. In short:

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

One thing to take into account is the risk you're putting yourself in though. If you pay off your house and the market explodes, you still have your house. Owning your house fully makes your costs very predictable and you don't need to suddenly worry about interest rates rising. Anything you have in the markets, unless they are all insured GICs have the risk of going poof (look at Cyprus or Greece as examples). Also consider if your portfolio dips one year, you still are required to sell parts of it to pay for your mortgage. So imagine 2008, where you'd have to sell off a good chunk, which rebounded very nicely a year or two later, at a huge loss, just to cover your everyday costs.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: ed on March 19, 2013, 11:54:48 AM
On the psychological front, you could consider a blending approach - you don't have to chose between full-speed towards FI or full-speed towards zeroing the mortgage.  We did the maths ourselves and realised that ending the mortgage as soon as possible wasn't financially optimal.   We opted to pay it off early, but not nearly so early as we could have.  We got the warm and fuzzy collapsing-debt feeling, while our more rational selves admired that oh-so-rationally invested portofolio (well, mostly!). 

The blending approach works well for other rational-but-psychologically troubling decisions like moving investments from individual share holdings to index-tracking ETFs.  We found that doing it piecemeal was a lot easier - leaving a few % of the portfolio somewhere thrilling was the small price our inner Spocks paid to do the logical thing with the vast bulk.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 19, 2013, 02:55:01 PM
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

That is crazy high interest rates.  Do you know what is causing them?  Is there huge inflation expected in the near term?  Weak dollar?  For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate.  Seems like an opportunity to invest in mortgage notes.  Is there a market for that in Australia?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 19, 2013, 03:06:47 PM
Hi Tom.  Lots of points there -- let me focus on just a few.

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

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

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

The tax savings were calculated in the first post at $1,008.  I used $1,000 for simple rounding.  Interest, taxes, charitable, and state taxes were at $15,500 while the standard is $11,900 for Married Filing Joint.  Take that at 28% or whatever your bracket is to come up with the benefit.  I don't think the taxes sways the calc much though.  Obviously if you have a house worth more than $300,000 then it becomes a bigger benefit while working.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BYUvol on March 19, 2013, 03:07:08 PM
   
Has anyone done the math to show the impact if you pay down/pay off  your mortgage v.s. investing the money into mutual funds or other investments?  Is there a calculator that shows your FI years and how many years it adds to your FI point if you pay off your mortgage vs. investing?

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

I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 19, 2013, 03:11:25 PM

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

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

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

Did those that came up with the 6.25% come up with a calculation, model, etc.  I think, that would go well with the surprising simple math to retirement, firecalc, and the other models out there.  If Firecalc has been proven to work, then figuring out exactly how much paying off your mortgage effects your FI and your years to FI seems like it could be boiled down to math vs. opinions on what is safer, better, etc. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BYUvol on March 19, 2013, 03:17:00 PM

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

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

Then you need to make assumptions based on future tax code, like how much they will increase the standard deduction by, every year, whether they continue the mortgage interest deduction, if LTCG and dividend rates and brackets stay as they currently are, etc. Making educated guesses on these things in the near term (<5 years) is a challenge, I can't imagine trying to guess out past 15 years. Who would have guessed when Bush Sr was in office, that in 10 years, his son would be President invading Iraq again.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: englyn on March 19, 2013, 07:01:09 PM
That is crazy high interest rates.  Do you know what is causing them?  Is there huge inflation expected in the near term?  Weak dollar?  For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate.  Seems like an opportunity to invest in mortgage notes.  Is there a market for that in Australia?

No, 17% is crazy high interest rates ;) they were up there for a brief period in the 80's for reasons I don't understand. 6% is low for Aus. Few years ago they were 8.5%. Dollar is strong and the reserve bank has been cutting the rates to try to stimulate retail spending, trying to avoid stagflation.
The banks say they have to keep the rates up there because of their own high borrowing costs on the international market. Partly influenced by our overvalued dollar I expect. But otherwise, HMMMM, given the rates in other countries. Suspect they're charging whatever people will pay.
Mortgage notes?? never heard of them! Will investigate.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 19, 2013, 07:34:35 PM
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

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

Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Self-employed-swami on March 19, 2013, 08:00:19 PM
I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.

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

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

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

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

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

I understand the over-thinking aspect of it, but since it applies to virtually everyone who owns a house and who wants to retire in the world, it seems like a topic to invest some mental energy.  Maybe the person that was looking for their thesis topic could team up with the owner of Firecalc.  This would be a mainstream topic and could highlight the calculated approach of retirement, the MMM community, and Firecalc.     
 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 20, 2013, 10:21:32 AM
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

I have had mortgages with rates above 6%.  It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years.  Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Tyler on March 20, 2013, 10:29:03 AM

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


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

It sounds like you need to get familiar with Excel and build your own tool. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Jamesqf on March 20, 2013, 11:32:38 AM
I have had mortgages with rates above 6%.

My original mortgage on the house I'm living in was IIRC 7.25%, and that was only like 12 or 13 years ago.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: daverobev on March 20, 2013, 11:51:42 AM
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

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

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

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

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

So: Chances of US$ gaining more than 3% p/a vs the AU$ for 5 years? Certainly possible.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: capital on March 22, 2013, 09:31:52 AM
Quote from: arebelspy
Hah.  You must be fairly young.  6% is quite low, historically, for most anywhere.  I wouldn't mind having access to 6% mortgages for life.
Within the last decade, 30 yr rates were over 6%.  People must have really short memories.

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

Australia's economy is pretty healthy due to resource exports and other factors-- it apparently hasn't been in recession since the early 1990s-- so their central bank has kept rates higher with the goal of keeping inflation lower, as allowing too much credit (and thus too much money) chasing after limited resources drives prices up.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: clifp on March 24, 2013, 05:10:08 AM
This is an oft discussed topic on the e-r.org forums.

So rather than recreate the wheel, here's plenty of reading for you. (http://www.google.com/search?q=site%3Aearly-retirement.org+mortgage+invest+firecalc+simulation)

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



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

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

Like so many other financial things, a mortgage can viewed two ways, as a debt which burdens you, or an financial opportunity.  At today's rates I view it as an opportunity.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2013, 07:42:08 AM
Right now I am in the process of getting 15 year mortgage, since the interest rate are so crazy low. I'll pay off my higher interest HELCO, do some real home improvements, buy an expensive car, and probably purchase another property in Vegas.  But partly I'll be borrowing the money because rates are so low.  One of the possible mortgage vendors is PenFed, and I will take great psychological pleasure  in looking at the 2.75% interest I am paying them and comparing it to the 5% interest I am getting for some 10 year CDs with them. I like knowing that if interest rates raise dramatically I can roll over my 10 year CDs and get higher interest rate but the mortgage (actually Fannie Mae) is stuck with my pay 2.75% for 15 years.

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

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

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

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

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

The second page of the standard form had a huge continuation sheet.  I'd seen it before but I'd never understood its purpose.  The processor mentioned that it was for people to list all of their debts:  car loans, credit card balances, student debt, personal loans, alimony/child support...
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 28, 2013, 08:25:23 AM
Actually getting the mortgage while FIRE'd does seem to be a tough nut to crack.  Clif's getting the HELOC is probably the simplest option, but of course doesn't lock you into a 30-year fixed, which may be desirable.

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

http://homes.yahoo.com/news/why-paying-off-your-mortgage-early-is-actually-dumb-174007929.html
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: expatartist on April 18, 2013, 09:01:01 PM
Quote
Aus, like Canada, is resource-and-finance. We are, probably, heading into a secular bear market for natural resources.

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

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

Good point. Particularly on the "normal" front!

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

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

Edit: bloody Mac autocorrect typos
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: leaderscorp on May 08, 2013, 12:20:28 AM
You should consider the stability of your job and your monthly budget before deciding whether you will get a 15 year fixed mortgage or 30 year. Your FI will not be affected if you get the right computation for sure.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on May 10, 2013, 08:17:38 AM
You should consider the stability of your job and your monthly budget before deciding whether you will get a 15 year fixed mortgage or 30 year. Your FI will not be affected if you get the right computation for sure.

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

 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: leaderscorp on May 10, 2013, 09:06:13 PM
So you are suggesting not to take fixed rate mortgage?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Alex in Virginia on May 11, 2013, 06:09:43 AM
Hi, All...

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

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

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

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

(I should add that we're not concerned about leaving an estate of zero. If you want to leave children or other bennies some legacy, a reverse mortgage may not be the right backstop for you.)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on May 11, 2013, 07:23:37 AM
So you are suggesting not to take fixed rate mortgage?

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

If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on May 11, 2013, 07:29:39 AM
So you are suggesting not to take fixed rate mortgage?

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

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

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

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

Great post tomsang.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: leaderscorp on May 13, 2013, 10:12:42 PM
So you are suggesting not to take fixed rate mortgage?

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

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

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

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

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

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

+1000
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: leaderscorp on May 14, 2013, 09:37:20 PM
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.

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

Can you elaborate this?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on May 14, 2013, 10:13:29 PM
Regarding the first, having a mortgage is a credit boost as it is a different credit type than most (credit cards, etc.). Paying it off won't help your credit score and could, in fact, lower it slightly.

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

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

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

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: leaderscorp on May 15, 2013, 09:37:56 PM
I understand now. But, I don't see any problem in paying the mortgage early.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on May 15, 2013, 09:56:49 PM
There's no problem with it persay, it's just not optimal. See tomsang's post above.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Nords on May 15, 2013, 11:22:27 PM
I understand now. But, I don't see any problem in paying the mortgage early.
It's a perpetual debate.

However before you retire you should maximize your opportunities to borrow money.  I'd say that (at a minimum) a homeowner should arrange for a home-equity line of credit at no closing costs, even if it's just for emergency use.  For some of us (like me) it's also a homeowner mortgage and a rental mortgage.  Loans are a lot easier to get it while you're working, and a lot harder to get it when you've retired.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on May 16, 2013, 09:59:17 AM
I understand now. But, I don't see any problem in paying the mortgage early.
It's a perpetual debate.

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

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

3.5%  fixed for 30 years is the biggest bargain ever. But you must offset the debt with equity invested elsewhere...
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: follicular on May 19, 2013, 06:17:05 PM
All, having followed most of the thread but still risking missing something, how about the following scenario for a near-retirement age working individual in the US whose current full-time IT consulting work is subject to the vagaries of the market and considerable downward pressure on billing rates:

Does it not make sense to pay down as quickly as possible one's residential mortgage and credit card debt while still maintaining a reduced, modest monthly contribution to 401k and other retirement accounts? Ideally, I will still have some earning years ahead of me after all is paid off to continue to supplement retirement accounts or other savings options yet in the worst case scenario that income dries up at least I won't be saddled with a hefty monthly mortgage and property tax bill (in NJ this is a killer) at a time when retirement is looming and SS and retirement accounts are my only income source.
Any thoughts about taking this sprint to the finish line?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on May 19, 2013, 06:27:03 PM
And if your income dries up, I'd much rather have that amount liquid, able to pay your mortgage (or not), rather than not have a mortgage and have lower expenses, but be unable to pay them because so much of your money is locked up in an inaccessible form of home equity.

YMMV.

[edit: autocorrect typo]
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: follicular on May 19, 2013, 06:47:15 PM
Arebelspy--
Your point is well taken. Maybe a few more facts may help:
I receive disposable income averaging $11000 per month after taxes, SS, withholding, etc., of which $2200 goes straight to 401k.
I intend to have all CCs paid off in 6 months(I am now paying about $3k/month). My $200k mortgage now costs me about $900/month--P&I (5/5 arm, 2.75%). My intent was to pay off the mortgage before the 5th year interest rate reset, i.e., about $40k/year in principal (=$3.5k/month). Interest on this mortgage is averaging about $450/month. I don't know how I would manage if in 3 or 4 years from now my income is drastically reduced and I have still to pay off a large mortgage balance. I would be able to dip into retirement savings for this (with no early withdrawal penalty as I am 62 yo) but it would have major impact on quality of life in my retirement years. It seems to me the sooner I can rid myself of the mortgage burden the better. Thoughts about this? Thanks
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Self-employed-swami on May 19, 2013, 10:21:35 PM
I want to pay mine off for cash-flow reasons, so yes, not financially optimal.  However, I do have other leveraged investments, so I'm not totally losing out on the low interest rates.

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

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

If you lose your job, you have more flexibility having money in marketable investments than in your house. If you have an ARM, then you are giving up the inflation hedge that a 30 year mortgage provides.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: SnackDog on May 31, 2013, 05:36:15 AM
Great thread.

How bad it is depends on: how much you borrow at what rate for how long, your age when you borrow it and how you invest the difference.  The effect on your portfolio is relative to portfolio size.

If you inherit $1MM at age 20 and invest it in stocks rather than paying off your $1MM 30 year 3% mortgage, you will see a huge difference at age 50, even if you invested right before a crash.  But if you had $1MM mortgage at age 20 you may be such a business whiz that you will be a billionaire at age 50 so you may not care.

On the other hand, if you invest $100k of your hard-earned pennies at age 55 and put them safely in 50% bonds, in today's bond market, you could be sorry at age 85 that you did so rather than pay off your little mortgage. You may have wished you had paid off the note to increase retirement income so you could eat.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on May 31, 2013, 06:31:58 AM
Oldtoyota posted this excellent link on mortgages.

http://financialmentor.com/financial-advice/pay-off-mortgage-early-or-invest/7478

My thoughts: 

Since most people do not stay in their homes for the term of the mortgage, I would prepay to eliminate interest expense so that when the property is sold, you have more principal paid down and thus more capital.  It's a very easy to do savings plan.  I don't think that is irrational to pay way less interest right away (on the first year over 200% of the prepayment principal).

I am reading William Bernstein's The Investors Manifesto; he states (p 37) that you should "never, ever pay more than 15 years fair rental value for any residence", and he prefers to buy at 150 times rental rate.  He goes on to say that imputed rent (the rental value of the residence on a paid for property) at that price  "is about what you might expect from a mixed portfolio of stocks and bonds.  (Imputed rent does have one real advantage over the return from stocks and bonds, which is that it is tax free)."  I like the tax free part. 

For me, in a high mortgage interest rate time, prepaying is essential; now, in a low interest rate time (I used 4%), each monthly prepayment through year 13 on the amortization schedule saves between a multiple of 200% to 100% of the interest charged for that period (it declines by each year on the amortization schedule).  That is a rich vein to mine! 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MorningCoffee on May 31, 2013, 07:33:59 AM
Sorry... I'm going off topic, but I just had an "aha" moment and finally understand all the talk about not paying off a mortgage early. In the US, if I have this right, you can lock in the rate for 30 years? At under 4%? Incredible.

I'm in Canada and from my understanding, mortgages are a little differently here. We can get a 30 year amortization for a mortgage, but locking in your rate for only 5 years is pretty common (at least from my personal experience). I went hunting online and some banks offer up to 10 years  (I don't remember that being an option when we first got a mortgage 12 years ago - but that doesn't mean it wasn't there, it was probably just a bad choice with higher interest rates back then. We were paying over 6%.)
I can't find anywhere I could lock in a rate for more than 10 years. Our mortgage interest is also not tax deductible, and rates higher (10 year posted above 4%, one bank posted at 6.5%!)

Again, personal experience here, so it may differ across the country/bank choices/etc. Considering we didn't know much about investing when we bought our house, and were way too conservative in our investments, we chose to focus on paying off our mortgage early. We were also worried we could get stuck with a much higher interest rate when the mortgage came up for renewal. I've heard enough horror stories of the 18% mortgage interest rates from the 80s!

So I guess I'm posting this simply to say do your research, as some info may not apply if you don't live in the US.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on May 31, 2013, 07:38:23 AM
MorningCoffee: Amazingly some people here in the U.S. are paying off their 30-year fixed loans at 3.xx%.  Mustachians even.  Sometimes it's hard to override emotions, apparently.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MorningCoffee on May 31, 2013, 07:46:13 AM
MorningCoffee: Amazingly some people here in the U.S. are paying off their 30-year fixed loans at 3.xx%.  Mustachians even.  Sometimes it's hard to override emotions, apparently.

It is hard to override emotions sometimes. That being said, I'd love a 30 year locked in rate of 3.xx%! Sign me up!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: oldtoyota on May 31, 2013, 08:51:48 AM
Here is a thread I started on a similar topic:

https://forum.mrmoneymustache.com/investor-alley/pay-off-mortgage-or-invest-5951/

The first post has a link to an excellent article on the topic.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on June 01, 2013, 05:31:47 AM
If you have a financially efficient mortgage (no PMI) at a good rate, you probably have a 20% down payment.  So everyone that has a mortgage has a partially paid off mortgage.  So everyone with a mortgage may have made in Arebelspy's somewhat dismissive terms, an emotional decision to have a partially paid off mortgage.  Now, if you are an efficient investor for a personal residence, wouldn't it make more sense to rent, not buy, and invest everything, especially given the liquidity issues of real estate?  So, is the real question, rent or buy?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on June 01, 2013, 06:13:42 AM
If you have a financially efficient mortgage (no PMI) at a good rate, you probably have a 20% down payment.  So everyone that has a mortgage has a partially paid off mortgage.  So everyone with a mortgage may have made in Arebelspy's somewhat dismissive terms, an emotional decision to have a partially paid off mortgage.  Now, if you are an efficient investor for a personal residence, wouldn't it make more sense to rent, not buy, and invest everything, especially given the liquidity issues of real estate?  So, is the real question, rent or buy?

No you're conflating two different questions. If it is more financially sound for you to buy a house, perhaps due to your plan to stay in one area for a given number of years, then putting the 20% down is not an emotional decision but a fiscal one. Putting more money into that mortgage you just took out when that money could be making more money for you elsewhere makes it an emotional decision because that individual is trying to eliminate a bill or "own" their home.

We've had the discussion about whether it is financially better for you to own or rent. And the answer is always the same. It depends on the circumstances, do whatever makes financial sense. If you run the NY Times Rent v. Buy calculator there are several scenarios where buying is a better financial decision. It just depends on your scenario.

*Edit*
And it is not dismissive when it is math. It's just math.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on June 01, 2013, 08:32:33 AM
+1 to matchewed.

First decide where you want to live.  Then evaluate buy versus rent.  If rent makes sense, do it. If buy makes sense, lock in the low rate for 30 years.  Then run the math on keeping it versus prepaying it.  If you're FIREing on a SWR of at least (mortgage rate minus inflation rate), you should keep it.

(I.e. mortgage rate is 3.5 and you think inflation will be 3%, and you have an SWR of 0.5% or higher, keep it).  I'd be keeping mortgages up to about 6% or so, definitely sub 5, absolutely sub 4.  It's free money.

So if it makes sense to buy, do it, if it doesn't, don't.  (Some buy when it doesn't make sense, and that's fine, just yet another emotional, rather than math-based, decision.  I'm good with that, if you acknowledge it and own it.) Then if you buy evaluate the mortgage.  Then keep it.  ;)   Paying it down based on today's rates is 100% based on emotion of wanting to be "debt free" (or, I suppose, could be based on not understanding the math).

And it is not dismissive when it is math. It's just math.

Agreed.

However, even if you think it is dismissive, I'm good with that, and feel like in almost all those situations the person prepaying a sub 4%, 30-year mortgage should be dismissed with a face punch!  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on June 02, 2013, 06:53:08 AM
This is from our spirit guide MMM (some words placed in bold by me)  http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

“But now I operate on an all-cash basis. I have no mortgage on my primary house, or the rental house, and I avoiding the temptation to borrow to expand my investments further. And many other retirees, both early and late, take the same path.”

“1.I am a wimp ...
2.I already have enough income ...
3.Paid-off assets can replace some of the “cash/fixed income” portion of a retirement portfolio ...”

“What is better for a retired person: keeping a $200,000 mortgage on your house and having $200,000 invested in corporate bonds that yield 3.5%? Or putting that cash into the mortgage and just having a more stock-heavy portfolio? In general, the mortgage is better since its return is 100% guaranteed and there are no income taxes on saved mortgage interest.”

4.Nobody wants to lend me money anyway ...

In the end, I respect the power of leverage, but I also came to appreciate the Peace and Quiet of Cash. But that doesn’t mean you can’t take a totally different strategy!”

 Another MMM blog post.   http://www.mrmoneymustache.com/2012/04/25/unlocking-your-home-equity-for-profitable-investments/

“On the other hand, I’m also a fan of paying off your full mortgage balance in the case of early retirement, since it provides a stable return equal to the interest rate of the mortgage you’re paying off, reducing the risk of trouble during economic storms of the future. A mortgage-free primary residence is the biggest factor that keeps the MMM family’s living expenses so low these days (around $2000 per month).

But mathematically, if you don’t mind higher risk, the odds are still in your favor if you leave your house leveraged and invest in higher-yielding assets. As noted in “Pay Down the Mortgage or Invest More?“. In that article, we learned that today’s cheap mortgage debt is a very useful tool in the hands of a skilled real estate investor.”

Or a very recent MMM post.  http://www.mrmoneymustache.com/2013/05/07/how-to-prosper-in-an-economic-boom/

“Lifestyle: But then save those windfall earnings. This is not the time to buy the new Accord V6 or the 92″ television, or fight with your coworkers to buy a bigger house in a rising market. An economic boom is the time you maximize earning (because the money supply is high), but minimize spending (because prices are likely high due to competition from other buyers). If you have a big house that you’d like to downsize, this is the time to do it. The most avid housing optimizers might even move to a rental during this time.

Investments: Everyone is speculating vigorously on stocks, and the index is at a high valuation. You’ll want to continue your regular investing program, but your asset allocation rules will automatically make you buy fewer stocks and more bonds. And especially look into alternatives like paying off your mortgage early – this is the time to get out of debt, because the getting is easy.”
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on June 02, 2013, 07:46:58 AM
Do you have an actual argument, or just a logical fallacy (http://en.wikipedia.org/wiki/Argument_from_authority)?

MMM's a great guy, and I respect the hell outta him, but at doesn't mean every word he says is holy writ and divinely inspired.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on June 02, 2013, 05:57:38 PM
A paid for house has an imputed rent, or the market rent for the property.  Using Zillow, my home rent would be $1600 per month so that is $19,200 per year.  Yearly rent/Zillow estimated value is $19,200/$203,000 or 9.6% tax free return or 12.8% taxable (at 25% rate).  If I used a lower 6% imputed rent per year, the fraction is $12,000/203,000 or 6% tax free (8% taxable).   William Bernstein in The Investor's Manifesto page 37 uses 6.7% which would be 8.9% taxable.  Using MMM's ideas of matching like investments to like, e.g. house to a corporate bond, I think it would be hard to beat this, especially with a 3.5% cost of money.  Now, if you ramp up the risk of the investment, that is not matching apples with apples.  Additionally, you are paying income taxes on the mortgage payment, let's say at 25%, so you have an additional tax cost to your mortgage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on June 02, 2013, 06:37:01 PM
But are you actually making money from this imputed rent? No.

Paying off your mortgage is the equivalent of investing in a vehicle which pays the mortgage rate. No matter what the other investment happens to be, if it is capable of producing returns higher than the mortgage rate it is a better investment. Ramping up the risk of the investment is not changing the comparison. You are still looking at what it the most efficient use of your money. If you do not like risk I can understand what you are saying. And that is fine, you should invest in a manner which is consistent with your risk tolerance.

You're paying income taxes on the money to be used for mortgage payment or any after tax investment regardless so that point is a wash.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on June 02, 2013, 08:05:56 PM
But are you actually making money from this imputed rent? No.

In Europe they are considering taxing imputed rent so it is real to somebody somewhere; also, it is somewhat like interest on a zero coupon bond.  Every month, the house gives me a value, tax free.  It is not money you put in the bank, yes, but, if I want to live in this house, this is the market price.  So that part is real; it's not just a dumb house, but a very crafty house.   Just nobody sees the monthly gift and nobody taxes the benefit, except the property tax, but the mortgage guy pays that too, along with maintenance, as do I.  It's like a company car type benefit, imputed.  See William Bernstein in The Investor's Manifesto, page 37.

The person doing the mortgage, is paying the bill every month and pays with after tax money, so that is a cost to that investment in taxes.  At 25% marginal tax, that's 4/3 times the principal and interest 360 times.  That is the cost of that option, plus any transaction costs.  If we compare after tax returns, the imputed rent is hard to beat.

If both the paid for house person and the investor start out with $203K, they just do what they want with the money.  One pays for the house in cash; the other gets a mortgage and buys financial products.  So each starts out with the same initial conditions.


Paying off your mortgage is the equivalent of investing in a vehicle which pays the mortgage rate.


For simplicity, I was assuming that the person just paid cash for the house.  Each investor has the same amount of $ on day one.  One bought the house; the other got a mortgage and invested the 80% remainder.   If I paid off the mortgage on day 1 of the experiment, I got a paid for house free of the mortgage lien. The mortgage is just  a document then, not a financial vehicle for me.

No matter what the other investment happens to be, if it is capable of producing returns higher than the mortgage rate it is a better investment. Ramping up the risk of the investment is not changing the comparison. You are still looking at what it the most efficient use of your money. If you do not like risk I can understand what you are saying. And that is fine, you should invest in a manner which is consistent with your risk tolerance.

The mortgage investor is competing against the imputed rent, not the 3.5% cost of the mortgage.  If one return on investment number is bigger, that is better.  But is the investor in equities going to go all hedge funds or oil futures?  I think MMM's example of matching apples to apples is a point well taken.  Can you point me to vehicles that gives me 9.6% tax free? 

You may see it simply as an arbitrage, but it is not just that.  Risk/reward calculations are important.  For me, cost efficient means using Vanguard like mechanisms. Risk tolerance was intended as a part of the deal, as I think it is with all investors. 

Now, if mortgage buyer invests in a taxable account. he will have the advantage of the capital gains tax rate for the count up at the end of the experiment.  But he has to get the money home, so that is another charge.  That means the taxable account would have to yield better than the lowest of my imputed rent projections, or 6%.  So that means a net taxable gain of over 7.05% plus the cost of the mortgage and all the taxes he paid paying the 360 mortgage payments.


Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on June 02, 2013, 08:53:30 PM
AJ. I think you need to look at the math. I did an example in another post, but it logically makes sense that you have two choices. Pay downthe mortgage or take that money and invest it. If you can get a higher rate than the mortgage over the mortgage life then you are better off doing that. If you can't then it is better to pay off the mortgage. If you are in the United States, then you can get a sub 4% 30 year fixed mortgage. If you don't think that your investments are going to beat this over the next 30 years you are basically saying that your Safe Withdrawal Rate is at or around 1% as we have never had returns lower than 4% since we have tracked the market. firecalc is based on returns higher than 4%. This would be one of those firecalc black swan events.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/mortgage-payoff-club!!/msg73689/#msg73689

It just doesn't seem right, since paying off my mortgage early saves me over $200,000 in interest.
According to Washington Post, Capital Gains Tax will increase from 15% to possibly 25%. Not pleasant news to us investors.[/color]

Paying off your mortgage may "Save You $200,000 in mortgage interest", but the bigger issue is how much does it costs you in "Portfolio Gain".

If you have a $600,000 mortgage and pay it off over 30 years at 3.5% mortgage rate, then you will pay approximately $370,000 in interest over the 30 years.  If you choose to make an additional $1,500 per month mortgage payment, then you will cut the 30 year mortgage down to 188 month mortgage and you will pay approximately $178,000 in interest.

So by making an additional $1,500 payment per month, you "save" $192,000 in interest.  Close to your $200,000 savings that you mentioned.

So how does $1,500 per month going to your mortgage cost your portfolio over time?

That depends on what return you have over a 188 month/close to 15.5 year time frame.

Starting with 0, your portfolio would grow to the following at the following yields:

11% = $746,000     
10% = $677,000
 9% = $615,000
 8% = $560,000
 7% = $510,000
 6% = $466,000
 5% = $427,000
 4% = $391,000
3.5% = $367,000

In 188 months your mortgage would be 0 if you made extra payments of $1,500  per month or it would be $367,000 if you paid $0 extra. 

188 payments of $1,500 = $282,000 of capital

So the taxes would be calculated based on the return - $282,000.  IE 11% = $746,000-$282,000 = $464,000 gain.  25% of the gain = 25% of $464,000 = $116,000 of taxes if you cashed them all in at once.  You would probably manage taxes better.  $746,000 - $116,000 = $630,000.  Subtract off the mortgage that you still have of $367,000 and you have a benefit of $263,000.

After your tax rate of 25%, the results would be as follows:

11% = $263,000
10% = $211,000
 9% = $165,000
 8% = $124,000
 7% = $86,000
 6% = $53,000
 5% = $24,000
 4% = $-3,250
3.5% = -21,250

This is calculated at a very high capital gain rate of 25%, and not managing any taxes.  Just cashing out in 188 months, and many other assumptions that don't make sense.  The biggest one is all the current tax benefits that you get by itemizing your taxes and claiming your home mortgage deduction. 

Using the current 15% tax rate would result in:

11% = $309,000
10% = $251,000
 9% =$198,000
 8%  = $151,000
 7% = $109,000
 6% = $71,000
 5% = $38,000
 4% = $7,650
3.5% = $12,750 

Again with managing your realization of the gains you should be able to bring down taxes even further and again this does not take into the benefits of having the home mortgage deduction on your tax return while you are still paying high tax rates while you are working.

So over a period of 30 years, if you can get anything above 4% you are better off keeping your 3.5% mortgage as long as possible.

I am confident that I can get above 4%, if I can't then I would probably be earning a 0% return after inflation.  If we have that then our Safe Withdrawal Rate would be close to 1% which would cause significant issues to everyone.  A 30 year fixed rate mortgage is a great hedge against inflation.  The Government is giving those who take it free money to jumpstart the economy.  Those who pay it down faster than required are foregoing the government's gift to homeowners.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on June 02, 2013, 08:57:16 PM
But are you actually making money from this imputed rent? No.

In Europe they are considering taxing imputed rent so it is real to somebody somewhere; also, it is somewhat like interest on a zero coupon bond.  Every month, the house gives me a value, tax free.  It is not money you put in the bank, yes, but, if I want to live in this house, this is the market price.  So that part is real; it's not just a dumb house, but a very crafty house.   Just nobody sees the monthly gift and nobody taxes the benefit, except the property tax, but the mortgage guy pays that too, along with maintenance, as do I.  It's like a company car type benefit, imputed.  See William Bernstein in The Investor's Manifesto, page 37.

The person doing the mortgage, is paying the bill every month and pays with after tax money, so that is a cost to that investment in taxes.  At 25% marginal tax, that's 4/3 times the principal and interest 360 times.  That is the cost of that option, plus any transaction costs.  If we compare after tax returns, the imputed rent is hard to beat.

If both the paid for house person and the investor start out with $203K, they just do what they want with the money.  One pays for the house in cash; the other gets a mortgage and buys financial products.  So each starts out with the same initial conditions.


Paying off your mortgage is the equivalent of investing in a vehicle which pays the mortgage rate.


For simplicity, I was assuming that the person just paid cash for the house.  Each investor has the same amount of $ on day one.  One bought the house; the other got a mortgage and invested the 80% remainder.   If I paid off the mortgage on day 1 of the experiment, I got a paid for house free of the mortgage lien. The mortgage is just  a document then, not a financial vehicle for me.

No matter what the other investment happens to be, if it is capable of producing returns higher than the mortgage rate it is a better investment. Ramping up the risk of the investment is not changing the comparison. You are still looking at what it the most efficient use of your money. If you do not like risk I can understand what you are saying. And that is fine, you should invest in a manner which is consistent with your risk tolerance.

The mortgage investor is competing against the imputed rent, not the 3.5% cost of the mortgage.  If one return on investment number is bigger, that is better.  But is the investor in equities going to go all hedge funds or oil futures?  I think MMM's example of matching apples to apples is a point well taken.  Can you point me to vehicles that gives me 9.6% tax free? 

You may see it simply as an arbitrage, but it is not just that.  Risk/reward calculations are important.  For me, cost efficient means using Vanguard like mechanisms. Risk tolerance was intended as a part of the deal, as I think it is with all investors. 

Now, if mortgage buyer invests in a taxable account. he will have the advantage of the capital gains tax rate for the count up at the end of the experiment.  But he has to get the money home, so that is another charge.  That means the taxable account would have to yield better than the lowest of my imputed rent projections, or 6%.  So that means a net taxable gain of over 7.05% plus the cost of the mortgage and all the taxes he paid paying the 360 mortgage payments.


Are you in Europe? Have they passed this? Is it relevant to the discussion?

If the money being used to pay off the mortgage or invest are both after tax it is irrelevant to the discussion as it affects both scenarios.

But we're not discussing the option of someone who is paying for a house with cash. That is not a mortgage, that's buying a house with cash, without a mortgage. The whole original topic of this is right in the topic - "Paying off Mortgage Early - How bad is it for your FI Date?" The answer is as bad as getting an investment with less yield than your other option. If I can get 7% from index funds over time (please keep in mind we are talking within the framework of FI so your taxes are not that bad) or I can pay off my mortgage @ 3.5% I've lost out on 3.5% over time. The actual performance may vary but the math still works out.

The individual investor is comparing the cost of paying off the mortgage vs. other investments, not imputed rent and not buying a house outright with cash. The imputed rent does not exist. Why is it even in this conversation? If I have a mortgage where is this imputed rent? Where am I actually getting any money from it? I'm not getting that money, throwing in a non-existent variable does not make the facts of the original question change.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sherr on June 02, 2013, 09:09:14 PM
The mortgage investor is competing against the imputed rent, not the 3.5% cost of the mortgage.

I'm not an economics expert, but common sense tells me that is simply not true. Imputed rent is an entirely theoretical number that is useful for comparing different situations in a rent vs. buy or a live-in vs. rent-out situation. But both of the people in your example are buying and living in the house, so theoretically what it would rent out for is completely irrelevant. It could be a million dollars a month or it could be nothing, it doesn't matter.

The only thing that differentiates the two homeowners in your example is that one owns a house and another owns a house, has a mortgage, and has the other 80% of the value of the house in investments. The only factors that are valid to compare in that situation are the cost of the mortgage and the return on the investments, tax-adjusted if you like. It's not difficult to find an asset allocation that can beat 3.5% a year on average. You have also failed to take into account the (likely) situation where the overall cost of the mortgage is decreased by inflation.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on June 02, 2013, 11:15:11 PM
AJ. I think you need to look at the math. I did an example in another post, but it logically makes sense that you have two choices. Pay downthe mortgage or take that money and invest it. If you can get a higher rate than the mortgage over the mortgage life then you are better off doing that. If you can't then it is better to pay off the mortgage. If you are in the United States, then you can get a sub 4% 30 year fixed mortgage. If you don't think that your investments are going to beat this over the next 30 years you are basically saying that your Safe Withdrawal Rate is at or around 1% as we have never had returns lower than 4% since we have tracked the market. firecalc is based on returns higher than 4%. This would be one of those firecalc black swan events.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/mortgage-payoff-club!!/msg73689/#msg73689

It just doesn't seem right, since paying off my mortgage early saves me over $200,000 in interest.
According to Washington Post, Capital Gains Tax will increase from 15% to possibly 25%. Not pleasant news to us investors.[/color]

Paying off your mortgage may "Save You $200,000 in mortgage interest", but the bigger issue is how much does it costs you in "Portfolio Gain".

If you have a $600,000 mortgage and pay it off over 30 years at 3.5% mortgage rate, then you will pay approximately $370,000 in interest over the 30 years.  If you choose to make an additional $1,500 per month mortgage payment, then you will cut the 30 year mortgage down to 188 month mortgage and you will pay approximately $178,000 in interest.

So by making an additional $1,500 payment per month, you "save" $192,000 in interest.  Close to your $200,000 savings that you mentioned.

So how does $1,500 per month going to your mortgage cost your portfolio over time?

That depends on what return you have over a 188 month/close to 15.5 year time frame.

Starting with 0, your portfolio would grow to the following at the following yields:

11% = $746,000     
10% = $677,000
 9% = $615,000
 8% = $560,000
 7% = $510,000
 6% = $466,000
 5% = $427,000
 4% = $391,000
3.5% = $367,000

In 188 months your mortgage would be 0 if you made extra payments of $1,500  per month or it would be $367,000 if you paid $0 extra. 

188 payments of $1,500 = $282,000 of capital

So the taxes would be calculated based on the return - $282,000.  IE 11% = $746,000-$282,000 = $464,000 gain.  25% of the gain = 25% of $464,000 = $116,000 of taxes if you cashed them all in at once.  You would probably manage taxes better.  $746,000 - $116,000 = $630,000.  Subtract off the mortgage that you still have of $367,000 and you have a benefit of $263,000.

After your tax rate of 25%, the results would be as follows:

11% = $263,000
10% = $211,000
 9% = $165,000
 8% = $124,000
 7% = $86,000
 6% = $53,000
 5% = $24,000
 4% = $-3,250
3.5% = -21,250

This is calculated at a very high capital gain rate of 25%, and not managing any taxes.  Just cashing out in 188 months, and many other assumptions that don't make sense.  The biggest one is all the current tax benefits that you get by itemizing your taxes and claiming your home mortgage deduction. 

Using the current 15% tax rate would result in:

11% = $309,000
10% = $251,000
 9% =$198,000
 8%  = $151,000
 7% = $109,000
 6% = $71,000
 5% = $38,000
 4% = $7,650
3.5% = $12,750 

Again with managing your realization of the gains you should be able to bring down taxes even further and again this does not take into the benefits of having the home mortgage deduction on your tax return while you are still paying high tax rates while you are working.

So over a period of 30 years, if you can get anything above 4% you are better off keeping your 3.5% mortgage as long as possible.

I am confident that I can get above 4%, if I can't then I would probably be earning a 0% return after inflation.  If we have that then our Safe Withdrawal Rate would be close to 1% which would cause significant issues to everyone.  A 30 year fixed rate mortgage is a great hedge against inflation.  The Government is giving those who take it free money to jumpstart the economy.  Those who pay it down faster than required are foregoing the government's gift to homeowners.   

It's just math folks.

Yes, if you have a large luxuriant stash, why not pay off your house indeed! You are already rich forever, so why not? Your marginal happiness is clearly to own your house and maybe have the leverage on a couple of rentals. A long term nominal fixed rate of interest is, afterall, the best low cost risk against inflation there is. And guaranteed by the U.S. government, no less.

But to those in obvious accumulation mode, right now in the USA, we all think your nuts turning down nominal fixed 30 year loans at these rates so waaaaaaaay below any investment return that supports a swr of 3 or 4 %. Real terms, remember.  To get that and pay taxes etc, we are implicitly assuming nominal rates of 9%.

So at least be consistent in your assumptions.

But, you must offset this debt with an asset allocation and keep focusing on net worth and the things you control, like savings rate.




Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on June 10, 2013, 12:57:48 PM
Interesting video on inflation, currency wars and hedging his mortgage in Yen.  Inflation solves a lot of problems for governments throughout the world.  A 30 Year fixed mortgage is an amazing hedge against the shennanigans that we most likely will be seeing in the near future by the various governments. 

http://finance.yahoo.com/blogs/breakout/am-hedging-entire-mortgage-yen-john-mauldin-160031514.html

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: FrugalZony on June 11, 2013, 08:51:22 PM
Oh my, so I have been doing it all wrong??
I was so proud of myself for getting that far. My mortgage is 30 year fixed at 4.375
I have lost so much money in investments since I started investing in stocks, that I really got cold feet
during the recent downturn
So I missed the upturn of the last couple years due to fear, but I needed that feeling of
reducing my dependence by trying to knock out the mortgage. Emotional, I know.
Apparently not good, as I just learned.

What should I do now?
I have 10 k left on it, should I change strategy now, or just be done with it and continue
my extra payments (will be done end of the year)

I have been maxing out my 401 k so I have had some participation in the market,
but 60% of my take home always went directly into the mortgage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on June 11, 2013, 10:20:37 PM
It's not bad, it's just suboptimal from a math standpoint.

On the other hand, some people's risk tolerance is very low, and it sounds like that might apply to you, in which case it is the best move.

If you can handle the variance, taking out a new loan on your property and investing it all will very likely (95% chance, historically) leave you with more money 30 years from now.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: ender on June 22, 2013, 04:28:19 PM
As someone currently saving money for potentially purchasing a house in the next few years and embracing MMM thinking more and more, this thread was interesting.

I happen to be fairly philosophically opposed to debt, which, should I buy a house will put me in an interesting position. Mathematically, assuming one is already living with an emergency fund of some sort, it doesn't really make sense to pay off a mortgage early. But I suspect I will have an intense emotional reward to throwing cash against a mortgage and eventually reducing my monthly cash outflow, regardless of the somewhat artificialness of doing so.

One exception is if you live paycheck to paycheck or plan on it and come into $100k randomly, it probably is in your best interest to pay off the mortgage to reduce your mandatory monthly expenses so that should you lose your job, you have less fixed expenses. Of course, if one willingly stays in this situation they probably aren't going to consider this should they run into $100k.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on June 26, 2013, 05:05:24 AM
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: jrhampt on June 26, 2013, 08:24:06 AM
On the psychological front, you could consider a blending approach - you don't have to chose between full-speed towards FI or full-speed towards zeroing the mortgage.  We did the maths ourselves and realised that ending the mortgage as soon as possible wasn't financially optimal.   We opted to pay it off early, but not nearly so early as we could have.  We got the warm and fuzzy collapsing-debt feeling, while our more rational selves admired that oh-so-rationally invested portofolio (well, mostly!). 

The above is what I am doing. I think there's strong supportive evidence--given low interest rates--NOT to pay off the mortgage early. I want to pay mine off early anyway, so I am paying a little extra toward the mortgage and then saving a lot in investments. I know it's not rational, which is why I am only putting a little extra toward the mortgage.

The rational advice as many stated above is that it makes sense not to pay off the mortgage. Is that still the direction you take when you want to get costs down in preparation for retirement? Many RE-ers mention living on $25K. My mortgage--if I kept it into retirement--would keep my yearly costs high.

Thoughts?

We are also doing both.  Maxing out tax-deferred investments, investing a healthy amount in taxable accounts, and planning to pay off the mortgage in another 4 years, which is right about the time we reach baseline FI.  I want the lowered expenses for flexibility.  That said, if we have another crash like in 2008, we will shift strategy toward more investments. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: oldtoyota on June 26, 2013, 10:12:00 AM
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.

Right. Mainly, I'm concerned with the additional expense (having a mortgage post-retirement vs not).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on June 26, 2013, 10:20:53 AM
My point is if you plan appropriately it is not an "additional" expense. It is just part of your planned expenses for FIRE. When/if it goes away you now have lower expenses. Or like many people here you aggressively attack your mortgage and FIRE without one.

One sentence you have makes me wonder about your question. You state -
Is that still the direction you take when you want to get costs down in preparation for retirement? Many RE-ers mention living on $25K. My mortgage--if I kept it into retirement--would keep my yearly costs high.

This makes me think that you're viewing your mortgage as something you only evaluate in preparation for FIRE. I would state that now and after any major life event is the time you evaluate your mortgage and living situation. Kids? Time to evaluate. Kids leave the house? Time to evaluate. Marriage? Time to evaluate.

And as for preparation for FIRE I would wrap it into your plan now and revisit as above. What does FIRE mean to you? Is it travel? Will you even need a house? Is it a smaller house? Is it a house which has enough land to do some gardening?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on June 26, 2013, 10:24:18 AM
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.

Right. Mainly, I'm concerned with the additional expense (having a mortgage post-retirement vs not).

Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: DoubleDown on June 26, 2013, 11:33:19 AM

Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.

Exactly.

I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay. If anything, having a lot of money tied up in a fixed asset like a house provides less flexibility to deal with uncertainties.

Maybe a simple example will help:

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 7%: $7000 annually = $583 monthly
Monthly expenses not covered by passive income: $1894

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000

As you can see OP, you end up with less money available for your total expenses each month, because you are losing the investing opportunity cost of your money tied up in the house. Also, you have no (or less) cash on hand to deal with life's uncertainties.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on June 26, 2013, 11:46:02 AM
Stellar post DoubleDown!

Clear and concise example of how not paying off the mortgage leaves more money in your pocket (assuming a higher return than mortgage rate).

I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay.

I believe that it is because they feel like their expenses will be lower, so it's easier to get by.  They don't understand that their income will be lower as well, it takes some clear examples to sink in.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on June 28, 2013, 04:07:54 PM
US Mortgage Interest rates had the largest increase in 38 years last week.

http://www.fool.com/investing/general/2013/06/27/weekly-mortgage-rates-rise-most-in-38-years.aspx

Those that have a 30 year fixed rate mortgage in the 3.xx increased their networth on the value of their mortgage.  The value of your locked in cheap loan is an asset as long as you keep it to term.  You can calculate the NPV of the loan with your interest rate and the market's interest rate to determine how much you have made.

To calculate the value of your gain,
1)  Calculate or obtain the Principal and Interest on your current mortgage payment
2)  Figure out what the current interest rate a similar loan at current rates.
3)  Go to this website or your favorite NPV website    http://www.pine-grove.com/online-calculators/present-value-annuity-calculator.htm
4)  Enter your monthly P&I payment as calculated or known in step 1:
5)  Enter today's mortgage interest rate as indicated in step two as the annaul discount rate.
6)  Fill out the term and other information and calculate.
7)  Take Present Value as calculated and subtract your current loan balance
8)  The difference is the NPV gain or loss on your loan vs. the current rates. 

IE:  $450,000 30 year fixed at 3.5% locked where interest rates are now at 4.5%, I left it with no payments made for simplicity sakes even though the 3.5% rates were easier to obtain a few months ago.  The value of your cheap loan is :

$450,000 Loan Balance
($397,086) Present value of the the monthly mortgage payments at 4.5%
$52,914 gain

If your PP, stocks or others are down.  Maybe your interest rate hedge(30 year fixed Rate Mortgage) kicked off a gain this week.  This works in reverse as well if interest rates drop, but they have been at historical lows so the downside risk is probably on the lower end of the spectrum.

Don't prepay your mortgage if you have a low 30 year fixed mortgage.  Enjoy the interest rate hedge.

Tom

 



Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: totoro on June 28, 2013, 05:40:21 PM
I was just considering the good feeling of paying off our mortgage early today.  It is tempting, but clearly not in our favour to do this right now at current interest rates. 

Our mortgage interest is tax deductible against rental income.  If we paid off the mortgages we would lose this tax deduction and the additional potential returns on the capital.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on July 05, 2013, 09:13:28 AM
I was thinking about how a 30 year fixed rate mortgage is a great inflation hedge and how a few days ago I valued our mortgage using the steps outlined in a previous post. I realized the hedge is created, because a 30 year fixed rate mortgage is really the mustachian selling a bond with the terms of our mortgage. Instead of us getting an asset on terms, we are actually selling a stream of cash flows that are fixed over the next 30 years for a set amount of money. This made us a bond originators with fixed odds. We are in charge!!

Unfortunately this asset, 30 year fixed mortgage, is not transfersble; which is different from 20+ years ago. If interest rates spike in 5 years and you sell the house you lose the asset of the 25 year mortgage. The value of the mortgage can be calculated by going through the steps as outlined. If that occurs and people know they are losing tens of thousands of dollars or more on their mortgage, they may be inclined to keep the house as a rental or stay in the house longer than they normally would.

The Sangria may be wearing off from the 4th of July celebration, so my mortgage power trip might wear off. Until then, buwahahaha in an evil chuckle. We are Wall Street creating an asset that only makes us money and screws over the little guy who doesn't understand the math behind the asset.

I hope everyone had a great 4th!!!!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on July 05, 2013, 09:37:44 AM
That's exactly what it is! 

Great post tomsang, awesome way to think of it.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: fiveoclockshadow on July 05, 2013, 01:01:22 PM
The 30yr FR mortgage is a useful asset for someone who will stay in their house for quite a long time.  For others, not such a good deal.

The loan is callable by the borrower - the worst kind of long term bond to own - and so it is priced accordingly by the lender.  However, since it is non-transferable the term is also rarely 30 yrs and on average much less because people move.  Thus it is priced more cheaply than a callable 30 yr bond would typically be (assuming yield curve not inverted).

This is an advantage to someone who will not move for a long time.  They get to sell a 30 yr callable bond at rates more akin to a 10 to 15 year bond.  However, to someone who will move more frequently the 30yr FR is a bad option and a 5/1 or 7/1 ARM will be more appropriate.  These loans will have a lower rate since they only pay for rate protection over the period for which they will likely hold the mortgage.  That is to say, they aren't subsidizing those folks who stay in their homes for greater than 5 to 7 years.  This can be a huge difference, as in the difference between 4% and 2.75% - though of course the difference depends on the yield curve.

As to investing vs. paying off your mortgage this often makes sense but it is important to realize that the advantage for many people can have a significant speculative component to it.  Again, if you can hold that mortgage for a very long time you'll likely get better return - but in the short term the volatility of the equities market could make it go either way.

So one has to be careful in making simplistic calculations or recommendations.  That said, most of the factors that apply to FIRE folks who have already relocated to their low cost of living house for a good long sit are positive.  However, for someone headed for FIRE in the next 5 to 7 years with a downsize and relocation in the not that distant future the benefits are less clear and more speculative.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Marmot on July 05, 2013, 01:19:08 PM
Unfortunately this asset, 30 year fixed mortgage, is not transfersble; which is different from 20+ years ago.

Mortgages used to be transferable?! 20+ years ago, could you actually bring your mortgage with you when selling old house/buying new house? Man the baby boomers had it easy.... =P
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on July 05, 2013, 02:26:33 PM
The 30yr FR mortgage is a useful asset for someone who will stay in their house for quite a long time.  For others, not such a good deal.

The loan is callable by the borrower - the worst kind of long term bond to own - and so it is priced accordingly by the lender.  However, since it is non-transferable the term is also rarely 30 yrs and on average much less because people move.  Thus it is priced more cheaply than a callable 30 yr bond would typically be (assuming yield curve not inverted).

This is an advantage to someone who will not move for a long time.  They get to sell a 30 yr callable bond at rates more akin to a 10 to 15 year bond.  However, to someone who will move more frequently the 30yr FR is a bad option and a 5/1 or 7/1 ARM will be more appropriate.  These loans will have a lower rate since they only pay for rate protection over the period for which they will likely hold the mortgage.  That is to say, they aren't subsidizing those folks who stay in their homes for greater than 5 to 7 years.  This can be a huge difference, as in the difference between 4% and 2.75% - though of course the difference depends on the yield curve.

As to investing vs. paying off your mortgage this often makes sense but it is important to realize that the advantage for many people can have a significant speculative component to it.  Again, if you can hold that mortgage for a very long time you'll likely get better return - but in the short term the volatility of the equities market could make it go either way.

So one has to be careful in making simplistic calculations or recommendations.  That said, most of the factors that apply to FIRE folks who have already relocated to their low cost of living house for a good long sit are positive.  However, for someone headed for FIRE in the next 5 to 7 years with a downsize and relocation in the not that distant future the benefits are less clear and more speculative.

+1 fiveoclockshadow for a good overview


Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.

Exactly.

I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay. If anything, having a lot of money tied up in a fixed asset like a house provides less flexibility to deal with uncertainties.

Maybe a simple example will help:

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 7%: $7000 annually = $583 monthly
Monthly expenses not covered by passive income: $1894

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000

As you can see OP, you end up with less money available for your total expenses each month, because you are losing the investing opportunity cost of your money tied up in the house. Also, you have no (or less) cash on hand to deal with life's uncertainties.

DoubleDown, I like the layout of your take.  However, we need to take into consideration taxes.  So the $583 monthly number is .85($583) or $496 (or less, if dividends are taxed at marginal rates) so the monthly expenses with the passive income is $1982, an $18 or $19 difference each month.  Further, the standard deviation on the equities return may be your friend or not in the situation.  IMO, the real benefit is the inflation hedge of a 30 year mortgage which could be big, but then, as DD points out, many, probably most people, do not have forever houses.  Also, to get to a 7% return, one must go up the risk/reward curve, which some might not be willing to do with their 'house money' or in their asset allocation. 


Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: RadicalPersonalFinance on July 05, 2013, 03:13:19 PM
This thread is filled with valid points.

Ultimately, this conversation seems to always come back to this question: Do you fear being thrown on the street because you can't make a monthly payment on your mortgage?  Or do you fear that the tens, hundreds, or thousands of companies that you [partially] own will go bankrupt and stop paying you income and growing their intrinsic value?

Those who come down on the side of paying down the sub 4.0% mortgage must feel that having a single asset that they can live in is safer than owning many companies that pay them money.  They have a fear that the companies might blow up and disappear, the USA/world might implode, and all global markets cease to function.  That's why they perceive owning companies as risky.

Those who come down on the side of enjoying the sub 4.0% mortgage must feel that having a single asset with all/lots of their money tied up is far riskier than owning many companies that pay them money.  They have a confidence that companies will grow their value and their income to them over time.  They view their house as simply where they live rather than a security blanket.

This is a really interesting little test because it really smokes out many investors' fear of their own investments.  It also illustrates the power of things you can see and touch (housing) and its impact on our emotional state of being.

I would like to add a link to this soon-to-be-legendary post by JLCollinsNH that should clearly illustrate the huge difference in investment value between one's home and companies: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: fiveoclockshadow on July 05, 2013, 06:22:23 PM
I would like to add a link to this soon-to-be-legendary post by JLCollinsNH that should clearly illustrate the huge difference in investment value between one's home and companies: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/

I saw that a few weeks ago, and it is an excellent perspective simply because it is a good foil to the whole "American dream" BS about home ownership.  Not that owning real estate is always bad, just it is very over hyped.

I've both owned and rented and I've never considered owning to be a particularly good investment.  This would be despite buying at very low interest both times and by total luck having good market timing.  When you crunch the numbers in many cases homes are very expensive "investments".

Personally I find one other risk to home ownership.  If you have a lot of income it is easy to end up down the un-Mustachian path of too big a house and thus too high housing expenses.  This is where the "investment" idea is pernicious.  When viewed as an "investment" there isn't anything too awful about buying a big expensive house beyond asset allocation.  When accounting for the actual costs of ownership and lack luster long term returns on real estate then it becomes clear what you've really done is dialed up your housing expenses through the roof rather than making an investment.  I've fallen into that trap twice now, though fortunately neither have been extreme cases and because of luck in market timing the abnormal price increases in the big expensive house have offset the high cost of ownership.  Well, I can only say that for sure on one house.  I'm still living in the other, which while bought right at the bottom of the market and up a good bit since then is no guarantee that when it is time for me to sell it will still be up enough to offset the big costs.  Of course this is something entirely in the control of the buyer - for smaller homes I think the downsides to owning are less pronounced.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dudemize on July 05, 2013, 06:25:54 PM
I would like to add a link to this soon-to-be-legendary post by JLCollinsNH that should clearly illustrate the huge difference in investment value between one's home and companies: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/

Altucher has been dissing on home ownership for years.  I think he is right for the most part.  I like that post by Jim as well.  Jim just sold his house and is renting now.  I still think you can make a good case for home ownership if you plan to live in the home forever.

The idea that paying rent is a -100% return is one of the biggest fallacies out there.  I've been renting for the last 3.5 years after many years of home ownership (renting out my old house now) and it has been great for all the reasons listed in Jim's post.  I've been able to save a lot more due to the lack of maintenance costs (not to mention the opportunity cost of a 20% down payment). 

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: oldtoyota on July 06, 2013, 05:37:07 PM
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.

Right. Mainly, I'm concerned with the additional expense (having a mortgage post-retirement vs not).
Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.

Yes. That makes sense. What I'm asking about, though, is whether other folks think it's worth considering that the mortgage would be an additional expense. My mortgage, if I keep it post-retirement, would be 50% of my monthly expenses. When I create projections of post-retirement expenses, I realllly like the expense number without the mortgage.

So, is there a rule of thumb to consider? Or, is it just a six or half dozen situation?

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: oldtoyota on July 06, 2013, 05:44:31 PM
As stated in an earlier post, I know my decision to pay down my mortgage is one of those "predictably irrational" situations. (Formerly, I paid a tiny bit extra toward the mortgage and then funneled the rest into savings.)

After reading through this thread, I decided to stop paying it down and to put that money aside to invest.

Thanks for the discussion, all!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on July 20, 2013, 07:54:13 AM
http://www.fool.com/investing/general/2013/07/20/5-questions-to-help-you-decide-pay-off-the-mortgag.aspx

Good article about the pros and cons of paying off your mortgage early.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on July 20, 2013, 08:40:20 AM
I only read the heading of each section (I.e. the questions) and they seem like the right questions to ask, in general.  Thanks for sharing!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: orpheus on July 20, 2013, 06:24:05 PM
I put this in another thread and got some great feed back but hoping to get some more here.

If you had investments properties that fully fund themselves including all bills and interest rates of 5.43% for 5 years ( New Zealand) with total debt of $1180000
And a fully paid off PPOR $660000

All investments property debt is fully tax deductible.

Would you pay down debt or invest in index funds?
All our money is tied up in realestate and that is our preferred assets but we do recognise the need to diversify.
We have only 50k in stocks(superannuation)

Orpheus
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tpozywio on July 22, 2013, 09:48:49 AM
Pay only a small amount to your mortgage payment, then once you hit your early retirement number, work an extra couple year and throw your money into the mortgage
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on July 22, 2013, 10:05:37 AM
Pay only a small amount to your mortgage payment, then once you hit your early retirement number, work an extra couple year and throw your money into the mortgage

Or just quit and live life however you want.

Working a few extra years for no reason doesn't make any sense to me.

(This is obviously assuming your ER number has in the budget the mortgage payment - why would you need to pay it off, given that?  If it doesn't, then you haven't hit your number.)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 15, 2013, 12:08:37 PM
An article, linked to a previous article that says pretty much what has already been discussed here, but it has formatted graphs.

http://www.economag.us/2013/08/11/paying-off-your-mortgage-early-is-still-silly/
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on August 15, 2013, 12:30:21 PM
Or this article, which looks at the question in 2 ways:

http://affordanything.com/2013/03/22/pay-off-your-mortgage-or-invest-in-the-stock-market/
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 16, 2013, 11:32:25 AM
Our glorious 30 year fixed mortgage loan may be in peril according to this article and the bills being proposed. 

"Eliminating Fannie and Freddie would mean that conventional loans, like the 30-year mortgage, would no longer be guaranteed. What that means for consumers is that long-term, fixed-rate loans would become too expensive to be an option. And with traditional, fixed-rate mortgages comprising the majority of the market, a loss of guarantee could be disastrous."
http://www.thestreet.com/story/12010622/1/why-the-30-year-mortgage-could-be-coming-to-an-end.html?puc=yahoo&cm_ven=YAHOO

Then we would be like the rest of the world with, 30 year amotization but only 5-10 year locks.  Other countries that have been discussed on this thread have rates in the 6% plus and increasing today.  With two rentals and a primary, my 30 year lock is at 3.80%.  It will be interesting looking at this in 15 years. 

Having your 30 year mortgage is the  greatest inflation hedge available.  Especially, when the government is artificially keeping rates low for US homeowners.  Lots of free money!!!!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on August 16, 2013, 08:44:45 PM
Tomsang, I agree, when we are in accumulation mode, a 30 yr mortgage on your own home is a great deal.

But once FIRE, having a place you own 100%,  low tax, not fancy but excellent for living, is not a bad strategy either, especially post tax.

Once FIRE I'll leverage my rentals and other real estate if I can get 4.5 fixed 30 years, absolutely. Free money.

So I think the answer changes once you get close to FIRE.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 21, 2013, 08:24:31 AM
Bo_knows can your new calculator take into account a mortgage? 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: lauren_knows on August 21, 2013, 08:42:02 AM
Bo_knows can your new calculator take into account a mortgage?

Other than compensating for reduced expenses due to paying off a mortgage... no.  I'm not sure how it could work any differently.  Thoughts?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 21, 2013, 10:25:09 AM
Bo_knows can your new calculator take into account a mortgage?

Other than compensating for reduced expenses due to paying off a mortgage... no.  I'm not sure how it could work any differently.  Thoughts?

Thanks for the KISS (Keep It Simple Stupid) answer.  I was getting all hung up on the principal increasing networth and being the equivalent of buying a bond that pays out at the interest rate, which I believe is more complicated than just reducing the expense of the P&I once it is paid off.  I track Net Worth, so it did not seem correct to basically call the mortgage payment an expense, when a portion is increaing your net worth.  Now that my eyes are open, I understant that this program is a portfolio program not a net worth program, so I think your solution would work well.

If the program can have expenses that do not increase with inflation then I think we have our solution.  The Principal and Interest should not change over the term, but the taxes and insurance should increase with inflation. I think on Firecalc, it was showing the expense increasing over time based on inflation vs. being locked for 30 year or term of the loan. Maybe Firecalc did this, but I did not understand it thoroughly. I need to spend some time on your program as it appears to be very robust. It does not appear to work with my Ipad, so that slows me down.   

So if the program can lock the mortgage payment P&I for the term of the loan and if it can eliminate the P&I in the year that the loan is paid off in today's dollars then I think it would capture the true reduction in expenses.

If you don't lock down the P&I, then it would always show that it is better to rent vs. buy a house.

Thanks for your response,

Tom

   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: lauren_knows on August 21, 2013, 10:37:55 AM

If the program can have expenses that do not increase with inflation then I think we have our solution.  The Principal and Interest should not change over the term, but the taxes and insurance should increase with inflation. I think on Firecalc, it was showing the expense increasing over time based on inflation vs. being locked for 30 year or term of the loan. Maybe Firecalc did this, but I did not understand it thoroughly. I need to spend some time on your program as it appears to be very robust. It does not appear to work with my Ipad, so that slows me down.   

Yup, in my example above ($30k spending plus $10k mortgage), you could instead just set your default spending to $30k, and add an input in the "Spending Inputs" section equal to $10k/yr, for X years, and set it to "Not Inflation Adjusted".

Quote
So if the program can lock the mortgage payment P&I for the term of the loan and if it can eliminate the P&I in the year that the loan is paid off in today's dollars then I think it would capture the true reduction in expenses.

If you don't lock down the P&I, then it would always show that it is better to rent vs. buy a house.

Thanks for your response,

Tom

I believe that it does what you say, but the example above.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: annod on August 22, 2013, 09:30:14 AM
Seems like most would agree that with a fixed 30 yr 3.x% mortgage, it is not wise to prepay mortgage. Today's rate is around 4.625-4.75%. It is more than what many treasury bond's return or TIPS.
Does it make sense that if I were planning to have a 10% of my savings allocated to bonds, and as long as the bond's return rate is lower than the mortgage interest rate, to put that 10% into mortgage prepayment instead? 

What are your thoughts?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 27, 2013, 01:05:47 PM
Seems like most would agree that with a fixed 30 yr 3.x% mortgage, it is not wise to prepay mortgage. Today's rate is around 4.625-4.75%. It is more than what many treasury bond's return or TIPS.
Does it make sense that if I were planning to have a 10% of my savings allocated to bonds, and as long as the bond's return rate is lower than the mortgage interest rate, to put that 10% into mortgage prepayment instead? 

What are your thoughts?

Sub 5% mortgage, you should be able to acquire equities that beat that rate over 20+ years.  By having money in taxable investments that provides you with the ability to have an emergency fund that is earning an equity level return vs. a savings account earning .5%.  If you have your money tied up in your house, then if you lose your job, have a medical emergency, etc. you won't have the cash to get through these events.  If inflation is chugging along at 2-3%, then your true cost to borrow is fairly low.  Some are predicting inflation to increase in the future, which would be good if you have a longterm fixed rate mortgage.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on September 05, 2013, 09:28:29 AM
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

US Mortgage Interest rates had the largest increase in 38 years last week.

http://www.fool.com/investing/general/2013/06/27/weekly-mortgage-rates-rise-most-in-38-years.aspx

Those that have a 30 year fixed rate mortgage in the 3.xx increased their networth on the value of their mortgage.  The value of your locked in cheap loan is an asset as long as you keep it to term.  You can calculate the NPV of the loan with your interest rate and the market's interest rate to determine how much you have made.

To calculate the value of your gain,
1)  Calculate or obtain the Principal and Interest on your current mortgage payment
2)  Figure out what the current interest rate a similar loan at current rates.
3)  Go to this website or your favorite NPV website    http://www.pine-grove.com/online-calculators/present-value-annuity-calculator.htm
4)  Enter your monthly P&I payment as calculated or known in step 1:
5)  Enter today's mortgage interest rate as indicated in step two as the annaul discount rate.
6)  Fill out the term and other information and calculate.
7)  Take Present Value as calculated and subtract your current loan balance
8)  The difference is the NPV gain or loss on your loan vs. the current rates. 

IE:  $450,000 30 year fixed at 3.5% locked where interest rates are now at 4.5%, I left it with no payments made for simplicity sakes even though the 3.5% rates were easier to obtain a few months ago.  The value of your cheap loan is :

$450,000 Loan Balance
($397,086) Present value of the the monthly mortgage payments at 4.5%
$52,914 gain

If your PP, stocks or others are down.  Maybe your interest rate hedge(30 year fixed Rate Mortgage) kicked off a gain this week.  This works in reverse as well if interest rates drop, but they have been at historical lows so the downside risk is probably on the lower end of the spectrum.

Don't prepay your mortgage if you have a low 30 year fixed mortgage.  Enjoy the interest rate hedge.

Tom

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mr. T on September 10, 2013, 08:04:04 AM
I live in the Netherlands. Our situation is as follows:
Mortgage interest is 4.8%. I can deduct this against 42% income tax. So I pay 0.58 * 4.8 = 2.784% myself.

But it doesn't end there. Holland has a capital tax of 1.2%, of which the first own house is exempted. Paying off the mortgage (instead of investing) saves this tax. So the effective rate of the mortgage becomes 2.784 + 1.2 = 3.984%.

But that's still not the end. Holland also has a tax on imputed rent (eigenwoningforfait). You have to add a percentage of the estimated value of your house (for a decent house this is 0.6%) to taxable income. So, for a 200k house this is €1200. Assume this is taxed by the marginal tariff of 42%. This will be €504 per year.

But of course it's not as simple as that. If your mortgage is very low, there is an exeption to the rule (wet Hillen). The imputed rent tax can't be higher then the deduction on the mortgage interest. So, as soon as you can deduct less then €504, this will decrease. In these situations, repaying the remainder will be beneficial.

Conclusion: the situation tends to be highly complex and very dependent on the fiscal regime and the interest rate that can realistically be achieved. Making sweeping statements is perilous.

If you ignore the imputed rent thing, not repaying is theoretically better when you can invest with a yield of more than 3.984%. But this implies some big assumptions:
1- that the fiscal regime stays unchanged. Here in Holland the rules change all the time. Mortgage interest deduction is under debate at the moment. No-one knows how the situation will be in 5 years time. The government can choose to index threshold numbers or not. The government can choose to change the boundaries of tax brackets. Or the tariffs of the tax brackets. Or the percentage of imputed rent tax. And the house is reappraised every year. Assuming a stable environment is skating on very thin ice.
2- here in Holland most mortgages are fixed-interest for about 10 years. Refinancing during this period is often not a good deal since the bank will levy a penalty that's close to the difference in interest. But waiting for renewal is a gamble too: no-one knows the interest rates in e.g. 5 years time. On top of that, 2 of the biggest banks here are nationalised, and a third is still on state aid. Competition on the mortgage market is virtually non-existent at this moment. So it's impossible to predict what kind of offer you will get in the future.
3- you don't know the interest rates of the future. If interest rates turn out to be in the double digits when renewal is due, you'll be very happy with a mortgage-free house.

My personal opinion is that's best to make hay while the sun shines. A low interest rate provides the cashflow that can be used to decrease gearing. When interest rates go up, free cashflow will dry up and repaying will become a lot more difficult. Call me emotional if you want.

About a mortgage as inflation-hedge. This is of course true, in theory. Because it assumes that your income will follow inflation while mortgage payments stay fixed. But for people on a salary this tends not to be the case: in situations with high inflation, salaries tend to stay behind. So, theoretically, your mortgage payments will decrease measured in purchasing power, but the purchasing power of your income will decrease too.  And you will still have to buy food. In this kind of environment, fixed costs can still be a millstone, even when in theory they are shrinking. Of course, if you have the slack to survive until salaries catch up, you're laughing. But a large amount of people will be crushed in the process. Ask the Germans.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Freeyourchains2 on September 10, 2013, 08:57:10 AM
How many people do you know leverage to the hilt @4.5% for 30 years fixed to gain profits?

$500,000 saved could leverage $2,500,000 which could make a profit of $153,000/ year depending on tenants vacancies and repairs. Just get a Jumbo Mortgage, or another option is a Non-recourse Loan and have the bank back your apartment complex as collateral.

Detail assumptions: Full vacancy. $25,000/month summed rents, 2% of Apartment complex for property tax and insurance estimated ($50,000/year). Mortgage @ $112,500/year. Fully runned by you the plumber, owner, manager; Or hire management team for $50,000/year.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mr. T on September 11, 2013, 02:06:08 AM
You ask me? Here in Holland it's normal to borrow 100% plus financing costs. So, in practice this will be about 110%. In the past it was even crazier: it was common to also borrow for remodelling. Mortgages could go up to 120-130% of the value of the property. In this country, about 1 million houses are underwater. That's an awful lot for a country of 17 million people. Repaying mortgages is a hot topic over here.

I understand that in the US there has been a window of opportunity to lock in an incredibly low interest rate for a very long period. I understand the reasoning behind getting that almost free money and investing it. It's like credit card stoozing. But that's a local and a temporal phenomenon that might not reappear for a very long time. And in many countries it hasn't appeared at all. I think some people here are a bit too easily making statements that will not apply to many readers.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: lithy on September 11, 2013, 07:18:58 AM
In this country, about 1 million houses are underwater.

Only now they also owe more on their house than it's worth!

Zing ;)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 11, 2013, 07:31:10 AM
In this country, about 1 million houses are underwater.

Only now they also owe more on their house than it's worth!

Zing ;)

(http://2.media.collegehumor.cvcdn.com/38/54/510cb82e152b2292b363d61c4214c3a6-sea-turtle-high-five.gif)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: jian on September 21, 2013, 02:56:56 PM
I suspect the equity market has been overvalued for a while now, in the US at least. So buying more US stocks now might be buying high. I know I know, this is tantamount to market timing, but I can't help it! :D

With that in mind, I wonder if it's safer to make extra mortgage payments? It's a bit complicated, as mine is a rental property with many tax benefits/deductions and I'm too lazy to do the math there. Also, I'm not talking about paying off the mortgage, just making extra payments while stock market seems too high and I hate buying high.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on September 21, 2013, 03:57:25 PM
I suspect the equity market has been overvalued for a while now, in the US at least. So buying more US stocks now might be buying high. I know I know, this is tantamount to market timing, but I can't help it! :D

With that in mind, I wonder if it's safer to make extra mortgage payments? It's a bit complicated, as mine is a rental property with many tax benefits/deductions and I'm too lazy to do the math there. Also, I'm not talking about paying off the mortgage, just making extra payments while stock market seems too high and I hate buying high.

If you are not doing long term investing I guess it's something that is valid. But for most FIRE people we're investing for 60+ year periods. Buying stocks now whether it is high or not won't matter in that time frame.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on November 10, 2013, 01:13:15 PM
Interesting article

http://www.mainstreet.com/article/retirement/pay-debt-or-maximize-retirement-savings?page=4
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: footenote on November 10, 2013, 01:37:10 PM
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: OptimusFrugal on November 10, 2013, 02:24:43 PM
When I finally paid my house off an incredible amount of stress that I did not even know existed was lifted from my life.  There is nothing like being debt free.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on November 10, 2013, 02:43:06 PM
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point.

It's not true for most of us here, but it certainly is true of most people.

I bought a motorcycle from a guy who just finished paying off the loan on it, so he upgraded and got a new loan and sold his "old" one to me.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?

At sub 5%?  Absolutely.  At sub 4% it's a no-brainer.  If you expect a 4% SWR to hold, you should be extremely happy at the FREE MONEY (after inflation).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: footenote on November 10, 2013, 03:51:33 PM
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point.

It's not true for most of us here, but it certainly is true of most people.

I bought a motorcycle from a guy who just finished paying off the loan on it, so he upgraded and got a new loan and sold his "old" one to me.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?

At sub 5%?  Absolutely.  At sub 4% it's a no-brainer.  If you expect a 4% SWR to hold, you should be extremely happy at the FREE MONEY (after inflation).
I wasn't saying it might not apply to most people. I was saying it doesn't apply to me.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: fmzip on November 19, 2013, 07:13:18 AM
I had my mortgage down to $35K many many years ago.

My financial adviser at the time suggested refinancing and getting equity out since money was so cheap (4.98%) and my income was high. The plan, invest the money in the market......

Well the market ultimately crashes and 10 years later my mortgage is back down to $45K as I diligently try to pay it off. Do I feel silly for making extra principle payments for the past several years of riding the bull market???

Certainly I'd prefer a larger portfolio but you really have no idea what the stock/housing market will do.

I am eagerly looking forward to having the house paid off in 47 months, much shorter term than some peoples car payments!

I think the other consideration is your age. At 47/49, we have less time to recover. Was this a good gamble 10-12 years ago? Sounded like a smart move.....

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: okiedoke on November 20, 2013, 11:29:11 AM
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

US Mortgage Interest rates had the largest increase in 38 years last week.

http://www.fool.com/investing/general/2013/06/27/weekly-mortgage-rates-rise-most-in-38-years.aspx

Those that have a 30 year fixed rate mortgage in the 3.xx increased their networth on the value of their mortgage.  The value of your locked in cheap loan is an asset as long as you keep it to term.  You can calculate the NPV of the loan with your interest rate and the market's interest rate to determine how much you have made.

To calculate the value of your gain,
1)  Calculate or obtain the Principal and Interest on your current mortgage payment
2)  Figure out what the current interest rate a similar loan at current rates.
3)  Go to this website or your favorite NPV website    http://www.pine-grove.com/online-calculators/present-value-annuity-calculator.htm
4)  Enter your monthly P&I payment as calculated or known in step 1:
5)  Enter today's mortgage interest rate as indicated in step two as the annaul discount rate.
6)  Fill out the term and other information and calculate.
7)  Take Present Value as calculated and subtract your current loan balance
8)  The difference is the NPV gain or loss on your loan vs. the current rates. 

IE:  $450,000 30 year fixed at 3.5% locked where interest rates are now at 4.5%, I left it with no payments made for simplicity sakes even though the 3.5% rates were easier to obtain a few months ago.  The value of your cheap loan is :

$450,000 Loan Balance
($397,086) Present value of the the monthly mortgage payments at 4.5%
$52,914 gain

If your PP, stocks or others are down.  Maybe your interest rate hedge(30 year fixed Rate Mortgage) kicked off a gain this week.  This works in reverse as well if interest rates drop, but they have been at historical lows so the downside risk is probably on the lower end of the spectrum.

Don't prepay your mortgage if you have a low 30 year fixed mortgage.  Enjoy the interest rate hedge.

Tom


This is not the full story.  When interest rates rise, people can afford less house (or, more accurately, less house payments).  House prices reflect that fact, if imperfectly.  So, to be theoretically honest and consistent, if you're counting a rise in interest rates as a "gain" because you have a locked-in lower rate, you need to offset that increase by calculating some measure of deduction in the value of  your house. 

There is no free lunch.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on November 20, 2013, 01:38:13 PM
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

/snip for brevity

This is not the full story.  When interest rates rise, people can afford less house (or, more accurately, less house payments).  House prices reflect that fact, if imperfectly.  So, to be theoretically honest and consistent, if you're counting a rise in interest rates as a "gain" because you have a locked-in lower rate, you need to offset that increase by calculating some measure of deduction in the value of  your house. 

There is no free lunch.

You're presuming a correlation between housing prices and interest rates. You don't need to offset that increase if that doesn't actually hold that the value of your house has reduced. More on the lack of correlation here. (http://www.theatlantic.com/business/archive/2011/07/how-rising-interest-rates-affect-home-prices/241504/) And here. (http://www.calculatedriskblog.com/2013/06/house-prices-and-mortgage-rates.html)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: okiedoke on November 21, 2013, 04:09:30 PM

Matchewed:  that's helpful, puzzling, and interesting.  Thanks. 

If Shiller says there's not a tight fit between rates and prices, I pretty much have to defer to him -- nobody would know better.   I have all sorts of thoughts about whether the explanation of "rising interest rates = good economy and higher wages that compensate for the decrease in purchasing power" would still hold true.  E.g., we're operating in an historically unprecedented rate suppression, with what seem like serious, titanic shifts in the labor market, etc.  But I confess that those are just grasping attempts to justify my position (well, a perfectly standard economic theory).  Since I have no data better than Shiller's, so I'll concede the point.   

How's that for a weird internet message board post?   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: jrhampt on November 21, 2013, 07:07:07 PM
I had my mortgage down to $35K many many years ago.

My financial adviser at the time suggested refinancing and getting equity out since money was so cheap (4.98%) and my income was high. The plan, invest the money in the market......

Well the market ultimately crashes and 10 years later my mortgage is back down to $45K as I diligently try to pay it off. Do I feel silly for making extra principle payments for the past several years of riding the bull market???

Certainly I'd prefer a larger portfolio but you really have no idea what the stock/housing market will do.

I am eagerly looking forward to having the house paid off in 47 months, much shorter term than some peoples car payments!

I think the other consideration is your age. At 47/49, we have less time to recover. Was this a good gamble 10-12 years ago? Sounded like a smart move.....

Great story!  This is exactly why I am paying down my mortgage ahead of schedule. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: willn on November 22, 2013, 10:23:38 AM
Math optimizing nerds calculating returns sometimes (often?) don't consider all risks-oh sure, they calculate the SWR based on long term market trend, and the lost opportunity of investment.

But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

But there are not insignificant risks to consider besides the lost opportunity of investment gains when considering whether to pay it off.

Accepting risk is a personal decision--no one can make if for you, so be sure you consider as many imaginable scenarios as you can.  Layoffs, illness, and bad economies happen pretty often, and sometimes they do overlap. Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.






Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: fiveoclockshadow on November 22, 2013, 12:09:42 PM
Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.

Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: footenote on November 22, 2013, 12:22:48 PM
Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.

Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.
+1
I often wince when reading advice here delivered as shibboleth regardless of your age or other circumstances. There are immense differences in the best decisions regarding investment / work / paying off a mortgage for a 25 YO vs a 45 YO vs a 65 YO. We shouldn't act or advise otherwise.

The "no/lo" insurance strategies also make me shake my head....
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: blanch1118 on November 22, 2013, 12:53:01 PM
But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

I would counter by saying, what if you lose your job and have your assets tied up by prepaying your mortgage? You can always sell shares (even devalued ones) to pay bills, but it is harder to sell your house to get your equity back.  Investments are much more liquid and leave the investor with more flexibility.

I am not necessarily advocating that, but just pointing out the other side.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: willn on November 22, 2013, 01:39:08 PM
But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

I would counter by saying, what if you lose your job and have your assets tied up by prepaying your mortgage? You can always sell shares (even devalued ones) to pay bills, but it is harder to sell your house to get your equity back.  Investments are much more liquid and leave the investor with more flexibility.

I am not necessarily advocating that, but just pointing out the other side.

Yep, that's the choice we all have to make.

For me, a paid for house, since its the single largest payment we (wouldn't) have, a 10 or 20k cash emergency fund could last a very, very long time, which to me is very valuable.  Faced with a series of crises, that peace of mind is a financial asset that will have returns.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on November 22, 2013, 09:33:17 PM
Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.

+1
I often wince when reading advice here delivered as shibboleth regardless of your age or other circumstances. There are immense differences in the best decisions regarding investment / work / paying off a mortgage for a 25 YO vs a 45 YO vs a 65 YO. We shouldn't act or advise otherwise.

The "no/lo" insurance strategies also make me shake my head....

To me, this attitudes much more likely to lead to portfolio failure.  Maybe not you two in particular, but those with the super conservative mindset.

People advocating for the aove almost always confuse risk with volatility.  Stocks are more volatile.  They aren't more risky.

Historically investing in "safer" assets is much more likely to lead to portfolio failure.  The worst years in history that lead to portfolio failure are due to inflation, not low or negative returns.  With us Mustachians especially, having super long retirements, inflation is the killer that will ruin you.

Volatility you see happening and can reduce expenses.  Slow erosion of your buying power though (while wages move to match pace, but your conservative investments don't) you can't come back from.

I'd much rather be in stocks and last for the long run than something "safe" in the short run (I.e. protects my principal with low/no volititlity) but guaranteed to fail in the long run.  I think you agree, which is why your portfolio isn't 100% cash, you just haven't played that tune to the end.

To each his own, and best of luck with your ER portfolio.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: footenote on November 23, 2013, 05:13:47 AM
ARebelSpy - No where did fiveoclockshadow or I advocate for anything nearly as conservative as 100% cash. I personally have relatively little cash in my portfolio.

I'm all for a balanced portfolio (including more equities than have been commonly recommended during retirement than was recommended in years past) at any stage of life. Both fiveoclockshadow and I were simply observing that 100% stocks is not always wisest for every stage in life. I don't understand what "you just haven't played that tune to the end" means - can you say more?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on November 23, 2013, 05:43:32 AM


People advocating for the aove almost always confuse risk with volatility.  Stocks are more volatile.  They aren't more risky.

Historically investing in "safer" assets is much more likely to lead to portfolio failure.  The worst years in history that lead to portfolio failure are due to inflation, not low or negative returns.  With us Mustachians especially, having super long retirements, inflation is the killer that will ruin you.

Volatility you see happening and can reduce expenses.  Slow erosion of your buying power though (while wages move to match pace, but your conservative investments don't) you can't come back from.

I'd much rather be in stocks and last for the long run than something "safe" in the short run (I.e. protects my principal with low/no volititlity) but guaranteed to fail in the long run.  I think you agree, which is why your portfolio isn't 100% cash, you just haven't played that tune to the end.

To each his own, and best of luck with your ER portfolio.

As you know, equities have higher standard deviations (volatility) than bonds and, usually, higher returns.  Yes, you can see volatility happen, but you can't control it, aside from lowering expenses or using human capital, if you don't have non-volatile assets to draw down until the storm ends or benefit from it, by re-balancing.  If the variance is a deep long sink, then what? 

BTW, I don't think anyone is planning on a portfolio of T-bills.  Bernsetin talks about stages to investing, but YMMV. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 03, 2014, 10:34:38 AM
http://vmichelangeli.com/Michelangeli_PayoffMortgInvest_Nov1_2011.pdf

Interesting Phd paper that I must claim that I don't fully track, but if I read it correctly it says you will be financially better off to not pay off the mortgage. If I read it correctly it also says that the probability that you will live to 80-100 increases if you pay off the mortgage. So you will live longer with no debt:)  I might need a true scientist to tell me what the paper says as it is pretty complex.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 03, 2014, 11:20:34 AM
Seems fairly straightforward.

Quote
I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

Quote
Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar on March 03, 2014, 12:18:19 PM
The question then is does what makes sense for a 20 year time frame (the paper) make sense for a 40 year one? The odds are not paying off the mortgage is the go up as your time frame expands (from 10 years to 30) AND as the rates go down (I have a lot of confidences I can bet <3%. The 6.75 of like 8 years ago is a lot tougher).


Seems fairly straightforward.

Quote
I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

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Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: PeteD01 on March 03, 2014, 03:03:50 PM
Seems fairly straightforward.

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I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

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Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.

Fortunately, the calculations do not have to be performed by the individual - only common sense is required.

If you don't plan for FIRE and 65 is a long ways off - don't pay off your low rate mortgage. All you need to do is to invest and at 55 you look if you got about $300k and if yes start paying off your mortgage. Not very smart but not too dumb either as a strategy.

If you do plan for FIRE you need to monitor your market investments and begin paying off the mortgage when you have enough invested to fund FIRE by the time the mortgage is payed off - that will likely be a shifting target for a while.
In other words, the decision to pay off your mortgage becomes dependent on the time to FIRE which in turn depends on the size of the stache. Your saving rate and market returns thus determine not only the timing of FIRE but also the timing of mortgage payoff - pretty straightforward, I think.

Peter
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 09:36:15 AM
There is a practical consideration that always seems to be overlooked in these "to pay off mortgage early or not" discussions.  Yes, it is true that paying off a mortgage early is "suboptimal from a math standpoint" if the interest rate on the investments that otherwise would have been made in lieu of the early principal payments exceeds the interest rate on the mortgage.  However, for cash flow purposes, the interest rate on the alternative investment needs to not only exceed the interest rate on the mortgage, but exceed it by enough of a margin that the investment income covers the ENTIRE mortgage payment (principal and interest).

Let's use the clear and concise example from earlier in this thread, except instead of assuming a 7% rate of return on the cash on hand, let's assume a 4.5% rate of return (which still exceeds the 4% interest rate on the mortgage).

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 4.5%: $4500 annually = $375 monthly
Monthly expenses not covered by passive income: $2102

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000
-----------------------------------------------------------

Now, even though the cash on hand is earning an interest rate higher than the interest rate charged on the mortgage, our hypothetical homeowner has $102 of monthly payments that is NOT covered by the passive investment income.  He/she would need additional income to make up the shortfall.  Which means he/she needs to wait until he/she has amassed additional assets to generate that income in order to retire.  Which means the decision not to pay off the mortgage has indeed DELAYED financial independence.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 04, 2014, 10:17:34 AM
Brooklynguy-  The major risk that you may want to consider is that paying off your mortgage early is creating liquidity risk. You are not improving networth per se, as you should be able to invest in assets that out perform a 4% or less mortgage.  In your scenario with a mortgage you have $100k of liquidity if it all hits the fan. Even if we have a huge recession and your investments lose 50% of their value you have $50k to get you through the rough patch.  This amounts to 20 months of protection or safety.  Under the paid off mortgage scenario you have no cushion or safety.  Even if you come back with "I have a 6 month emergency fund", you are still much riskier than if you had the investments in the bank.  The person with a mortgage would have an emergency fund and 20+ months of investments (40+ if the world didn't crash and you still have $100k+ in investments). 

The other major issue when you are paying off your mortgage early is you are not off the hook for your monthly payment.  Until you have paid off your mortgage, you still owe the payment each month.  So if you prepay $50k, then it all hits the fan you still owe the $477 per month payment.  If you can't make the payment because everything hits the fan, you can't call the bank and say I prepaid $50k.  They will say thank-you, please make your payment of $477 by this date or we will begin foreclosing procedures.  At this point you don't have the investment fund to get you through this rough patch.  So under the prepaying each month scenario you are in the riskiest scenario as you are illiquid, still owe a set amount each month, and you have your assets tied up in an asset that probably lost value and the assets can not be extracted. 

The only benefit of paying off your mortgage early is that it is a way to lock up your assets so you don't buy stupid stuff.  If you need that then you will be better off. By setting up this system, you are taking on a lot of liquidity risk and you don't have a diversified asset allocation.

Again paying off the mortgage isn't as "evil" as buying an SUV, but it may not be optimal for investment returns or as safe as people believe.  Having debt for assets is not evil and it can be safer than having no debt.  Debt is a business transaction.  If it used in a Mustachian manner it may push up your FI date, especially for those that have sub 4% fixed rate mortgages.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 10:41:57 AM
Tomsang - my example referred to paying off the mortgage in full, in which case you are off the hook for the monthly payments.  You are right that liquidity risk is an issue, but with a paid off mortgage you remove the mortgage payment from the monthly expenses.  In my personal situation, unlike the hypothetical example, my mortgage payment represents over half of my monthly expenses.

And there are other factors to consider as well, which I didn't want to complicate my first post with.  For example, in my situation (with my very large NYC-area mortgage), if I keep my mortgage outstanding and invest that money instead of using it to pay off my mortgage, the investment earnings will have a substantial effect on the tax credits I would receive under the Affordable Care Act.

So I'm just trying to point out that the calculus isn't as simple as "if I can earn a better rate of return than my mortgage interest rate, I should not pay off my mortgage."
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 10:58:55 AM
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 04, 2014, 12:07:21 PM
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 12:34:02 PM
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.

Good point.  So that takes care of the compounding of the cash flow problem, but not the original cash flow problem itself.  In my situation, I have a mortgage interest rate of 3.875% but would need to earn 6.3% on the outstanding principal balance (assuming I had that amount saved) in order to generate income to cover my total mortgage payment (I refinanced in April 2013 and have been paying down pretty aggressively since then -- if I had not made any additional principal prepayments, the rate I would need to earn would be 5.64%).

In these discussions, people generally say if the mortgage rate is less than 4% you should keep it outstanding, but doesn't that implicitly assume that your stash will earn at least 5.64% (rather than the standard 4% generally assumed for SWR purposes)?  Is the discrepancy that the 4% SWR already accounts for inflation, while inflation can be disregarded (and therefore a higher rate of return can be assumed) for purposes of the mortgage determination since mortgage payments are fixed over time?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar on March 04, 2014, 12:48:20 PM
Why on earth would payment need to be made using the passive return of the investment? In your example, you are losing 23k by paying off the mortgage early. Put in 7% and you gave up on 200k in order to sleep better at night. And if you follow Dave Ramsey and are getting your 12% you passed up 1.9 million:)

By paying off the mortgage you avoid market risk but by doing the lower return/lower risk option, you bring longevity risks into the equation. When you need to write 20k/yr property tax checks in 30 years would you rather have a paid off mortgage or a payed of mortgage and 200k in cash?

There is a practical consideration that always seems to be overlooked in these "to pay off mortgage early or not" discussions.  Yes, it is true that paying off a mortgage early is "suboptimal from a math standpoint" if the interest rate on the investments that otherwise would have been made in lieu of the early principal payments exceeds the interest rate on the mortgage.  However, for cash flow purposes, the interest rate on the alternative investment needs to not only exceed the interest rate on the mortgage, but exceed it by enough of a margin that the investment income covers the ENTIRE mortgage payment (principal and interest).

Let's use the clear and concise example from earlier in this thread, except instead of assuming a 7% rate of return on the cash on hand, let's assume a 4.5% rate of return (which still exceeds the 4% interest rate on the mortgage).

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 4.5%: $4500 annually = $375 monthly
Monthly expenses not covered by passive income: $2102

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000
-----------------------------------------------------------

Now, even though the cash on hand is earning an interest rate higher than the interest rate charged on the mortgage, our hypothetical homeowner has $102 of monthly payments that is NOT covered by the passive investment income.  He/she would need additional income to make up the shortfall.  Which means he/she needs to wait until he/she has amassed additional assets to generate that income in order to retire.  Which means the decision not to pay off the mortgage has indeed DELAYED financial independence.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 04, 2014, 01:06:22 PM
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.

Good point.  So that takes care of the compounding of the cash flow problem, but not the original cash flow problem itself.  In my situation, I have a mortgage interest rate of 3.875% but would need to earn 6.3% on the outstanding principal balance (assuming I had that amount saved) in order to generate income to cover my total mortgage payment (I refinanced in April 2013 and have been paying down pretty aggressively since then -- if I had not made any additional principal prepayments, the rate I would need to earn would be 5.64%).

In these discussions, people generally say if the mortgage rate is less than 4% you should keep it outstanding, but doesn't that implicitly assume that your stash will earn at least 5.64% (rather than the standard 4% generally assumed for SWR purposes)?  Is the discrepancy that the 4% SWR already accounts for inflation, while inflation can be disregarded (and therefore a higher rate of return can be assumed) for purposes of the mortgage determination since mortgage payments are fixed over time?

So draw down on the principal a little to cover the whole payment.  You'll still come out ahead, as long as the amount you earn is higher than the mortgage interest, it doesn't have to be high enough to cover the whole thing merely with interest, if you have to draw down some of your liquid principal to turn it into equity (i.e. the principal part of your mortgage payment), that's fine.

You're assuming the amount generated has to cover the interest and principal, when that isn't the case, your original premise is faulty.

:)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: PeteD01 on March 04, 2014, 01:12:47 PM
If you do not have enough (potentially liquid) investments to be able to make your mortgage payments when you lose your job, you do not have enough investments to do an early mortgage payoff and you will need to keep investing as much as you can. That is simple and straightforward.

If you do have enough investments to be able to weather a temporary job loss AND have enough investments for FIRE (at the time of loan termination) without the mortgage payment, then paying off the mortgage (deleveraging your investments) is an excellent way to reduce overall volatility (you can express that as the volatility of time to FIRE).

What you are engaging in is liability matching and, by using the mortgage payoff route, you need less than by trying to match the liability with investment returns which means less time to FIRE.

There is only one way that market investments will put you ahead in time to FIRE in this scenario and that is unusually high market returns.

Now, if you do not have enough (potentially liquid) investments to weather job loss and to be FIRE without the mortgage payments, the opposite is true - well, not quite: The odds of less time to FIRE are lower with paying off your mortgage earlier because volatility has a much lesser effect on time to FIRE because of the extended time in the market. In other words, the closer you are to FIRE, the more susceptible your date of FIRE is to market volatility.

None of this makes any sense though if one assumes any sort of constant return from the market - but that is just not how the market works.

Peter
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 01:14:11 PM
Why on earth would payment need to be made using the passive return of the investment?

Because once I am retired that will be the only source of cash flow to make the payment.  That was my point -- I understand that if you have the capability to make the mortgage payments, it is optimal to keep the mortgage outstanding as long as you can invest in assets that outperform the mortgage rate.  But for an early retiree with no income other than investment returns, the investment really needs to earn enough to cover the entire mortgage payment (not just the interest portion) or you simply won't have the cash to make the mortgage payment (and that's when you start to run the risk of needing to sell assets in down years to make the mortgage payments).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 04, 2014, 01:24:58 PM
Why on earth would payment need to be made using the passive return of the investment?

Because once I am retired that will be the only source of cash flow to make the payment.  That was my point -- I understand that if you have the capability to make the mortgage payments, it is optimal to keep the mortgage outstanding as long as you can invest in assets that outperform the mortgage rate.  But for an early retiree with no income other than investment returns, the investment really needs to earn enough to cover the entire mortgage payment (not just the interest portion) or you simply won't have the cash to make the mortgage payment (and that's when you start to run the risk of needing to sell assets in down years to make the mortgage payments).

No, this is not true.

Did you read what I said?  You can draw down on the principal (of the amount that you'd have used to pay the mortgage off, not your other stache).

Let say you have 1MM portfolio and 300k mortgage (scenario A)

Or you can pay that mortgage off and have 700K portfolio, no mortgage (scenario B).

And we'll say that you need 700k portfolio to live on.  You're saying option B is the only viable one if the interest earned on the 300k doesn't cover the full mortgage payment (principal + interest).  I'm saying you can use the interest earned from the 300k, and withdraw some of the 300k, to make that payment.  Then you're transferring that extra in your stache to extra equity (via the principal part of your payment) in the house.

You were already willing to draw down the whole 300k in scenario B, in scenario A you will draw it down slowly as well (and either way you're living on the income from the 700k, that doesn't change, and doesn't get drawn down in either scenario), but as long as that 300k is earning more interest in your portfolio than you are paying on your mortgage, then the longer you keep it as part of that portfolio, instead of equity not earning anything (or rather, earning the rate of the mortgage interest), the more you'll have in the end.  In scenario A you'll end up with more money overall.

Do you understand now why your premise that it has to cover the full payment isn't valid (because you can use those funds you would have used to pay it all off to instead draw down on slowly)?  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 01:39:11 PM
Thanks, arebelspy.  Our posts crossed.  You are right, my original premise was faulty.  But in your scenario A, there is the risk that principal will have to be drawn down after a huge market crash in the early years, which could severely impair the ability to catch back up later.  But I suppose that risk could be mitigated by holding a cash cushion.  I also need to weigh factors like the other one I mentioned, eligibility for ACA subsidies.  But you have given me a lot think about -- thanks very much!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 04, 2014, 01:47:03 PM
Thanks, arebelspy.  Our posts crossed.  You are right, my original premise was faulty.  But in your scenario A, there is the risk that principal will have to be drawn down after a huge market crash in the early years, which could severely impair the ability to catch back up later.  But I suppose that risk could be mitigated by holding a cash cushion.  I also need to weigh factors like the other one I mentioned, eligibility for ACA subsidies.  But you have given me a lot think about -- thanks very much!

Yes, that is a risk.  But on a long enough timeline (i.e. a 30 year mortgage), you'll come out ahead the vast majority of the time (maybe every time, historically, depending on the rate of your mortgage).

There is always some slight risks/tradeoffs.  No one is saying that investing is the right decision 100% of the time.  Just that mathematically, you'll nearly always have more money in retirement if you don't pay it down, and if you want to play the odds, they're vastly in favor of not paying off your mortgage, paying it down early is costing you money from the opportunity cost of those funds.

Thanks for the fun discussion.  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 04, 2014, 03:00:08 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark 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.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tj 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%.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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."
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MrCash on March 11, 2014, 08:55:12 AM
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MrCash 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: hodedofome 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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."
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: hodedofome 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: hodedofome 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark 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.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MrCash 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mobyrocket 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mobyrocket 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.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: GoldenStache 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mobyrocket 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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.         

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sherr 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mobyrocket 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 : )
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: PeteD01 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: PeteD01 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






Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar on March 16, 2014, 06:42:21 PM
When your stocks drop 50% what are you going to be using to buy those "on sale" funds? Taking out a mortgage or a helo?:)  I could see a person playing an interest timing game. You stick you money in short term treasures and expect to lose 3% per year (versus paying off) and hope to make it up over the last 20 years when you can lock your money into treasuries paying 7+% (imagine if inflation goes up to 5% for example). I must admit to having a real lack of enthusiasm for bonds these days. At  5-6%  I could talk myself into them.  Right now I pretty much prefer cash (i.e. 6-18 month cds)  to taking on the interest rate risk.



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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: PeteD01 on March 16, 2014, 06:49:12 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.

Yes, a 30 year mortgage is not the negative equivalent to a bond index fund investment in which the interest risk is attenuated in sufficiently long investment horizons.
However, there is no compelling reason for an investor with a relatively short time horizon who wishes to invest in bonds to invest in bond funds in expectation of higher rates, if equivalent rates are available in negative bonds she is already holding.
The question remains if bond funds will ever return enough to justify holding them for an investor with a long time horizon, who desperately needs stock market level returns to achieve her goals and even uses leverage to get there. In a way, the bond fund duration and long term interest rate roll up are considerations for the already well off investor.

Inflation poses a different problem: if inflation is high and one carries low interest debt, it is of advantage to keep the loan. If inflation is low there is nothing to be had in the present. With a long time horizon, different inflation conditions are more likely to be encountered and then and only then can the loan be considered an inflation hedge.

What is funny about all this is that the risk management view actually results in highly leveraged investing for the underfunded young investor, elimination of leverage for the adequately funded investor and in increasing leveraged investments for investors with otherwise fully funded retirements. In other words, when you are rich beyond your needs (that is volatility cannot affect your standard of living) you should think about leveraging again and keep the shorter duration of bond funds in mind.
Just think about having gone into the last meltdown with a moderately leveraged portfolio and a good chunk in bond funds without having to worry to make ends meet - that's how fortunes are made.

Peter
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: aj_yooper on March 16, 2014, 06:54:45 PM
+1, Peter!  Stages of investing.  That's why the argument is always so intense and unresolved.  William Bernstein does say that the younger investor would benefit by leverage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on April 06, 2014, 09:41:24 AM
Plus, if you buy good properties and do a little improvement to it, a bit of market growth does wonderful things to equity when leveraged.

Take this year in my area. Prices are up 25% +  over the past 2 years. A 400k house, with a 300k 4% mortgage and 100k down, plus a bit of investment on some improvements,  say 10k, could go now for 600k. Less 7% fees, thats a killer roi. Tax free.

Looking back, almost all my big payouts have involved real estate.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on April 28, 2014, 10:36:19 AM
Interesting perspective. I agreed with most until he uses an example of paying down a 15% credit card or saving. Maybe he is saying that the stress of having the debt will cause the person to be mindful and pay it off within the year and will therefore only cost $100 of interest to get money locked up in an IRA. if you are Mustachian you invest or payoff based on expected returns vs. games to save or paydown.

http://finance.yahoo.com/news/debt-unstuck-123024913.html
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 28, 2014, 10:37:54 AM
Interesting perspective. I agreed with most until he uses an example of paying down a 15% credit card or saving. Maybe he is saying that the stress of having the debt will cause the person to be mindful and pay it off within the year and will therefore only cost $100 of interest to get money locked up in an IRA. if you are Mustachian you invest or payoff based on expected returns vs. games to save or paydown.

http://finance.yahoo.com/news/debt-unstuck-123024913.html

Oh god that's bad math.

Quote
Say you are 25 years old and are carrying a $1,000 balance on a credit card at 15% interest, and you get a $1,000 bonus at work. Which is better, paying off the credit card or saving the money and paying off the debt slowly during the next year? The instant payoff of paying down a 15% interest credit card balance is obvious (it would save you roughly $100 in interest payments, assuming you paid the card down throughout the year). But in the long run, $1,000 saved in an IRA for 30 years will be worth $10,935 (assuming an 8% annual return). The $100 savings on interest payments at age 25 is worth $830 by age 55. So, which is greater, $10,935 or $830?

Wow.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Bob W on July 22, 2014, 08:34:34 AM
Glad I finally found this thread!

IMHO paying off more than 30% of a mortgage is the opposite of badassity.  I would characterize it as wussassity.   

Psychologically have the money to pay cash for your home and then put it into a REIT that you name "paid off home account."   Then party on Garth because you have both an investment and a home you get to live in!   You still "own" it because on the boxes you check with the choices  "rent"  or "own" your home?   You always check "own."

That said consider the following. 
1.  A home is a titled item  -- that is the King or Government grants you a title.  The King or Government can and will tax you on that title.   There is also the chance the King may want his house back.   In the US,  (since we are approaching a Greek point of debt)  it is likely at some point there will be a national property tax that is very substantial.   So from a psychological standpoint you are fooling yourself if you think you "own" your home or that it is paid off.   The King owns your home.  You own a piece of paper.   
2.  A mortgage is a long term rental agreement.  Yes that is correct.  Read the fine print on that 40 page contract.   The bank owns the home.  You are renting at a super low rental rate.   You are also responsible for all repairs and maintaining the property.
3. Your home is too big and/or expensive.  Yes, I said it!  90% of readers of this thread are living in homes that are "clown houses."    A good rule of thumb is 400 sq foot per person.   Otherwise your are living in the house equivalent of a "Hummer."   Very unmustachian.  (by the way, MMM lives in the house equivalent of a "clown car." 
4.  Home prices do not always go up.   We have seen this recently.  In one scenario you put 50K down on a home and the home value goes down so much in the next 3 years that you lose 100K in total.   At least in the stock market your loss is limited to your initial investment. 
5.  Renting an appropriate size and priced home has many advantages.  A. You don't do maintenance.  B. Your risk is very limited.  C. Your need to/want to move risk is very limited as in you can move anytime you like.  D. Should you decide to take an extended trip you will have no worries back home. You are free.   E.  This is a truism -  "You don't own a home,  it owns you"  And that pull is deeply psychologically based.   It is why people struggle so much with this thing, because it has been drummed into their psyche from an early age to own a home.   

So if you must fool yourself and "own" a home  ---

Buy the smallest least expensive, on sale home,  you can and put down 20% while investing the value of your home.

Or

Rent the most appropriately sized, nice and inexpensive place you can find.   Invest the entire difference.

By the way,  if the starter of this thread has 1.5 mill in assets they are doing very well and way past the blog definition of FI.    Were it me,  I would dump the home concept and take a very,  very long RV trip followed by a very, very long world hiking trip.   That would give you 3-6 years to consider your home options. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 28, 2014, 11:58:32 AM
Time to Refi?  Time to Restock?

"At its 52-week low of 4.10 percent, the rate on a 30-year mortgage is down from 4.53 percent at the start of the year. Rates have fallen even though the Federal Reserve has been trimming its monthly bond purchases, which are intended to keep long-term borrowing rates low. The purchases are set to end in October."

http://www.seattlepi.com/business/article/Average-US-30-year-mortgage-rate-at-4-1-percent-5718720.php
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: mobyrocket on August 28, 2014, 01:28:40 PM
tomsang,

I wanted to thank you for this thread.  After a fairly thorough review of the numbers you provided throughout this thread (others as well - especially the concept of the mortgage as bond portion of one's retirement), we are refinancing from a 15 year loan into a 30 year loan and reinvesting the difference from the monthly mortgage payment.  It actually allows us to top off our pretax savings as an added bonus.  We are completing this now as the rates are super low and we have a lot of confidence in our plan, in part, based on information in this thread.

Thank you mmm community and especially tomsang!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: fartface on August 28, 2014, 04:43:35 PM
I like your FIRE Calc. calculations over the long term.

I was paying $550/month interest one year ago on my $350,000 home. After selling a rental property I applied $140,000 from the proceeds of the sale towards the principal on my home. I now pay $170/month interest and have a balance just under $70,000.

It felt good psychologically to do this. What if the market had dropped 20% or more last year? I am risk-adverse and reducing my monthly interest by $380/month was a "sure thing" I felt good about.  My home will be paid off within two years. My oldest daughter heads off to college in five years. This gives me three full years to apply that $1600/month mortgage payment towards college savings or ERE or whatever else I please. It's a choice I'm most comfortable with...so do what helps you sleep best at night. Good luck!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on August 29, 2014, 05:45:27 AM
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.

I'm glad this thread popped back up. You're right! Objection withdrawn.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on August 29, 2014, 05:46:45 AM
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.

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

Can you elaborate this?

Just to put a concrete example - I have a mortgage and an 850 FICO.* 

It is literally impossible to increase my FICO, yet I have a mortgage.

*Thanks for the free FICO every month, Discover! Yes, it's a real 850-scale FICO. Yes, it is rather silly, and bounces between 849/850 and 850/850 depending on whether they make the pull before or after we've paid the monthly credit card bill.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Kevin Aster Tin Obin on August 29, 2014, 04:59:37 PM
I have been battling the mortgage payoff decision for a year now.  Sold previous residence so cash is increased, have 2 mortgages, primary residence and investment property.  We already max out 401k/Roth for spouse and I, but keep putting monthly savings in savings account at 0.8% interest.. I need to think more about the reverse bond and feel like I should hold no bonds in my AA at vanguard...trying to get more cashflow to retire in 5 years.. Can use cash for another investment property down payment, pay down mortgage, or continue to buy stocks/index funds in a taxable account.. With markets at all time high, I struggle with the feeling to dump a few years worth of expenses into stocks this month instead of just paying down 4.25% mortgage as Schiller predicted 10yr returns at 4% from here...  But then of course I don't have that capital to do what I want with a buy/sell/withdrawal if needed.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: nottoolatetostart on August 31, 2014, 03:53:27 AM
Glad I finally found this thread!

IMHO paying off more than 30% of a mortgage is the opposite of badassity.  I would characterize it as wussassity.   

Psychologically have the money to pay cash for your home and then put it into a REIT that you name "paid off home account."   Then party on Garth because you have both an investment and a home you get to live in!   You still "own" it because on the boxes you check with the choices  "rent"  or "own" your home?   You always check "own."

That said consider the following. 
1.  A home is a titled item  -- that is the King or Government grants you a title.  The King or Government can and will tax you on that title.   There is also the chance the King may want his house back.   In the US,  (since we are approaching a Greek point of debt)  it is likely at some point there will be a national property tax that is very substantial.   So from a psychological standpoint you are fooling yourself if you think you "own" your home or that it is paid off.   The King owns your home.  You own a piece of paper.   
2.  A mortgage is a long term rental agreement.  Yes that is correct.  Read the fine print on that 40 page contract.   The bank owns the home.  You are renting at a super low rental rate.   You are also responsible for all repairs and maintaining the property.
3. Your home is too big and/or expensive.  Yes, I said it!  90% of readers of this thread are living in homes that are "clown houses."    A good rule of thumb is 400 sq foot per person.   Otherwise your are living in the house equivalent of a "Hummer."   Very unmustachian.  (by the way, MMM lives in the house equivalent of a "clown car." 
4.  Home prices do not always go up.   We have seen this recently.  In one scenario you put 50K down on a home and the home value goes down so much in the next 3 years that you lose 100K in total.   At least in the stock market your loss is limited to your initial investment. 
5.  Renting an appropriate size and priced home has many advantages.  A. You don't do maintenance.  B. Your risk is very limited.  C. Your need to/want to move risk is very limited as in you can move anytime you like.  D. Should you decide to take an extended trip you will have no worries back home. You are free.   E.  This is a truism -  "You don't own a home,  it owns you"  And that pull is deeply psychologically based.   It is why people struggle so much with this thing, because it has been drummed into their psyche from an early age to own a home.   

So if you must fool yourself and "own" a home  ---

Buy the smallest least expensive, on sale home,  you can and put down 20% while investing the value of your home.

Or

Rent the most appropriately sized, nice and inexpensive place you can find.   Invest the entire difference.

By the way,  if the starter of this thread has 1.5 mill in assets they are doing very well and way past the blog definition of FI.    Were it me,  I would dump the home concept and take a very,  very long RV trip followed by a very, very long world hiking trip.   That would give you 3-6 years to consider your home options.

Oh my gosh....Love this! I too am teetering on paying off our 2.75% mortgage a little early and throwing a few extra dollars towards it each month. Whenever I have that thought when playing with my spreadsheets (which all support investing over paying the mortgage off, BTW), I will say to myself "rental, rental, this is a rental"

This post alone is very thought provoking. Thank you!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MidWestLove on August 31, 2014, 08:16:59 AM
"That said consider the following. 
1.  A home is a titled item  -- that is the King or Government grants you a title.  The King or Government can and will tax you on that title.   There is also the chance the King may want his house back.   In the US,  (since we are approaching a Greek point of debt)  it is likely at some point there will be a national property tax that is very substantial.   So from a psychological standpoint you are fooling yourself if you think you "own" your home or that it is paid off.   The King owns your home.  You own a piece of paper.   
"

I am not sure I understand this - would you mind expanding on it (or anyone else commenting on it)? if you think house is a titled item , then what your stock are (or for that matter every financial instrument that is not a hard asset)? all you "have" is a record entry in the computer , 100% visible to the "King" who can (and will, in times of desperation) change the rules whatever way the "King" wants. Be it mandatory confiscation (Cyprus style), mass freezing of the accounts while their worth decreased 1000x in 2.5 years (Soviet Union style 1991-1993), in desperate times, Kings do desperate things and they have the army and write the rules. Before people think I am a gold bug , I just do not see house as any more or less susceptible to King's whims and actually carrying utility for you vs pure 'paper' (now electronic) 'ownership' rights.


thank you






Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MidWestLove on August 31, 2014, 08:40:17 AM
and for those who are curious about "Kings" actions in Soviet Union , there were simple
- the expenses were far higher than receipts ( same situation as in US, with our King in much worse state)
- to pay for it, debt was monetized, and money supply was continuously increasing
- everything worked with no inflation until it did not
- King decided to rapidly decrease the amount of money in circulation with idea that everything will return to normal and printing/money creation could be continued at will.

so in January of 1991 King decided that
- only "new" money would be valid , personally signed by our King or whatever
- existing physical persons with SSN would be allowed to exchange up to X into "new" money (say 10,000)
- everything above X would be transferred into special accounts (liberty/freedom accounts , whatever)
- people would be allowed to take out (in new money) up to X amount a month (i.e. 500 a month)

what it has done
- immediately created black market due to disconnect between electronic and 'real'/new money
- created massive organized crime
- increased social friction to the point of the state collage
- triggered runaway inflation that took 8 years to tame. for comparison , in 1991 , 5 rubles were cost of 25 loafs of bread. By 1993, 5000 rubles would buy you a single loaf of bread (if you can find it)

whose who lived through this learned very well that
- every promise can (and will if it is convenient to the King) get broken.
- playing games with the state is like making deals with the devil - you will always lose.
- do not put too much stock into 'ownership' rights unless you physically control it and can post a guy with a rifle in front of it (and then worry about how to ensure that person with the rifle will not take over the same ownership as most organized crime teams did).



Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on August 31, 2014, 09:58:22 AM

Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.

Exactly.

I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay. If anything, having a lot of money tied up in a fixed asset like a house provides less flexibility to deal with uncertainties.

Maybe a simple example will help:

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 7%: $7000 annually = $583 monthly
Monthly expenses not covered by passive income: $1894

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000

As you can see OP, you end up with less money available for your total expenses each month, because you are losing the investing opportunity cost of your money tied up in the house. Also, you have no (or less) cash on hand to deal with life's uncertainties.

This makes sense to me, except for one thing. In the scenario where you pay cash for the house with no mortgage, you also have an extra $477/mo to invest since you have no mortgage payment. How does that factor in?

With mortgage:
A $100k investment at 7% for 30 years would be $566k.
We will have paid $171,720 for the mortgage, using your $477/mo figure.

With no mortgage:
Investing $477/mo at 7% for 30 years would be $475k.
We will have paid $100k for the house.

So, the investment acct has an extra $91k if you get a mortgage, but you have paid $71k for the interest. So, the net gain of having a mortgage is $20k.

Is that right? Is $20k really that much over a 30 year period? What about factoring in closing costs?

***edit***
So, the other thing to factor is that you wouldn't actually let that $100k sit untouched in the mortgage scenario. You would actually be drawing it down each month to pay the mortgage. So, using this calc (http://www.calcxml.com/calculators/how-long-will-my-money-last?skn=#results) it looks like you would have $118k at the end of it all, plus the 100k house that you paid $71k in interest for. How does that change things? It just confused me more and I honestly can't see what scenario is the best one.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 31, 2014, 12:15:46 PM
BooksAreNerdy-  The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous.  I put together an Excel workbook to show this.  But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover.  Check out the workbook and let me know if it clarifies or confuses.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 31, 2014, 12:19:16 PM
With markets at all time high, I struggle with the feeling to dump $100K into stocks this month instead of just paying down 4.25% mortgage as Schiller predicted 10yr returns at 4% from here...  But then of course I don't have that capital to do what I want with a buy/sell/withdrawal if needed.

Markets are usually at an all time high unless there was a serious correction.  Regarding Shiller, do you have a link to that?  I believe he was saying a conservative estimate would be at 4% after inflation.  IE 6.5% - 7% before inflation.  A 30 year mortgage is an amazing hedge against inflation as your P&I are locked in at the current rate for 30 years.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on August 31, 2014, 01:45:18 PM
BooksAreNerdy-  The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous.  I put together an Excel workbook to show this.  But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover.  Check out the workbook and let me know if it clarifies or confuses.

Mostly clarifies, but I feel like I should add some more specifics to our particular situation as the workbook just can't address all of my various ins and outs.  Our current house is on the market, its sale would leave us about $130-150k cash.  We are looking at houses in the $100k range for our next purchase, as this range allows the house to be quite livable for our family or a future rental/investment should we ever desire it to be such. 

DH is planning to retire in 6 years at age 38.  We aim to have enough in taxable accts to hold us over for 20 years, and then enough in retirement accts to last indefinitely.  We would also like to have a total of 3 houses in this 80-100k range, one for living and two for rentals. 

DH is of the opinion that we want to minimize our costs/payments in retirement.  So, he would rather have a paid off house and paid off rentals.  DH's argument is than in a downturn, you want to be withdrawing as little as possible from investments.  ie, have low enough expenses that you could easily use a side hustle to pay the bills.  So, he would rather pay cash up front and make sure our expenses are low when we hit retirement.  I, otoh, am trying to figure out the exact math of which is better.  Funny enough, he is the engineer and I am the english lit major.  So, I do appreciate the hand holding as I struggle with the math.  :)

One thing in my post above that I didn't think of, was that if we didn't have a mortgage, we likely wouldn't budget an extra $477/mo (or $382 in the case of an 80k mortgage) into our post retirement budget to invest instead of making a mortgage payment.  So, that investment benefit goes away. 

Scenario A, no mortgage:
Pay $100k cash for house
$382/mo is invested (vs spent on mortgage payment) for next 6 years, netting $35k. Untouched, this would grow to $177k over the following 24 years.

Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest. 
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k.

In Scenario A, you end up with a value of $100k+$177k=$277k in home cost plus investment growth. 
In Scenario B, you end up with $100k+$183k-$57k=$226k as your total value from home cost plus investment growth, minus mortgage interest paid. 

So, in this situation, it looks like NOT having a mortgage would actually be a better move financially, as you would end up with an extra $51k at the end.  Does that seem right?  It isn't exactly comparing apples to apples as I had originally posted, but it gives more of a real life example. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 31, 2014, 02:10:11 PM
If you already have more money than you know what to do with then having a paid off house makes sense.  If you are in the cusp, then having a low fixed rate mortgage and an 80/20 investment portfolio shows greater success. 

I haven't had enough time to look at your calc, but it sounds like there is something wrong with you analysis if it is showing a benefit of $51k by paying cash for your mortgage.  Are you including the investment returns?  I think the spreadsheet still works for your scenario.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on August 31, 2014, 02:55:27 PM
If you already have more money than you know what to do with then having a paid off house makes sense.

So if you had multiple millions and someone offered you free money, you'd say "nah, I'm good"?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on August 31, 2014, 03:40:43 PM
If you already have more money than you know what to do with then having a paid off house makes sense.

So if you had multiple millions and someone offered you free money, you'd say "nah, I'm good"?

sometimes, yes, because it's not all just economics.

I think at MMM levels of FIRE income, circa 30k, having a non mortgage home can be an advantage in that it helps lower earned declared income, and this may assist in getting capital gains tax to zero, and getting under this magical 90k a year with zero tax due limit that I'm looking forward to! Plus helping to qualify for ACA subsidies, possibility reduced local taxes too.

So, while at my income level I'm opting for a 80% 30 yr fixed mortgage in FIRE, one should first do the math, cashflow post tax etc vs cashflow post tax option 2.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on August 31, 2014, 03:41:53 PM
If you already have more money than you know what to do with then having a paid off house makes sense.

So if you had multiple millions and someone offered you free money, you'd say "nah, I'm good"?

I do that now. There are many great ideas on this website to make or save $10 - $30. It usually entails minimal effort. I don't do it as it isn't worth my time. If people are so set with money and don't want the hassle of paying their mortgage or the idea that they have a mortgage then I don't knock them. If it is pushing off or putting you into a riskier SWR then I don think it is wise.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on August 31, 2014, 03:45:41 PM
I don't do it as it isn't worth my time.

That wasn't what I was asking.  I don't do that either.  The question was about free money.  (If it takes time/effort, it's not free.)

Someone offers you a wad of cash, legally, would you say no, because you have enough?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on August 31, 2014, 06:33:05 PM
I don't do it as it isn't worth my time.

That wasn't what I was asking.  I don't do that either.  The question was about free money.  (If it takes time/effort, it's not free.)

Someone offers you a wad of cash, legally, would you say no, because you have enough?

Though it doesn't relate to my question, I had to jump in here. I would hope that as soon as any one of us had enough, we would know when to say 'no thanks' to anything in excess. :)

To tomsang, yes, my calculations included returns at 7%. I can be more specific with the calculators I used, if needed.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on August 31, 2014, 08:07:38 PM
I don't do it as it isn't worth my time.

That wasn't what I was asking.  I don't do that either.  The question was about free money.  (If it takes time/effort, it's not free.)

Someone offers you a wad of cash, legally, would you say no, because you have enough?

I'm willing to be the first test subject for examining this theory.

Keep handing me wads of cash until I say "no,that's enough."

;)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on August 31, 2014, 08:16:28 PM
BooksAreNerdy-  The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous.  I put together an Excel workbook to show this.  But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover.  Check out the workbook and let me know if it clarifies or confuses.

Mostly clarifies, but I feel like I should add some more specifics to our particular situation as the workbook just can't address all of my various ins and outs.  Our current house is on the market, its sale would leave us about $130-150k cash.  We are looking at houses in the $100k range for our next purchase, as this range allows the house to be quite livable for our family or a future rental/investment should we ever desire it to be such. 

DH is planning to retire in 6 years at age 38.  We aim to have enough in taxable accts to hold us over for 20 years, and then enough in retirement accts to last indefinitely.  We would also like to have a total of 3 houses in this 80-100k range, one for living and two for rentals. 

DH is of the opinion that we want to minimize our costs/payments in retirement.  So, he would rather have a paid off house and paid off rentals.  DH's argument is than in a downturn, you want to be withdrawing as little as possible from investments.  ie, have low enough expenses that you could easily use a side hustle to pay the bills.  So, he would rather pay cash up front and make sure our expenses are low when we hit retirement.  I, otoh, am trying to figure out the exact math of which is better.  Funny enough, he is the engineer and I am the english lit major.  So, I do appreciate the hand holding as I struggle with the math.  :)

One thing in my post above that I didn't think of, was that if we didn't have a mortgage, we likely wouldn't budget an extra $477/mo (or $382 in the case of an 80k mortgage) into our post retirement budget to invest instead of making a mortgage payment.  So, that investment benefit goes away. 

Scenario A, no mortgage:
Pay $100k cash for house
$382/mo is invested (vs spent on mortgage payment) for next 6 years, netting $35k. Untouched, this would grow to $177k over the following 24 years.

Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest. 
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k.

In Scenario A, you end up with a value of $100k+$177k=$277k in home cost plus investment growth. 
In Scenario B, you end up with $100k+$183k-$57k=$226k as your total value from home cost plus investment growth, minus mortgage interest paid. 

So, in this situation, it looks like NOT having a mortgage would actually be a better move financially, as you would end up with an extra $51k at the end.  Does that seem right?  It isn't exactly comparing apples to apples as I had originally posted, but it gives more of a real life example.

Your scenarios are not equal. You are double subtracting the $382 per month. And it looks like you are subtracting the interest AGAIN. Or I'm missing something.

Scenario A, no mortgage:
Pay $100k cash for house. At the end of 30 years, you have a house.

Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest. 
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k and you have a house.

Both houses are the same value at the end. Drop them from the calculation.

$382 you said covered P&I - the I being the interest on the loan. No need to subtract it yet again.

Scenario B ends up with an extra $183k.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on August 31, 2014, 08:57:41 PM
Though it doesn't relate to my question, I had to jump in here. I would hope that as soon as any one of us had enough, we would know when to say 'no thanks' to anything in excess. :)

Depends on what you mean by excess.  I already have enough, and all excess goes to charity.  Therefore when I don't optimize and choose mathematically inferior strategies to give myself warm fuzzies, I am taking money out of those charities.  That free money I can get by optimizing and then add to my contributions is not something I'd say "no thanks" to, personally.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on September 01, 2014, 08:30:18 AM
BooksAreNerdy-  The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous.  I put together an Excel workbook to show this.  But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover.  Check out the workbook and let me know if it clarifies or confuses.

Mostly clarifies, but I feel like I should add some more specifics to our particular situation as the workbook just can't address all of my various ins and outs.  Our current house is on the market, its sale would leave us about $130-150k cash.  We are looking at houses in the $100k range for our next purchase, as this range allows the house to be quite livable for our family or a future rental/investment should we ever desire it to be such. 

DH is planning to retire in 6 years at age 38.  We aim to have enough in taxable accts to hold us over for 20 years, and then enough in retirement accts to last indefinitely.  We would also like to have a total of 3 houses in this 80-100k range, one for living and two for rentals. 

DH is of the opinion that we want to minimize our costs/payments in retirement.  So, he would rather have a paid off house and paid off rentals.  DH's argument is than in a downturn, you want to be withdrawing as little as possible from investments.  ie, have low enough expenses that you could easily use a side hustle to pay the bills.  So, he would rather pay cash up front and make sure our expenses are low when we hit retirement.  I, otoh, am trying to figure out the exact math of which is better.  Funny enough, he is the engineer and I am the english lit major.  So, I do appreciate the hand holding as I struggle with the math.  :)

One thing in my post above that I didn't think of, was that if we didn't have a mortgage, we likely wouldn't budget an extra $477/mo (or $382 in the case of an 80k mortgage) into our post retirement budget to invest instead of making a mortgage payment.  So, that investment benefit goes away. 

Scenario A, no mortgage:
Pay $100k cash for house
$382/mo is invested (vs spent on mortgage payment) for next 6 years, netting $35k. Untouched, this would grow to $177k over the following 24 years.

Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest. 
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k.

In Scenario A, you end up with a value of $100k+$177k=$277k in home cost plus investment growth. 
In Scenario B, you end up with $100k+$183k-$57k=$226k as your total value from home cost plus investment growth, minus mortgage interest paid. 

So, in this situation, it looks like NOT having a mortgage would actually be a better move financially, as you would end up with an extra $51k at the end.  Does that seem right?  It isn't exactly comparing apples to apples as I had originally posted, but it gives more of a real life example.

Your scenarios are not equal. You are double subtracting the $382 per month. And it looks like you are subtracting the interest AGAIN. Or I'm missing something.

Scenario A, no mortgage:
Pay $100k cash for house. At the end of 30 years, you have a house.

Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest. 
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k and you have a house.

Both houses are the same value at the end. Drop them from the calculation.

$382 you said covered P&I - the I being the interest on the loan. No need to subtract it yet again.

Scenario B ends up with an extra $183k.

Ah, I see how that is double subtracting interest in scenario B. However, I don't think you can ignore the potential added investment of $382 from cash purchase date until retirement, and then its growth during the time we would have had a loan. So, perhaps the actual gains in each situation (house being equal in both scenarios and removed from the calculations) is Scenario A is $177k and Scenario B  is $183k.

So, having a mortgage puts us about $6k ahead at the end of 30 years. $6000 is not a huge 'wad of cash' to me, especially over 30 years. And certinally not worth the added peace of mind of having lower expenses for 30 years in retirement.

This has been a fun and interesting calculation, to be sure. Thanks for the help!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 01, 2014, 09:34:38 AM
However, I don't think you can ignore the potential added investment of $382 from cash purchase date until retirement

No, that doesn't exist in this scenario.  Think about it, you're pretending that the $382 is coming from your pocket, so by not having the mortgage you'd have that money freed up to invest.  But it's not - it's coming from the investment.  If you don't have the investment, you don't have that extra 382.

In other words, in both scenarios, A and B, you can invest ALL your extra money from your job after paying your other expenses (food, gas, etc.).  In the mortgage free option you invest all your job money, because you have no mortgage.  In the mortgage scenario, the INVESTMENT pays the mortgage, and you can invest all your job money.

In either scenario, you're investing all your job money.  There is no extra $382 you can magically invest in scenario A, because you're already investing all your extra money.

The only time what you're thinking would apply is if you were paying $382 from your job money in scenario B, then scenario A would have an extra $382 to invest.  Since it's not coming from that, but from the investment, you don't have that extra $382.

Therefore scenario B, having a mortgage, does, in fact, leave you with an extra $183,000.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on September 01, 2014, 06:05:16 PM
I updated the spreadsheet I created to show you how it works. 

As Tomtx mentioned you can eliminate some variables.  IE the house.  The house remains on both sides of the equation.  To make things simpler I would also eliminate the 20% down payment and just focus on the mortgage as the 80% is the only part that could be invested and the 20% is paying down the mortgage under both scenarios.

Under the Input page, note that I have it set up at a 4% investment return.  Go next to the answer by month.  Note that Column L shows 0 net benefit as the 4% invest rate is the same as the mortgage rate. 

Now go back to the Input sheet.  Input an investment rate.  I believe you were using 7%.  You will see on the Answer By Month Page Column L line 366 the benefit of keeping your mortgage for 360 months or 30 years is $182,309 if you can get a 7% return while having a 4% fixed rate mortgage.  You can play around with the Input sheet on what you want to use for variable, but it show that if you can get an investment return that is greater than your Mortgage Rate  then mathematically you are better off.

Let me know if this helps or confuses the situation.  When it comes down to it if you are assuming a 7% investment rate and have a 4% mortgage, then it is logical to put more dollars in the bucket that is earning the higher yield.

Good luck! 


[Mod Edit: Attachment removed.  Updated one two posts down.]
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 01, 2014, 06:39:58 PM
It has a broken link to another mortgage sheet it references.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on September 01, 2014, 07:54:33 PM
Updated links.  The links weren't effecting the calcs, just leftovers from me trying to reuse calcs from the previous spreadsheet.  Let me know if anything is funny!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on September 01, 2014, 09:43:02 PM

Ah, I see how that is double subtracting interest in scenario B. However, I don't think you can ignore the potential added investment of $382 from cash purchase date until retirement, and then its growth during the time we would have had a loan. So, perhaps the actual gains in each situation (house being equal in both scenarios and removed from the calculations) is Scenario A is $177k and Scenario B  is $183k.


Still wrong. Either there is NO "potential added investment" or you do it in both scenarios.

The (expected) increases in the $80k loan money you invest are paying the principal and interest on the loan.

There is NO justification to add magic outside money or "added investment" for the no-mortgage scenario.

Seriously. The difference in the scenarios is over $180,000 for "mortgage" with your stated parameters.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on September 02, 2014, 04:37:04 AM
Holy balls, I understand! Thank you for the light bulb. I totally get it. The 'budget' stays the same, the money for the house/mortgage only comes from that lump sum. Why was I making that so complicated?!


OK, so how does it actually work to USE that investment? It goes into a taxable acct, then is it best to not touch it for a year so the gains become long term gains? Or is it like a Roth, where your contributions and gains are treated differently? Would I just make a monthly draw from the taxable acct or an annual draw? How will taxes on this acct effect the end value? We plan to be in a low enough tax bracket in retirement for capital gains to be at 0%. When I play around with the turbo tax tool, it looks like, we might somehow be in the 15% tax bracket right now since we max out 401k and IRAs. So, does that meann that it is possible for that whole 80k investment to grow tax free?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Patrick A on September 02, 2014, 09:30:54 AM
What an amazingly awesome thread.  Lots of great arguments and math, as well as some very emotionally (and mathematically) unstable ones too.  I actually just posted a thread about this exact topic and quickly deleted it because of the great discussion and answers provided here.  Thank you to all of the contributors!

My only question:  I am 26 with my super padded worst case FI date sometime in the next 10 years.  I am looking at buying a house very soon and considering mortgage length.  With 15 year at 3.2% and 30 year at 4.1%, should I go for a 30 year or 15 year?  I can guess the answer based on my reading of this thread and many others, but would love to hear some input and reasoning from others.

Thanks
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 02, 2014, 11:50:43 AM
Holy balls, I understand! Thank you for the light bulb. I totally get it. The 'budget' stays the same, the money for the house/mortgage only comes from that lump sum. Why was I making that so complicated?!

(https://i.imgur.com/FfrvSq0.gif)

Absolutely, great way to think of it.  Your budget doesn't go up with a mortgage - your budget is the same, and the mortgage payment comes out of the higher investment money you have from not paying off the mortgage.

OK, so how does it actually work to USE that investment?

Treat it no differently than the rest of your investments.  You can think of it as a separate bucket if it helps you, but optimize your strategy/AA/tax efficiency with your WHOLE portfolio, that included.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on September 02, 2014, 12:54:48 PM
tomsang,

I wanted to thank you for this thread.  After a fairly thorough review of the numbers you provided throughout this thread (others as well - especially the concept of the mortgage as bond portion of one's retirement), we are refinancing from a 15 year loan into a 30 year loan and reinvesting the difference from the monthly mortgage payment.  It actually allows us to top off our pretax savings as an added bonus.  We are completing this now as the rates are super low and we have a lot of confidence in our plan, in part, based on information in this thread.

Thank you mmm community and especially tomsang!

Thanks for joining in on the discussions.  My goal is for people to understand why they are doing what they are doing, vs. the simplistic debt is evil and must be eliminated approach.  If after the discussion they choose to pay down their mortgage, then I am good with that if it is based on understanding the various variables.  A lot of people focus on one side of the equation - Saving Mortgage Interest vs. looking at both sides of the equation.  I am glad that the forum provided you a different perspective.  Enjoy those amazing 30 year fixed rates.  What rate did you get?         
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mr Mark on September 02, 2014, 03:58:03 PM
Once FI though, at low income levels (<$35k)  there may be tax advantage owning where you live, as the 'avoided rent' or mortgage payment, has to come from post tax income, whereas that free rent you get by owning is not declared income, so is effectively paid pretax.

It could also allow you to have a lower declared income for tax purposes, and hence gain tax credits and health insurance subsidies you wouldn't get if you had a mortgage and had to decalre and pay tax on that income draw from the stash. It could impact your capital gains tax, and tax paid paid on ordinary dividends perhaps.

In accumulation mode, or a significant earned income to declare,  I agree a fixed rate 30 yr deal is the way to go. You can always pay it off early at no fee anyway!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BooksAreNerdy on September 02, 2014, 05:17:57 PM
But wouldn't pulling out the lump sum to pay off the mortgage increase your income a HUGE amount for that year and trigger a ton owed in taxes?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on September 02, 2014, 08:50:46 PM
But wouldn't pulling out the lump sum to pay off the mortgage increase your income a HUGE amount for that year and trigger a ton owed in taxes?

Might take a couple of years, but you're only paying 15% on income up to ~$74,000 for a married couple. Plus $20,000 in standard deduction + exemptions.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: ender on September 03, 2014, 06:41:56 PM
Once FI though, at low income levels (<$35k)  there may be tax advantage owning where you live, as the 'avoided rent' or mortgage payment, has to come from post tax income, whereas that free rent you get by owning is not declared income, so is effectively paid pretax.

The opposite is true, you would have been better off having invested the extra money during your working and higher income years, so when you pull it out (either with traditional 401k/IRA counting as income or capital gains) you are paying a lower marginal rate on the money.

Quote
It could also allow you to have a lower declared income for tax purposes, and hence gain tax credits and health insurance subsidies you wouldn't get if you had a mortgage and had to decalre and pay tax on that income draw from the stash. It could impact your capital gains tax, and tax paid paid on ordinary dividends perhaps.

This could be true, but you also must figure the additional costs of paying off the mortgage and either losing tax advantaged space or tax free growth on taxable accounts (given where long term capital gains taxes are if someone is FI they have a lot of 0% capital gains space each year).

Quote
In accumulation mode, or a significant earned income to declare,  I agree a fixed rate 30 yr deal is the way to go. You can always pay it off early at no fee anyway!

Financially it's always the best option unless you expect the long term market to be worse than your interest rate (adjusted slightly if you are able to itemize interest).

If you are choosing to forgo tax advantaged space (especially non-Roth options) for the sake of paying off the mortgage it becomes even worse financially, especially for those planning any type of ER.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Kevin Aster Tin Obin on September 04, 2014, 05:11:50 PM
Found an interesting result in mortgage payoff spreadsheet...

For a rental property, If one pays off the note, the fire date is months to years earlier..   This would be different near the end of a 30 year mortgage when the payoff date is in sight, but if only a few years in, why not payoff the mortgage, increase monthly cashflow, and be closer to FIRE than if just continued saving... 

ready for anyone to poke holes in my math..
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 05, 2014, 04:54:39 PM
Found an interesting result in mortgage payoff spreadsheet...

For a rental property, If one pays off the note, the fire date is months to years earlier..   This would be different near the end of a 30 year mortgage when the payoff date is in sight, but if only a few years in, why not payoff the mortgage, increase monthly cashflow, and be closer to FIRE than if just continued saving... 

ready for anyone to poke holes in my math..

The question is: what is the alternative to paying off that debt?  If you can invest it at a higher rate, you can FIRE earlier than you would if you paid it off, because the investment will pay that debt service + give you extra cash flow for living expenses.

Read Scenario 2 in MMM's post here: http://www.mrmoneymustache.com/2012/02/24/pay-down-the-mortgage-or-invest-more-a-winwin-question/

That applies to rentals as well as primary.

By getting more rentals with that money you're using to pay off your first rentals, assuming the ROI is greater than the mortgage rate, you'll FIRE earlier.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 05, 2014, 05:12:34 PM
Re-read that scenario 2 a few times and make sure you understand every part of the math of it.

Now let's look at your scenario from your spreadsheet.

First of all, that's a pretty mediocre rental numbers-wise.  Unless the "monthly cash flow" is net after expenses, and the gross is more like double that.  EDIT: That appears to be cash flow after paying the mortgage, based on row 12, so it's actually not bad at all, it's actually really high, 17k net annual profit. Is that a typo in row 12? /END EDIT

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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on September 14, 2014, 09:08:56 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 14, 2014, 09:27:13 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.

The problem is that no one thinks they're the average investor, so this point of view will help almost no one.

Here's the groups of people:
1) People who think they can't beat the market, so they index.  They, reading this article, then will conclude they shouldn't pay it off.
2) People who think they can beat the market.  They, looking at average market returns, will conclude they shouldn't pay it off.

I don't think there's hardly anyone out there going "well I invest and consistently am bad at it, but am going to keep doing it, but I'll pay off my mortgage so I don't suck quite as much."

In other words, people who already accept they can't beat the market shouldn't pay it off, and people who don't accept that think  they're above average, by definition, so looking at how the average investor should pay it off doesn't help.

:)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar on September 14, 2014, 08:48:41 PM
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:)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on September 15, 2014, 09:19:53 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Kevin Aster Tin Obin 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...

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: ender 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%.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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%
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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...
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: VirginiaBob 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: foobar 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:)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: medinaj2160 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% ;).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang 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.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: defenestrate 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 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

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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"?

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Scandium 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 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
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Cheddar Stacker 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: bacchi 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: gluskap 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. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: The Happy Philosopher 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr 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. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday 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"...)

Quote
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?


Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.

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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).

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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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy 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).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy 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.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 10:34:45 AM
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Additionally while making plans to keep a mortgage for 30yrs seems like a nice idea on paper, I think in practice for primary residences it happens a lot less often than most here might think.  Life gets in the way: most ppl move many times over the course of their life due to jobs, divorce, kids (having them and also pushing them out of the nest), change in financial circumstances (both for the better and worse), and even early retirement.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2015, 10:38:55 AM
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Many HELOCs were shrunk or cancelled in the recession.  It's something that's nice to plan for, but I wouldn't count on.  And most people trying to pay down their mortgage aren't thinking about taking out a second mortgage (essentially).  And good luck trying to get it if you don't do it ahead of time, after you've lost your job.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.

This is true.  Or smart Mustachians who read the arguments, do the math, and purposefully decide to hold their low-rate, fixed mortgage and invest everything they can instead.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 10:51:41 AM
There has been comments about trapped equity which seems to be a bit of a fallacy

The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)

Many HELOCs were shrunk or cancelled in the recession.  It's something that's nice to plan for, but I wouldn't count on.  And most people trying to pay down their mortgage aren't thinking about taking out a second mortgage (essentially).  And good luck trying to get it if you don't do it ahead of time, after you've lost your job.

The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.

This is true.  Or smart Mustachians who read the arguments, do the math, and purposefully decide to hold their low-rate, fixed mortgage and invest everything they can instead.

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.  And yes my premise did assume the owner took out the HELOC while employed.

Additionally, those arguing so strongly for never paying down principal may have their dream house in the perfect location with the ideal family size for the next 30yrs (or may simply add it to a portfolio of rental properties if not) but I think it is fair to say that probably is not the case for most readers.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2015, 11:14:20 AM
If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.  And yes my premise did assume the owner took out the HELOC while employed.

They aren't necessarily correlated, but even so, if you have the extra funds you can wait out a stock market crash.  If you're relying on a HELOC and don't have access to one, you can't necessarily wait that out.

Additionally, those arguing so strongly for never paying down principal may have their dream house in the perfect location with the ideal family size for the next 30yrs (or may simply add it to a portfolio of rental properties if not) but I think it is fair to say that probably is not the case for most readers.

Not necessarily.. as long as the investment beats the mortgage rate over whatever time period, it's worth it.  Even if you only have the house for 5 years, or 10.

Now, it's more likely (close to every time) when you're holding the whole 30 years, but even on a short time frame you're more likely than not to beat today's low rates. 

Some may not want to take that chance, and others might want to play the odds.  I'd prefer to maximize, even with risk, but it's okay if others want to play it different.  But the "only works if you have your dream home to hold for 30 years" simply isn't true.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 24, 2015, 11:19:28 AM
^^^ Arabelspy -- well put. You and others have pretty much debunked all the arguments against prepaying such low rate mortgage loans. I realize that there is a risk but for those that are willing to take it, a payoff awaits.


Sent from my iPad using Tapatalk
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 11:22:23 AM

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.

I disagree that that's a fair statement.  It doesn't matter if stocks are "massively underwater" (as compared to the "return" on mortgage prepayment) at any given point during the 30-year run; it only matters if the CAGR outperforms the mortgate rate over the entire 30-year period.  At the snapshot in time when HELOCS were cancelled during the financial crisis, stock performance would have been trailing mortgage prepayment performance for someone who started down that road right before the financial crisis, but now stock performance is back on track to outperform.  If you look at the entire history of the markets, with all the market crashes and calamities, there hasn't been a 30 year period where the markets didn't outperform today's super-low mortgage rates.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 12:14:28 PM

If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.

I disagree that that's a fair statement.  It doesn't matter if stocks are "massively underwater" (as compared to the "return" on mortgage prepayment) at any given point during the 30-year run; it only matters if the CAGR outperforms the mortgate rate over the entire 30-year period.  At the snapshot in time when HELOCS were cancelled during the financial crisis, stock performance would have been trailing mortgage prepayment performance for someone who started down that road right before the financial crisis, but now stock performance is back on track to outperform.  If you look at the entire history of the markets, with all the market crashes and calamities, there hasn't been a 30 year period where the markets didn't outperform today's super-low mortgage rates.

The entire premise of needing a HELOC would be in the case of an unforeseen event (job loss, health issue) where immediate liquidity is needed - comparing apples to apples that means selling stocks in whatever mkt environment exists at the time vs drawing on the line of credit

If you want to compare a 30yr term where you never need the cash then it is true a high % of the time a passive equity index investment would beat a 3.5-4% annual rate.  More importantly, though, ppl should consider the correlation and likelihood of certain events occurring:
- what happens to stocks in times of high unemployment?
- what happens to stocks when real estate prices stagnate or drop?
- what happens to stocks when interest rates rise?
- what have realized returns been historically when rates are so low as they are now?

Take your personal situation into account, which includes likelihood of moving (and if so, what possible time period from now - the shorter it is, the less likely stocks will outperform even a 3% rate), stability of employment and income, expected expenses (marriage, college, rainy day).

This isn't a one-size-fits-all approach.  There are many ppl whose income is very highly correlated to the stock market.  I would argue they should never consider such a strategy until they are very close to FI and can weather almost any storm.  Others live in areas of the country (NY metro or Bay Area) where the strength of the equity market or tech companies is almost perfectly correlated with their employment as well as their home price.  It would seem silly to leverage up (which is what the strategy entails) for these individuals if financial ruin in the disaster scenario is a possibility.

I personally am interested in understanding what the long-term (even 30yr) historical return on equities has been from the starting point of current valuations, interest rates and profit margins.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 01:19:08 PM
NewNormal -

I agree with the overall sentiment in your post above.  You need to compare the risks associated with each strategy and pick your poison.  But I would say that for most people, all things considered, the odds will favor the strategy of carrying the mortgage.  If there's a strong chance you will be selling your house in the short-term, it would be stupid to leverage up and invest the proceeds in the stock market, but generally speaking it is a bad idea to buy property in the first place if there's a strong chance of selling in the short-term.  Yes, shit happens and unexpected circumstances may arise that force you to sell early, but generally you can control the timing of your sale -- so do you pick the plan that protects you against the remote risk of being forced to sell at a bad time, or do you pick the plan that protects against the very large risk of harming your chances of retirement success (i.e., requiring you to either work longer than what would otherwise be necessary, or cut expenses or seek alternative income in retirement, or some combination)?

But some of the bad outcomes in your list of correlated events argue against your point.  Instability of employment income is a good reason not to pay down your mortgage.  If you lose your job midway through an aggressive prepayment plan (which, as you said, will quite possibly happen at a time when your access to cash through other alternatives, including extraction of home equity, is also limited), you would have been better off had you been investing in lieu of prepaying (because even a depreciated pile of investments provides better liquidity than nothing).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Cheddar Stacker on March 24, 2015, 01:53:32 PM
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.

I disagree with most of what you wrote but this bit is simply ridiculous.

#1-again this isn't apples to apples. You are completely ignoring the other side. Mr. Aggressive debt reducer loses his house within a month or two since his capital is trapped. At least Mr. Investor keeps it for a few years in your example.

#2-you don't need $900k and a 4% SWR. You need assets that support the 4% SWR on your $1k/month spending (so $300k) + assets to payoff the house when you lose your job. On a 30 yr note at 4.25% interest with $2k P&I, the note is ~400k at the start and declining every year. So you might need $500-600k at most. But that "zone of risk" as you called it is declining rapidly every month.

Please recognize the debt reducer is at a much higher risk to lose his house during the zone of risk period. Beyond the zone of risk it depends on ROR on investments, but as others have stated 95% of the time investor will be in a much better position at the end of the zone of risk if it's > 5-10 years. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 03:04:29 PM
NewNormal -

I agree with the overall sentiment in your post above.  You need to compare the risks associated with each strategy and pick your poison.  But I would say that for most people, all things considered, the odds will favor the strategy of carrying the mortgage.  If there's a strong chance you will be selling your house in the short-term, it would be stupid to leverage up and invest the proceeds in the stock market, but generally speaking it is a bad idea to buy property in the first place if there's a strong chance of selling in the short-term.  Yes, shit happens and unexpected circumstances may arise that force you to sell early, but generally you can control the timing of your sale -- so do you pick the plan that protects you against the remote risk of being forced to sell at a bad time, or do you pick the plan that protects against the very large risk of harming your chances of retirement success (i.e., requiring you to either work longer than what would otherwise be necessary, or cut expenses or seek alternative income in retirement, or some combination)?

But some of the bad outcomes in your list of correlated events argue against your point.  Instability of employment income is a good reason not to pay down your mortgage.  If you lose your job midway through an aggressive prepayment plan (which, as you said, will quite possibly happen at a time when your access to cash through other alternatives, including extraction of home equity, is also limited), you would have been better off had you been investing in lieu of prepaying (because even a depreciated pile of investments provides better liquidity than nothing).

I would normally not disagree with your logic, because rates are indeed low, which makes the hurdle rate for investment returns seem very beatable.  The current reality is assets which generate a return are expensive by almost any measure.  And the most important criteria in an investment decision is the price paid, irrespective of asset class or holding period.  A few observations:

- you need to have a HELOC set up before you need it; this speaks to the trapped liquidity aspect; additionally....

- most lenders will now allow you to recast or recapitalize your loan for little or no cost if you have paid down principal, while keeping the initial maturity date, thereby decreasing your monthly payment; this effectively reduces your monthly cash outflow going forward, which is really the key to avoiding insolvency when the sht hits the fan (which it inevitably does every so often)

- yes most ppl should think long and hard about the likely timeframe of selling before actually buying; but the reality is a lot of the reasons for selling are simply not predictable or deemed unlikely at the time of purchase:
1) divorce - no one gets married thinking it will end in tears, yet more than half of romantic mergers crumble
2) jobs - even successful executives sometimes get relocated against their will, and moving is sometimes the best way to move up the ladder
3) family - not all kids are planned, nor are all living situations expected: the boomerang millennials are a great example, as well as retirees who will eventually move back in with their children out of necessity; and of course downsizing is a major demographic trend among boomers now as their children leave the nest
4) financial circumstance (for better and worse) - few successful professionals in their late 30s and early 40s will be content to live the post-undergrad starter home lifestyle once they have tasted a bit of success; alternatively ppl who are "unlucky" at some point in their careers may need to recalibrate expectations to the downside

- the correlation of unfortunate circumstances you question (job loss + lower home prices + lower stocks) happened just 5-6 years ago!  and it caused financial ruin for many ppl who thought they had an adequate margin of safety; the truly amazing thing is there is actually skepticism this could happen again, and that ppl actually think having more leveraged exposure to common stocks is safer than having a lower amount of debt (leverage) in one's personal balance sheet

As an aside, I write about many of these things out of my own personal experience: I did not anticipate some of life's curveballs and of course did not think that something that had never happened in the history of markets would transpire leading to the financial crisis.  It delayed my FIRE date by many years, but I was lucky: others I knew on the cusp of FI or already there on paper were ruined with no chance of recovery
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: skyrefuge on March 24, 2015, 03:15:47 PM
First, mefla, I'm about to talk some mid- to high-level shit here that doesn't actually impact the low-level stuff that brooklynguy and arebelspy are trying to help you to understand. So no need to read this until you understand everything they're saying.

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).

Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 24, 2015, 03:27:56 PM

This is my understanding thus far. There are two strategies  here.

I. If you are exceedingly risk-averse, go ahead and prepay your mortgage and get that guaranteed current sub-4% return on your prepayments over 30+ years.

II. If you are OK with the risk and have a long remaining investing life ahead of you, go ahead and invest for the higher returns. It will probably be higher than the 4% but no guarantees.

Mathematically (financially) over long durations (20-30 years)  investment ROR under II. will most likely beat I. It will be a bumpy ride. If you need the comfort, safety, and security, stay out of the ride.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 03:41:15 PM
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 04:22:23 PM
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).

Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 04:29:51 PM
NewNormal,

These are mostly valid points.  Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.

But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin.  I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding.  The first person at least has some depreciated investments to be liquidated.

Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options).  And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.

The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio.  If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so.  By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time.  Leveraging up your investments is doubling down on this approach.  For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate.  If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed at debunking [EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.

I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).

I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Dodge on March 24, 2015, 04:51:13 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 05:17:45 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Drew664 on March 24, 2015, 05:23:28 PM

This is my understanding thus far. There are two strategies  here.

I. If you are exceedingly risk-averse, go ahead and prepay your mortgage and get that guaranteed current sub-4% return on your prepayments over 30+ years.

II. If you are OK with the risk and have a long remaining investing life ahead of you, go ahead and invest for the higher returns. It will probably be higher than the 4% but no guarantees.

Mathematically (financially) over long durations (20-30 years)  investment ROR under II. will most likely beat I. It will be a bumpy ride. If you need the comfort, safety, and security, stay out of the ride.

Wouldn't the returns on I only be for the time it takes to paydown the mortgage, not 30+ years? After that, you'd have a lot of cash flow to pursue FI, RE, or both through whatever investment channels you desire. Nothing wrong with having principals that don't align with leveraging debt.

Good succinct summary post as this is how I understand it.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Eric on March 24, 2015, 05:31:18 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 05:31:43 PM
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)

I thought about this my entire bike-ride home.  I think the best answer is the Churchillism you coined that history-based prediction is the worst form of retirement success prognostication we have, except for all the others.  The caveat that the future may not resemble the past applies to all the retirement planning we discuss in this forum.  As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.  Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?  Is there any reason to think it works in this context but not that context?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 05:42:43 PM
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?

I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.

cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)

I thought about this my entire bike-ride home.  I think the best answer is the Churchillism you coined that history-based prediction is the worst form of retirement success prognostication we have, except for all the others.  The caveat that the future may not resemble the past applies to all the retirement planning we discuss in this forum.  As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.  Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?  Is there any reason to think it works in this context but not that context?

I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 05:43:35 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 05:51:50 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 05:54:16 PM
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.

Somewhere in the neighborhood of current mortgage rates (maybe 3.5% or so), in every single historical 30-year period (including all of those with low-interest starting environments) the market returns would have outperformed the mortgage (if cfiresim were working, we would be able to confirm the exact level, and I've become so dependent on cfiresim as to have near-total incompetence at using other calculators).

The claim that we're in a new world, and have never before experienced low interest rates combined with other aspects of the current market climate, and therefore can't use history as a guide, is pessimistic perspective, similar to what Pfau argues.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 05:57:25 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 24, 2015, 06:03:17 PM
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 06:06:21 PM
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points.  It shouldn't be hard to calculate.

Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.

Somewhere in the neighborhood of current mortgage rates (maybe 3.5% or so), in every single historical 30-year period (including all of those with low-interest starting environments) the market returns would have outperformed the mortgage (if cfiresim were working, we would be able to confirm the exact level, and I've become so dependent on cfiresim as to have near-total incompetence at using other calculators).

The claim that we're in a new world, and have never before experienced low interest rates combined with other aspects of the current market climate, and therefore can't use history as a guide, is pessimistic perspective, similar to what Pfau argues.

I think it is your assertion, that future returns will look similar to the past, despite the recent massive run up in prices and valuations (some would argue the valuations are high BECAUSE OF low interest rates - although that ultimately begs the question what happens when rates normalize), is the one that may be a off base, considering we have almost 200 years of financial history showing mean reversion of asset prices based on valuations (pick your value indicator, they all give similar results).

If returns are always 7% real despite starting point I am happy to be disproved.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 06:10:04 PM
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Eric on March 24, 2015, 06:13:47 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

Sure there is.  It's one example after another showing how dividends are mathematically equivalent to selling shares of stock.  Above you claimed that was incorrect.  So since they're equivalent, it's irrelevant to the withdrawal rate whether those withdrawals come from all dividends, all shares, or some combination.

Maybe I could've pointed you a little more directly.  Try here (http://forum.mrmoneymustache.com/investor-alley/total-stock-vs-500-vs-dividend-growth/msg184781/#msg184781) or here (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/msg584803/#msg584803)

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

I'm not sure what this has to do with the difference (or lackthereof) between dividends and sales of shares to fund your withdrawal.  It seems like a wholly different argument, so I'm not sure how it got tacked on here.  But if you don't think that your stocks are going to return greater than 3.5% per year over the next 30 years, then your proposed withdrawal rate will have to be extremely small, leaving you at work for a long long time. (basically the whole point of this thread)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 24, 2015, 06:19:16 PM
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?

I don't want to derail this thread into yet another discussion on dividends so this will be my only reply on it.

You brought up dividend yields with the assumption that the valuation of a company changes depending upon their dividend payout. The link that Eric posted contains comments and links that are a direct response to this assumption as well as:
... whether selling a share of stock (index) is equivalent to receiving a dividend...
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 06:26:51 PM
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

Wow, no relevance? Did you even read the thread??

Yes

How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?

I don't want to derail this thread into yet another discussion on dividends so this will be my only reply on it.

You brought up dividend yields with the assumption that the valuation of a company changes depending upon their dividend payout. The link that Eric posted contains comments and links that are a direct response to this assumption as well as:
... whether selling a share of stock (index) is equivalent to receiving a dividend...

Where did I say the valuation of a company changes depending upon their dividend payout?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 06:36:24 PM
I personally don't think a 4% withdrawal rate is prudent in this environment.  Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal.  Sounds to me like high sequence of return risk.

Dividends are mathematically equivalent to selling stock.  If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock.  They are mathematically equal.

This is incorrect.

When you receive a dividend, you receive a % of the corporation's profits.  While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.

When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits.  The going rate for profits does change dramatically over time.  If you sell today you will receive a much higher multiple than if you sold just a few years ago.

Oh boy!

Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.

Sure there is.  It's one example after another showing how dividends are mathematically equivalent to selling shares of stock.  Above you claimed that was incorrect.  So since they're equivalent, it's irrelevant to the withdrawal rate whether those withdrawals come from all dividends, all shares, or some combination.

Maybe I could've pointed you a little more directly.  Try here (http://forum.mrmoneymustache.com/investor-alley/total-stock-vs-500-vs-dividend-growth/msg184781/#msg184781) or here (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/msg584803/#msg584803)

The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).

I'm not sure what this has to do with the difference (or lackthereof) between dividends and sales of shares to fund your withdrawal.  It seems like a wholly different argument, so I'm not sure how it got tacked on here.  But if you don't think that your stocks are going to return greater than 3.5% per year over the next 30 years, then your proposed withdrawal rate will have to be extremely small, leaving you at work for a long long time. (basically the whole point of this thread)

You are referring to the financial theory of two identical companies A & B (one which pays dividends vs one that doesn't) and saying it doesn't matter if company A gives a dividend to shareholders while B doesn't bc you can simply sell shares in B to equate the dividend payout.  I agree with this theory.

That says nothing about the market multiple that is priced to company profits, which fluctuates over time, or the overall level of dividends paid by all stocks divided by their total price, or the yield, of the entire mkt.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?  (EDIT: knowing that dividend payout ratios don't fluctuate that much over short time periods)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 24, 2015, 06:57:37 PM
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2015, 07:02:15 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 24, 2015, 07:15:21 PM
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done. Great spreadsheet. I'll play with it some.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 07:30:56 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: skyrefuge on March 24, 2015, 07:42:00 PM
I thought about this my entire bike-ride home.

Ha, I know the feeling!

As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.

No, that'd be like saying "the inflation rate at the beginning of a 30-year cycle is irrelevant to the question of portfolio survival". If we just look at nominal investment returns (ignoring inflation), the 30-year cycle starting in 1966 would look just fine with a 4% WR. But we know that inflation affects real returns, so we include the historical inflation value when running the simulations, which reveals 1966 to be a bust.

So ignoring the historical inflation levels and using the current-but-historically-low 1.5% inflation rate for all cycles would cause cFIREsim to overestimate the success rate for portfolio survival. Likewise, I think it's probable that ignoring the historical mortgage rates and using a the current-but-historically-low 4% mortgage rate for all cycles would cause cFIREsim to overestimate the success rate for leveraged-investing-via-mortgage. Maybe the cycle starting in 1980 shows that it would have been a fantastic idea to borrow money to invest if you could have borrowed it at 4%, but a terrible idea if you had to borrow it at 10%. If so, the 1980 cycle would be a "false positive" in your cFIREsim results, since you couldn't actually borrow money at 4% in 1980.

Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?

No, those are different things. Something like CAPE would have no role in the cFIREsim model. It's not necessary to tell us what actual returns were like in a historical cycle. Inflation-adjusted prices are sufficient for that. While there are surely things that could be added to the cFIREsim model to refine its re-creation of history (the change of bond modeling was one such thing), CAPE is not one of those things. On the other hand, when you're using cFIREsim as a leveraged-investing-via-mortgage simulator, you're implicitly adding the need for more historical data, namely mortgage rates, and using a constant, current rate is a crude substitute when everything else is historically-accurate.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: skyrefuge on March 24, 2015, 08:07:00 PM
Where did I say the valuation of a company changes depending upon their dividend payout?

Er....right here (http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg602238/#msg602238): "The dividend yield is one of many ways to determine valuation".

Sure, it's a way to determine valuation, but it's a naive and worse-than-useless way to do so. You might as well use Facebook "likes". Looking at earnings makes a lot more sense, since a company can choose to stop distributing its earnings via dividends and distribute them via buybacks instead, and that wouldn't change anything about the company's value.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?

It certainly could be. If the dividend yield was 4% because companies were distributing 100% of their earnings via dividends, and then changed to 2% because they started distributing their earnings 50% via dividends and 50% via buybacks, then yeah, the total return would be the same. It seems like you understand how this works for a single company, so it's a pretty small leap to see how it works the same way for a group of companies, aka, "the market". Or just imagine that "the market" is made up of a single giant company.

Ok, like Runge, to avoid derailing the thread, this is my last post on the matter of dividends. If you'd like to discuss it more, please post in the referenced thread about dividends. (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please)

But while I'm here going off-topic...

I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post (http://forum.mrmoneymustache.com/welcome-to-the-forum/but-aren%27t-we-ignoring-inflation%27s-impact-on-our-cost-of-living-in-retirment/msg469217/#msg469217) for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 24, 2015, 08:17:31 PM
I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post (http://forum.mrmoneymustache.com/welcome-to-the-forum/but-aren%27t-we-ignoring-inflation%27s-impact-on-our-cost-of-living-in-retirment/msg469217/#msg469217) for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)

My bad. Thank's for the clarification on my poor choice of words. :D
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 08:21:33 PM
Where did I say the valuation of a company changes depending upon their dividend payout?

Er....right here (http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg602238/#msg602238): "The dividend yield is one of many ways to determine valuation".

Sure, it's a way to determine valuation, but it's a naive and worse-than-useless way to do so. You might as well use Facebook "likes". Looking at earnings makes a lot more sense, since a company can choose to stop distributing its earnings via dividends and distribute them via buybacks instead, and that wouldn't change anything about the company's value.

Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?

It certainly could be. If the dividend yield was 4% because companies were distributing 100% of their earnings via dividends, and then changed to 2% because they started distributing their earnings 50% via dividends and 50% via buybacks, then yeah, the total return would be the same. It seems like you understand how this works for a single company, so it's a pretty small leap to see how it works the same way for a group of companies, aka, "the market". Or just imagine that "the market" is made up of a single giant company.

Ok, like Runge, to avoid derailing the thread, this is my last post on the matter of dividends. If you'd like to discuss it more, please post in the referenced thread about dividends. (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please)

But while I'm here going off-topic...

I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post (http://forum.mrmoneymustache.com/welcome-to-the-forum/but-aren%27t-we-ignoring-inflation%27s-impact-on-our-cost-of-living-in-retirment/msg469217/#msg469217) for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)

I reference dividend yields for the mkt as a form of valuation only wrt the entire mkt given payout ratios don't change much from year to year.  Taken in this context your theoretical scenario of 100% dividends is not only improbable (i.e. never before happened) but also not very useful for the discussion unless we wanted to continuously pontificate about the vast exceptions as opposed to likely events.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2015, 08:54:33 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

I consider ROR of holding a market index fund to be very close to zero.  And in the case of total economic collapse, having a bit more equity in your house won't help you one bit.  And yes, equity extraction in a time of turmoil I consider much less liquid than selling a publicly traded stock.


Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

If you have years of payments saved up that you haven't put into the mortgage, you won't need to sell.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.

If my mortgage balance at a given time should be 50k according to the standard amortization table when I got the loan, if I had just made all my regular payments, my PITI is $400/mo, and I've put an extra $30k into it, so it's actually only 20k, and I lose my job, I still have to make that $400 payment.  It doesn't matter one whit that I'm slightly less deleveraged.  But if I still owe 50k, and have that 30k extra in the bank (which is reduced by 30%, say, from a market drop to 21k), that extra 21k gives me over 4 years of payments in the bank.  That's lots of time to find a new job, wait for the stock market to correct, etc.

Not having being forced to sell low is less risky, IMO.

If instead my mortgage is only 20k at that point, but I have very little in the bank (say, a 1K emergency fund, or just over 2 months of mortgage payments) and I'm forced to sell the house to extract that equity (as my well prepared HELOC plan gets me a letter in the mail saying the bank has closed it due to economic times), I could be in quite a bad spot, start taking hits to my credit as I'm unable to make the payment in the meantime, etc.

I much favor the person with cash in the bank (even invested in equities that have dropped) over the one with it as equity in the house, even if that person is a bit more leveraged on paper.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 24, 2015, 08:59:26 PM
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?

Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.

It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet

Define risk.  Stocks are more volatile, but not more risky, IMO, over a long enough time period.

Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.

Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.

I consider ROR of holding a market index fund to be very close to zero.  And in the case of total economic collapse, having a bit more equity in your house won't help you one bit.  And yes, equity extraction in a time of turmoil I consider much less liquid than selling a publicly traded stock.


Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation.  People have been trapped and unable to relocate due to being upside down on a mortgage.

If you have years of payments saved up that you haven't put into the mortgage, you won't need to sell.

Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.

If my mortgage balance at a given time should be 50k according to the standard amortization table when I got the loan, if I had just made all my regular payments, my PITI is $400/mo, and I've put an extra $30k into it, so it's actually only 20k, and I lose my job, I still have to make that $400 payment.  It doesn't matter one whit that I'm slightly less deleveraged.  But if I still owe 50k, and have that 30k extra in the bank (which is reduced by 30%, say, from a market drop to 21k), that extra 21k gives me over 4 years of payments in the bank.  That's lots of time to find a new job, wait for the stock market to correct, etc.

Not having being forced to sell low is less risky, IMO.

If instead my mortgage is only 20k at that point, but I have very little in the bank (say, a 1K emergency fund, or just over 2 months of mortgage payments) and I'm forced to sell the house to extract that equity (as my well prepared HELOC plan gets me a letter in the mail saying the bank has closed it due to economic times), I could be in quite a bad spot, start taking hits to my credit as I'm unable to make the payment in the meantime, etc.

I much favor the person with cash in the bank (even invested in equities that have dropped) over the one with it as equity in the house, even if that person is a bit more leveraged on paper.

Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 24, 2015, 09:02:40 PM
As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.

No, that'd be like saying "the inflation rate at the beginning of a 30-year cycle is irrelevant to the question of portfolio survival". If we just look at nominal investment returns (ignoring inflation), the 30-year cycle starting in 1966 would look just fine with a 4% WR. But we know that inflation affects real returns, so we include the historical inflation value when running the simulations, which reveals 1966 to be a bust.

So ignoring the historical inflation levels and using the current-but-historically-low 1.5% inflation rate for all cycles would cause cFIREsim to overestimate the success rate for portfolio survival. Likewise, I think it's probable that ignoring the historical mortgage rates and using a the current-but-historically-low 4% mortgage rate for all cycles would cause cFIREsim to overestimate the success rate for leveraged-investing-via-mortgage. Maybe the cycle starting in 1980 shows that it would have been a fantastic idea to borrow money to invest if you could have borrowed it at 4%, but a terrible idea if you had to borrow it at 10%. If so, the 1980 cycle would be a "false positive" in your cFIREsim results, since you couldn't actually borrow money at 4% in 1980.

Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?

No, those are different things. Something like CAPE would have no role in the cFIREsim model. It's not necessary to tell us what actual returns were like in a historical cycle. Inflation-adjusted prices are sufficient for that. While there are surely things that could be added to the cFIREsim model to refine its re-creation of history (the change of bond modeling was one such thing), CAPE is not one of those things. On the other hand, when you're using cFIREsim as a leveraged-investing-via-mortgage simulator, you're implicitly adding the need for more historical data, namely mortgage rates, and using a constant, current rate is a crude substitute when everything else is historically-accurate.

I don't think the analogy to ignoring inflation rates is quite right.  When we determine the success rate for leveraged-investing-via-mortgage using actual historical market performance but using today's prevailing mortgage rate, that is no different than determining the success rate of an equivalent non-mortgage-related spending plan (we are not purporting to be determining the actual historical success rate of leveraged-investing-via-mortgage, because, as you said, we are looking at the success rate using today's low-interest rates which were unavailable for most of history; we are just trying to determine the historical success rate of coming out ahead by investing a starting portfolio equal to the mortgage rate and spending it down according to a withdrawal plan that matches the mortgage's amortization schedule).

So when you run the cfiresim analysis to determine the leveraged-investing-via-mortgage success rate, just pretend you are doing a normal portfolio success/failure analysis where your projected living expenses coincidentally just happen to be equal to the principal + interest payments on the mortgage (your pretend projected living expenses are going to decline over time, which explains why they remain constant in nominal terms (and decrease in real terms) over the 30-year period).

There's no reason you can't use history-based cfiresim as the best (that is, the worst, but better than all the rest) predictive tool to determine the chances of success for this pretend spending plan, right?  And if the answer is no, because you want to take each historical period's actual interest rate environment into account, then why should that not be the case for all of the cfiresim analyses we ordinarily do?

What your argument implies (I think) is that some characteristic about a market exists (the prevailing mortgage rate?  a treasury yield benchmark?) from which it is possible to determine future returns.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 24, 2015, 09:29:49 PM
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?

My understanding is that lenders are not required to recast mortgages on request. This can especially happen if the loan has been sold to a different investor who may or may not be willing to recast. In fact, there is nothing I see in the usual mortgage agreement that contains a provision for recast. You can certainly prepay without penalties but the lender is not required to recast/re-amortize  the balance.

That said, my lender is willing to recast currently but their policy may change in the future. I'd rather on be dependent on the whims of my lender. It is a policy not within my control and no guarantee that I'll be able to when needed.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 24, 2015, 10:19:16 PM
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?

My understanding is that lenders are not required to recast mortgages on request. This can especially happen if the loan has been sold to a different investor who may or may not be willing to recast. In fact, there is nothing I see in the usual mortgage agreement that contains a provision for recast. You can certainly prepay without penalties but the lender is not required to recast/re-amortize  the balance.

That said, my lender is willing to recast currently but their policy may change in the future. I'd rather on be dependent on the whims of my lender. It is a policy not within my control and no guarantee that I'll be able to when needed.

This.  As we've mentioned multiple times, you may not be able to access that equity when you want.  Someone with control of the cash themselves is in a much better position than someone relying on the financial industry for access to it when they need it.

And even if you can recast to a lower payment, that still doesn't help you access the equity - in other words, you still need to make that payment, and have very little money with which to do so.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on March 24, 2015, 10:45:37 PM
And even if you can recast to a lower payment, that still doesn't help you access the equity - in other words, you still need to make that payment, and have very little money with which to do so.

This is profoundly true. I still need to make that payment.

But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on March 24, 2015, 10:52:47 PM
First, mefla, I'm about to talk some mid- to high-level shit here that doesn't actually impact the low-level stuff that brooklynguy and arebelspy are trying to help you to understand. So no need to read this until you understand everything they're saying.

Don't worry, I'll avert my eyes while you kiss their asses. Just wash up and let yourself out afterward, OK?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: skyrefuge on March 24, 2015, 11:03:53 PM
There's no reason you can't use history-based cfiresim as the best (that is, the worst, but better than all the rest) predictive tool to determine the chances of success for this pretend spending plan, right?  And if the answer is no, because you want to take each historical period's actual interest rate environment into account, then why should that not be the case for all of the cfiresim analyses we ordinarily do?

I suppose to the extent that your yearly expenses are attributable to historically-known factors, those factors should be incorporated into the simulation for ultimate accuracy. We just enter "$20,000" for our yearly expenses because it's easy. "100 lbs. of beef, 500 gallons of gasoline, 100GB of mobile data, interest payments on a $200k loan, etc" would actually be better, since our desire is not really to make a particular amount of dollars disappear, but to acquire products and services we need in our lives. But breaking things down that way would be a serious pain in the ass, both for us and the cFIREsim designer, so we don't do it that way. However, in the special case of leveraged-investing-via-mortgage, 100% of the expenses are easily attributable to a knowable factor, and furthermore, that factor is much more likely to be correlated with other cFIREsim factors than the price of beef is.

What your argument implies (I think) is that some characteristic about a market exists (the prevailing mortgage rate?  a treasury yield benchmark?) from which it is possible to determine future returns.

I would say more that I'm offering the hypothesis that prevailing mortgage rates have a correlation with future market returns, and plugging that data into cFIREsim would be an informative exploration of that hypothesis.

I mean, this is the reason why we (I think?) like historical simulators like cFIREsim vs. Monte Carlo simulations, because Monte Carlo simulations ignore the possibility of equity returns, bond returns, interest rates, and inflation being interrelated. The Fed (these days) directly connects inflation to interest rates, interest rates directly affect bond returns, and bond returns theoretically and indirectly affect equity returns. None of those links are ironclad, and the gross effect is pretty unpredictable, but the ability to at least recognize any interrelation is one big thing that differentiates cFIREsim from Monte Carlo simulations.

Say 4%-or-lower mortgage rates actually existed in only 20% of cFIREsim's start years. If it showed that the success rate of the leveraged-investing-via-4%-mortgage plan was 50% when looking at only those years, vs. the 96% success rate when you use 4% for all years, would you still say that the leveraged-investing-via-4%-mortgage plan has a 96% chance of beating the pay-off-your-mortgage plan? (for the record, if historical mortgage data was used, my random-ass guess is that the cFIREsim success rate would only be reduced to 80% or something; I'm not at all saying that the leveraged-investing-via-4%-mortgage plan is the wrong choice, just that it's possible that "there's a 96% chance of it being the right choice" could be overstating it a bit).

And yes, this is similar to the recent thread on CAPE and SWRs (http://forum.mrmoneymustache.com/investor-alley/using-market-valuation-measurements-to-affect-swr/) where I made the possibly-heretical admission that I feel the odds of success for someone retiring at today's high CAPE-levels may be slightly lower than the overall cFIREsim success rate indicates. But the historical mortgage rate information could (theoretically) be plugged into cFIREsim and applied to automatically affect the success rate, while incorporating CAPE requires us to arbitrarily create a filter to cherry-pick the "years like the current one" to include in the success-rate calculation.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 07:35:15 AM
I suppose to the extent that your yearly expenses are attributable to historically-known factors, those factors should be incorporated into the simulation for ultimate accuracy. We just enter "$20,000" for our yearly expenses because it's easy. "100 lbs. of beef, 500 gallons of gasoline, 100GB of mobile data, interest payments on a $200k loan, etc" would actually be better, since our desire is not really to make a particular amount of dollars disappear, but to acquire products and services we need in our lives.

I disagree.  We primarily are interested in merely determining the likelihood of success of a plan to make a particular amount of dollars disappear, taking into account the overall inflation rate but not the inflation rate as it pertains to a particular product or service.  When I run a cfiresim simulation, I want to find out the historical success rate of withdrawing $20k per year, and not the historical success rate of withdrawing an amount of money sufficient to purchase $20k worth of beef as of the date I run the simulation.  If the price of beef for whatever reason fluctuates in a non-correlated way with the overall inflation rate, I might decide to substitute more chicken for beef, or vice versa.

Take the hypothetical example of someone whose entire living expenditures does and will always consist of nothing but purchases of large quantities of pocket calculators.  When this person uses cfiresim to plan his retirement, should cfiresim take into account the actual historical cost of pocket calculators (which, I'm assuming, was extraordinarily higher in today's-dollars in 1965 than today)?

Quote
However, in the special case of leveraged-investing-via-mortgage, 100% of the expenses are easily attributable to a knowable factor, and furthermore, that factor is much more likely to be correlated with other cFIREsim factors than the price of beef is.

I don't see leveraged-investing-via-mortgage as a special case.  Yes, the reason the mortgage's amortization is what it is is because of the interest rate environment at the period start-date when the mortgage is obtained.  But that doesn't change the fact that the annual withdrawals, although in fact being used to service the mortgage, could just as easily be used to purchase beef, or pocket calculators.

Quote
I would say more that I'm offering the hypothesis that prevailing mortgage rates have a correlation with future market returns, and plugging that data into cFIREsim would be an informative exploration of that hypothesis.

I mean, this is the reason why we (I think?) like historical simulators like cFIREsim vs. Monte Carlo simulations, because Monte Carlo simulations ignore the possibility of equity returns, bond returns, interest rates, and inflation being interrelated. The Fed (these days) directly connects inflation to interest rates, interest rates directly affect bond returns, and bond returns theoretically and indirectly affect equity returns. None of those links are ironclad, and the gross effect is pretty unpredictable, but the ability to at least recognize any interrelation is one big thing that differentiates cFIREsim from Monte Carlo simulations.

Say 4%-or-lower mortgage rates actually existed in only 20% of cFIREsim's start years. If it showed that the success rate of the leveraged-investing-via-4%-mortgage plan was 50% when looking at only those years, vs. the 96% success rate when you use 4% for all years, would you still say that the leveraged-investing-via-4%-mortgage plan has a 96% chance of beating the pay-off-your-mortgage plan? (for the record, if historical mortgage data was used, my random-ass guess is that the cFIREsim success rate would only be reduced to 80% or something; I'm not at all saying that the leveraged-investing-via-4%-mortgage plan is the wrong choice, just that it's possible that "there's a 96% chance of it being the right choice" could be overstating it a bit).

I'm sure it's true that the number of leveraged-investing-via-mortgage success cases among only the subset of historical cases with a low-interest-rate-environment starting point is lower than 96% (bo knows, please bring cfiresim back online so we can stop hypothesizing!), but that calls into question not just the approach of using the overall historical leveraged-investing-via-mortgage success rate to predict one's current likelihood of leveraged-investing-via-mortgage success, but the entire approach of using overall historical success rates to predict one's current likelihood of success, which we have been doing for some time (in this thread, for example:  http://forum.mrmoneymustache.com/ask-a-mustachian/firecalc-and-cfiresim-both-lie/), and which is why you borrowed from Churchill to astutely observe that it's the worst approach we have, but better than all the rest.

Quote
And yes, this is similar to the recent thread on CAPE and SWRs (http://forum.mrmoneymustache.com/investor-alley/using-market-valuation-measurements-to-affect-swr/) where I made the possibly-heretical admission that I feel the odds of success for someone retiring at today's high CAPE-levels may be slightly lower than the overall cFIREsim success rate indicates.

Most of us (myself included) share your schizophrenia about simultaneously believing in the inability to "time the market" or even "time your retirement" while also worrying about current pessimistic market indicators.  That is the reason we, on the one hand, speak about the absurdly ridiculous margins of safety built into our retirement plans (judging by historical SWR analysis) and, on the other hand, continue to worry that signs point to our own situation being like one of the historical 5%, or 2%, or 0.01% failure cases.  If we truly, honestly believed that the actual odds of success of our own retirement plans, with absolutely no corrective action or other external levels of safety margin needed, were greater than 95 out of 100, would any of us really have any legitimate concerns about the safety of the approach or succumb to OMY syndrome?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 07:51:48 AM
This is profoundly true. I still need to make that payment.

But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.

So now your previous plan to prepay in lieu of investing has morphed into a plan to invest in cash in lieu of investing in stocks/bonds?  That is not addressing the "carry mortgage vs. pay off mortgage" decision (which is the subject of this thread), and is instead addressing the question of the advisability of engaging in market timing.  Even the person with no mortgage has to decide whether to deploy excess cash towards their bank account or their brokerage/mutual fund account.  And, consistent with the upthread attempts to stymie the off-topic detours into the matter of dividends, that's all I'm going to say on the subject.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on March 25, 2015, 10:03:47 AM
This is profoundly true. I still need to make that payment.

But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.

So now your previous plan to prepay in lieu of investing has morphed into a plan to invest in cash in lieu of investing in stocks/bonds?  That is not addressing the "carry mortgage vs. pay off mortgage" decision (which is the subject of this thread), and is instead addressing the question of the advisability of engaging in market timing.  Even the person with no mortgage has to decide whether to deploy excess cash towards their bank account or their brokerage/mutual fund account.  And, consistent with the upthread attempts to stymie the off-topic detours into the matter of dividends, that's all I'm going to say on the subject.

Look: I'm not coming to you or anyone else to determine "my plan". I have a plan and I'm sticking to it based on my prior personal investment experience and the experience I've seen other people go through. If avoiding another Enron or GM bailout is "market timing", then I have to accept that you and I are never going to have a reasonable discussion about this question.

I'd truly be a lost soul to take guidance from people who've been so irrational in a public forum. You guys keep dreaming up ridiculous ideas in your head about what I'm really doing, simply because I contested a point and asked questions that so far none of you poop-flinging monkeys has an interest in answering.

Look: here's what's printed at the bottom of the Vanguard Investments website:

"All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Investments in bonds are subject to interest rate, credit, and inflation risk."
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 10:13:29 AM
Not sure what questions you have asked that you believe haven't been answered, since answering your questions is all us "poop-flinging monkeys" have been exhaustively trying to do (which is what set this thread ablaze anew in the first place).

Also not sure why anyone would be considered a "lost soul" for taking advice from a public forum.  I myself am in that boat on this precise issue, as anyone can see by scrolling five pages back into this very thread.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 10:18:30 AM
We're not talking about your plan, mefla.  We don't even know what it is.  We're talking about paying off your mortgage versus investing.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Eric on March 25, 2015, 10:31:19 AM
I sense a new tagline:

The MMM forums:  Home of the most irrational people on the internet.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on March 25, 2015, 10:41:38 AM
I sense a new tagline:

The MMM forums:  The Internet: Home of the most irrational people on the internet.

FTFY ;)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 10:50:02 AM
I'd truly be a lost soul to take guidance from people who've been so irrational in a public forum ... you poop-flinging monkeys ...

I really did enjoy this though, it's almost sig-worthy.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 25, 2015, 10:50:44 AM
... ideas in your head about what I'm really doing, simply because I contested a point and asked questions ...

Speaking of questions:
Mortgages are capitalized up-front, investments are capitalized "late".
Don't understand - could you elaborate?
arebelspy offered his opinion of what you were thinking, but it would be better to hear a first person response.  There has been a lot of back and forth since then, so I may have missed it, but what do you mean about the capitalization timing?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 10:55:21 AM
... ideas in your head about what I'm really doing, simply because I contested a point and asked questions ...

Speaking of questions:
Mortgages are capitalized up-front, investments are capitalized "late".
Don't understand - could you elaborate?
arebelspy offered his opinion of what you were thinking, but it would be better to hear a first person response.  There has been a lot of back and forth since then, so I may have missed it, but what do you mean about the capitalization timing?

I thought mefla agreed with my interpretation based on his response:
Quote
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.

But if not, feel free to chime in with what you did mean.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BarkyardBQ on March 25, 2015, 11:17:45 AM
Look: I'm not coming to you or anyone else to determine "my plan". I have a plan and I'm sticking to it based on my prior personal investment experience and the experience I've seen other people go through. If avoiding another Enron or GM bailout is "market timing", then I have to accept that you and I are never going to have a reasonable discussion about this question.

All investing is subject to risk, TRUE
including the possible loss of the money you invest. If you take out or sell your principal when it's down
Diversification does not ensure a profit or protect against a loss. sure... 1 goes up 1 goes down... usually more like 10 go up, 2 go down, 1 goes out
Investments in bonds are subject to interest rate, credit, and inflation risk. Cash in a savings account loses 2% when inflation is 3% on average and your savings account returns 1%... same for bonds if inflation goes above the average.

mefia, I'm not nearly as smart as some of the people trying to reply to you but I at least understand the math and especially risk tolerance and time horizon involved in weathering a devalued portfolio during a financial crisis... so what I'm going to offer are scenarios that may appeal to your emotional decision.

Scenario:
1) You have a 30 year mortgage with a 1k payment. The economy fumbles, you lose your job, you have no emergency fund, no investments, and you've simply made your normal monthly payments and burned all your remaining disposable income. You are screwed, you either go on subsidized funding and/or default on your mortgage.

2) You have a 30 year mortgage with a 1k payment. The economy fumbles, you lose your job, you have no emergency fund, no investments, and you've  doubled down on your mortgage payments for years. You own half your house, but you have no income, and nothing to liquidate. You will default on your next payment and you will not be able to buy groceries.

3) You have a 30 year mortgage with a 1k payment. The economy fumbles, you lose your job, you have no emergency fund, no investments, and you've doubled down on your mortgage payments for years. You own your house, you have no income, banks are in crisis mode and will not give you a HELOC. You cannot buy groceries.

4) You have a 30 year mortgage with a 1k payment. The economy fumbles, you lose your job, you have a 6 month emergency fund, no investments, and you've doubled down on your mortgage payments for years. [pick one], you have no income, you can chose to either default or buy groceries.

-or-

A) You have a 30 year mortgage with a 1k payment. The economy fumbles, you lose your job... You only ever made your minimum monthly mortgage payment, you built up a 6-12 month emergency fund (because you hate risk) which includes mortgage + expenses. You've invested 1k a month into the market, which is now worth 50% of your peak balance. Because you have 6 - 12 month emergency fund you can survive 6-12 months or you can cut back to beans and rice (you don't buy gas anymore cause you don't have a job) and you can stretch your fund +33% longer while you ride out the crisis or find a new job. You're portfolio is still worth something and can be utilized if this event depletes your emergency fund.


The point everyone else is trying to make is that you cannot predict the next crisis, but if it happens while you are prepaying your mortgage, you will have NO funds to weather the storm. If you are completely against investing in the market because you cannot handle the risk/time horizon for it to return again, then cash is your friend, it will become worth less over time and you should probably check out this thread http://forum.mrmoneymustache.com/welcome-to-the-forum/preppers/

The only way to avoid another Enron/GM, bailout, or crisis is to never invest in the market... 7 years later we have recovered quite well, read http://forum.mrmoneymustache.com/ask-a-mustachian/how-did-you-fare-during-the-20002008-stock-crashes-regale-this-stocks-noob/

I think this one from h2Ogal highlights it pretty well...
Quote
2008      151000 - left old job - options also underwater - lost them - downturn also
2009      103834 - at one point even lower like 70K
2010      161963

That's a speed bump... if you are driving around in one of those bottomed out Honda CRX's... enjoy driving through the parking lot like Frogger avoiding all the trouble.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on March 25, 2015, 01:12:10 PM
Quote
Quote
Quote
I thought mefla agreed with my interpretation based on his response:

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.

But if not, feel free to chime in with what you did mean.

I see now, I should have put "not understanding" in quotes. Those are your words, not mine. I was trying to make a peace offering to get you assholes off my back and engaged in meaningful communication.

Do you get it? It was a peace offering. it was me saying "stop, stop: I want to listen to your points...This crap where you guys make up stupid things I "allegedly" believe is driving me nutso and it serves no useful purpose except to make me think you are kids with no real-world investing experience.

Now, Here's the deal:

What I mean by "front capitalization" is pretty much what some of the alternative arguments are in the OTHER "mortgage thread" (that brooklynguy was trying to get me to shut up in, since others had come to my rescue there...).

That when you take out a mortgage, but you have no liquid investments, you are standing there in a fairly high state of risk with nothing to cover you in case of job failure. That you run the risk, with a 30 year mortgage, as many people have EXPERIENCED, of being upside down in the property with no way to restructure the debt.

This is the state in which all of you began the discussion, and properly assessed: without any investments you can draw on in the case of job loss, you're screwed. You're standing there owing however-many thousands of dollars. You've leveraged the house you live in and you MUST make the payments.

Day 1 of your mortgage, you and brooklynguy and all the other assholes who chimed in to kick me in the balls are right about. Day 1, you are "screwed".

At this point, the "screwee" is in what I call the "zone of risk". It's the state where job loss = home loss. Now, this is a WORSE state to be in than if you rented. All you assholes say this and I agree. Losing your job in either case is bad, but with a fresh 30 year mortgage, it has a far worse impact than being kicked out of your rental property.

So your first priority, above all - especially above prepaying the mortgage - is to build an "FU FUND". This is a common-enough mustachian principle that it's been made perfectly clear to me and I have done this personally myself. I have an FU fund of about 8 months right now and I've been building it to reach a 12 month level of security. And I've used the other principles that get commonly discussed, to determine what level that needs to be at, while simultaneously cutting my cost of living to fit down into a 4% SWR.

Now, what I did was I built multiple FU funds out of liquid investments. I got this idea from the "CD Ladder' concept. Realizing that I could reinforce those funds by making them investments, not just ramming that money straight into the mortgage or caching it in a  passbook savings account. (although, if that's all you have access to, it's better than nothing...)

And of course, because I'm not an idiot, I'm still investing. I'm contributing pre-tax to a 401k spread over a Vanguard indexed fund. This year, got HSA capability, so I'm pushing a teeny tiny bit to that also.

Fast forward to about two years ago. I've got multiple "tiered" FU funds, a 401k, some stock in an E*TRADE account and I'm restructuring my life to lower my cost of living to approach that magic 4% (or preferably 3%) SWR. Life is good.
 
Suddenly I realize something quite sucky: it's impossible for me to fit down into a 4% SWR while carrying the mortgage I have. I do some back-of-napkin estimates and I realize that I won't reach a high enough level of investment for at least 10 years, to be able to carry my mortgage + retire. I am over-leveraged in my mortgage, and it's REALLY not that big of a mortgage: $200,000.

Well screw that. I want to retire in 2020, five years from now. I can reach 4% SWR with no mortgage and the investment level I feel comfortable that I'll reach in five years.

I decide to accelerate my 15 year mortgage to a capitalization level low enough that I can then refi (remember, they will pay me) to a 10 year low-interest mortgage, with the plan to pay that off in 5 years.  And since I'm aiming for a lower capitalization, as long as I remain employed, I can still continue pre-paying the mortgage AND investing for FIRE.

And then I come across "Runge" and his simulator spreadsheet, and it damn near perfectly describes what I'm aiming for anyway:

Quote
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.

So look: I'm not saying you are wrong about any math. I buy it, OK? What I'm saying is that your job, your employer, your personal history, investment options, mortgage terms, and even the design of the house one lives in, all dictate how you want to move money around among your various asset classes.

In my case, I've chosen to diversify by investing a little faster in my own home, given that, in my estimate, I'm over-leveraged in my mortgage and I don't want to sell this home to rent or buy another house. It has features in it that are very important and still somewhat unique that make 4% SWR much more feasible for me.

FIN
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 01:27:55 PM
mefla - it might be best to just focus on winning in life rather than on this Internet forum. 

There do seem to be a few jerks, and I guess is it is human nature to state things confidently as black and white, when in reality there may be gray areas (I am guilty of this myself at times).  There are quite a few friendly + helpful ppl as well and they are really the ones who add value to the discussions.

I have gotten irritated at times myself, which has forced me to consider how much time I want to spend participating rather than just casually observing.  I do think it would ultimately be in everyone's interest to keep the tone friendly and welcoming, lest ppl who actually have something meaningful to contribute decide to disengage, but I leave that to others to police and manage, particularly the forum moderators and established participants.

Good luck in your endeavors
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on March 25, 2015, 01:39:59 PM
mefla - it might be best to just focus on winning in life rather than on this Internet forum. 

There do seem to be a few jerks, and I guess is it is human nature to state things confidently as black and white, when in reality there may be gray areas (I am guilty of this myself at times).  There are quite a few friendly + helpful ppl as well and they are really the ones who add value to the discussions.

I have gotten irritated at times myself, which has forced me to consider how much time I want to spend participating rather than just casually observing.  I do think it would ultimately be in everyone's interest to keep the tone friendly and welcoming, lest ppl who actually have something meaningful to contribute decide to disengage, but I leave that to others to police and manage, particularly the forum moderators and established participants.

Good luck in your endeavors

I appreciate your comments. I got an answer that satisfies me from VikB in the other thread. I'm comfortable accepting your counsel and your considerations - I'm doing that now myself by winding down my postings.

What I didn't understand (and walked into blindly) is that there are people here getting their rocks off on making other people look stupid. To the point that they slice out small bits of comment, repeat what they said before, then make claims like "you don't understand the math".

I really wasn't prepared for that - I asked an honest question and the people who came at me the hardest have done their damndest not to answer it, preferring to extend the feeding frenzy on someone they want to think of a a weak-minded idiot.

The pathos of that overwhelms me, and yes, scares me into limiting my time on the forums.

But I'm happy, too. Two threads embraced the more complicated risk elements of the discussion, and one person actually gave me a real, honest-to-god answer, which I deeply appreciate. I've got something now I can act on, and that's a Good Thing.

As for arebelspy "enjoying the thread", more power to him. I sure as hell haven't. If he's supposed to be a moderator and trusted keeper of the forums, he damn well failed in that mission on this thread.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Eric on March 25, 2015, 01:50:50 PM
As for arebelspy "enjoying the thread", more power to him. I sure as hell haven't. If he's supposed to be a moderator and trusted keeper of the forums, he damn well failed in that mission on this thread.

LOL!  This from the person that just called everyone else assholes.

Most people take disagreement as just that -- disagreement.  You're the one the raised the ante with personal attacks.  So I can understand why you didn't enjoy the thread.  You're taking things that aren't personal and making them so.  The rest of us (arebelspy included I'm sure) enjoy the discussion even if there is disagreement.  That's how you learn.  Or at least that's how it's supposed to work unless you dig your heels in and consider any other points of view to be those of poop flinging monkeys.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 01:54:30 PM
I appreciate your comments. I got an answer that satisfies me from VikB in the other thread.

I took a look at that other thread.  No one ever answered that question because you never asked it.  If you want to talk about what to invest in, by all means, start a thread with your parameters.  Maybe I missed it.  Please quote where in this thread you asked what investments you should make.

Also VikB gave a quite shallow/quick answer (I don't disagree, but it's certainly not nuanced discussion - simply because no one knew what you were asking, IMO).  You should dig deeper.

In this thread, I see one comment where you ask if you're missing any pre-tax investments and state what you're doing post-tax:
Quote
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.

And one where you ask if you should do a case study:
Quote
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?

And you're promptly told yes.  Did you do that?

As for arebelspy "enjoying the thread", more power to him. I sure as hell haven't. If he's supposed to be a moderator and trusted keeper of the forums, he damn well failed in that mission on this thread.

I enjoy pretty much everything.  I'm a regular person, moderator doesn't mean I represent anything in any way, it means I delete spam and deal with trolls.

If you're having trouble with multiple people in multiple threads, maybe you should look at how you're approaching the issue.

Good luck buddy.  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 01:57:12 PM
Most people take disagreement as just that -- disagreement ... You're taking things that aren't personal and making them so.  The rest of us (arebelspy included I'm sure) enjoy the discussion even if there is disagreement.

This.  Many of us have learned things and changed our minds about things based on discussions here.  We try to have intelligent, respectful discourse.  Unfortunately it doesn't always work out that way.

But disagreement does not necessarily have to be antagonistic.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 01:58:28 PM
I do think it would ultimately be in everyone's interest to keep the tone friendly and welcoming, lest ppl who actually have something meaningful to contribute decide to disengage

I wholeheartedly agree with this sentiment, and would just note that it's sometimes difficult to communicate tone through internet postings so we should all try not to jump to conclusions.  I can see how mefla might have felt that everyone was ganging up on him (particularly given how aggressive some of the posters were getting in expressing their viewpoints in the other thread), but it's a two-way street and the guy who starts tossing around the asshole and poop-throwing monkey comments should probably develop a thicker skin.  As one of the designated assholes myself, I won't speak on my own behalf, but I found it funny that the other folks who were responding to and trying to help answer mefla's questions are some of the friendliest, nicest and most even-tempered folks we have in this forum, including arebelspy and MDM.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 25, 2015, 02:14:47 PM
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done, but there are some items that seem pertinent.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.

When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement   = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K

...and retirement occurs at exactly the same time in both scenario 2 & 3.

The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: skyrefuge on March 25, 2015, 02:29:04 PM
When I run a cfiresim simulation, I want to find out the historical success rate of withdrawing $20k per year, and not the historical success rate of withdrawing an amount of money sufficient to purchase $20k worth of beef as of the date I run the simulation.

Is that really what you want, or is that just a reasonable compromise between what you want and what is possible?

Here is what *I* want cFIREsim to tell me, where, if "A" is not implementable, then I'll settle for the next one on the list, and so on:

A) A visitor from the future to tell me that my retirement worked perfectly, where I never wanted for money, and died with $1 to my name.
B) A time machine that sends versions of me into the past, and tells me that "1871 skyrefuge" through "1970 skyrefuge" all would have made it successfully and happily through their retirements.
C) A time machine that sends a Generic Money-Spender into the past, and tells me that "1871 GMS" through "1970 GMS" don't run out of money.

Note that each step down comes at the cost of decreased accuracy in the prediction of my actual life path. "A" is the ultimate, because it removes all concern about whether the future is likely to resemble the past. "B" doesn't tell me anything about the future, but it tells me how *I* would have done in the past, with my desires and behaviors and flexibility in the face of differing economic conditions. "C", believe it or not, is what cFIREsim actually does ("whoa....")

And yes, until we can see the future, it will remain the best-of-the-worst retirement predictors, but that doesn't mean clairvoyance is the only way its class-leading predictive ability could be improved.

Take the hypothetical example of someone whose entire living expenditures does and will always consist of nothing but purchases of large quantities of pocket calculators.  When this person uses cfiresim to plan his retirement, should cfiresim take into account the actual historical cost of pocket calculators (which, I'm assuming, was extraordinarily higher in today's-dollars in 1965 than today)?

Yes, this is exactly what a B-Level cFIREsim would and should do. If there was actually such a person whose only desire was a fixed quantity of pocket calculators per year, then B-Level cFIREsim would look into its database for the historical calculator prices and show that cycles starting in 1980 were far more successful than cycles starting in 1950, as calculator-acquisition costs required much smaller WRs in later years. For the years before the invention of the pocket calculator, it would "know" that it's really calculation in any form that's important to our subject (rather than battery-powered electronic devices), and would substitute the cost of slide-rules for the cost of calculators, just as it would also know your meat-eating preferences and substitute chicken for beef when beef prices got too high for you.

Of course B-Level cFIREsim would be impossible to implement for a general, real-world user. First it would have to incorporate historical prices of everything into its database, though that would actually be the "easy" part. The hard part would be to incorporate the user's desires and behaviors and substitution preferences, which would take like a 20,000-line form even if all of that stuff was knowable to the user, which it isn't. So that's why a fully-functional B-Level cFIREsim would require genuine mind-reading and/or time-travel technology.

But for the special case of a calculator nut? A one-off B-Level cFIREsim is totally possible, because the "user" in that case is extremely easy to model since we already know everything in their mind.

And so similarly, a one-off B-Level cFIREsim for a leveraged-investing-via-mortgage nut would also be possible. If I was such a nut and had the choice of using a B-Level cFIREsim or a C-Level cFIREsim, of course I would choose the B-Level, because it would provide a more accurate prediction of my actual life path than C-Level. It would still be a terrible prediction, since, unlike an A-Level cFIREsim, it can't actually know the future. But that doesn't mean I'd say "pfft, since it's not as good a A-Level, I'm just gonna stick with C-Level".

So I can imagine a C-plus-Level cFIREsim, that sits between C-Level and B-Level, where there would be optional fields for "percentage of expenses directed to mortgage payments" and "percentage of expenses directed to pocket calculators". In fact, the variable spending method options are already a significant step in the direction of C-plus-Level, as they allow the user to incorporate some of their personal behaviors into the simulation, making Generic Money-Spender slightly less-generic.

Of course I'm not actually calling for such features to be added to cFIREsim, since they're silly and would confuse the heck out of things, even if they improved it for a few specific users/uses. It's really just a mental exercise to explore whether using historical mortgage rates should be considered an improvement.

But once we get these mind-reading and backward-time-travel things worked out, bo_knows should totally expect to hear from me!

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 02:58:29 PM
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done, but there are some items that seem pertinent.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.

When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement   = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K

...and retirement occurs at exactly the same time in both scenario 2 & 3.

The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.

So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?

Why invest in bonds when you can earn 100s of bps more after tax and risk free by paying down your own mortgage?  And if you want to effectively "rebalance" you can simply extract equity that was paid down by selling bond portion to 0%.

And let's assume that for discussion purposes the risk of HELOC shutdown is de minimis (in reality the probability of a shutdown occurring is more than compensated by the extra spread you get by effectively owning your own MBS) and should not be a factor.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 03:20:21 PM
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?

No, but it is arguably logical to assume that they should do so, assuming they are capable of completely excising all emotion from their investing decisions (which most people (or all people?) aren't).  Some of us (including me) routinely argue that there is no logical reason to hold bonds, period, if you can be absolutely certain that your time horizon is sufficiently long (30 years passes that test, IMO), except to the extent the bonds operate as self-restraint tool to prevent your own irrational, emotionally-driven self to panic-sell during a market downturn (there are lots of threads on that topic, like this one (http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/)).  But it is especially illogical to do so while simultaneously carrying a mortgage (which effectively operates as a bond holding and can be used as a substitute for the desired bond portion of your allocation).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 03:23:01 PM
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?

No, but it is arguably logical to assume that they should do so, assuming they are capable of completely excising all emotion from their investing decisions (which most people (or all people?) aren't).  Some of us (including me) routinely argue that there is no logical reason to hold bonds, period, if you can be absolutely certain that your time horizon is sufficiently long (30 years passes that test, IMO), except to the extent the bonds operate as self-restraint tool to prevent your own irrational, emotionally-driven self to panic-sell during a market downturn (there are lots of threads on that topic, like this one (http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/)).  But it is especially illogical to do so while simultaneously carrying a mortgage (which effectively operates as a bond holding and can be used as a substitute for the desired bond portion of your allocation).

Except for the whole rebalancing thing.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 03:39:23 PM
Except for the whole rebalancing thing.

You mean as far as a reason that it makes sense to hold bonds, or as far as why you can't equate carrying a mortgage to holding a bond?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 03:50:43 PM
Except for the whole rebalancing thing.

You mean as far as a reason that it makes sense to hold bonds, or as far as why you can't equate carrying a mortgage to holding a bond?

Yes.

I believe it's significantly harder to access equity in a house when the market crashes and your AA is unbalanced than it is to sell bonds when that happens.

I think thinking of your house as a bond (and paying down your mortgage as holding bonds) makes a lot of sense.  But it's not a perfect comparison due to that issue.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 25, 2015, 05:29:35 PM
...
The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
The spreadsheet analysis makes no assumption about asset allocation.  It assumes only that one receives a certain (in the example, 7%) investment return, in order to demonstrate numerically that investing at a higher return is better than paying a mortgage with a lower interest rate.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 25, 2015, 06:36:25 PM
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done, but there are some items that seem pertinent.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.

When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement   = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K

...and retirement occurs at exactly the same time in both scenario 2 & 3.

The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
MDM and Runge -- Thank you.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 25, 2015, 07:48:42 PM
@rpr, you're welcome!

Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).

Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.

What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.

In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.

HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).

I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Nicely done, but there are some items that seem pertinent.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.

When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement   = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K

...and retirement occurs at exactly the same time in both scenario 2 & 3.

The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.

Thanks for the feedback. I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.

As for my calculations not accurately calculating the post fire number correctly, I was lazy and didn't implement that. I just said, hey cool, green cells mean I'm eligible to FIRE. :D Thank's for taking the time to update it to reflect the FIRE choice.

...
The math remains the math: investing at 7% is better than prepaying at 4.25%.  Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
The spreadsheet analysis makes no assumption about asset allocation.  It assumes only that one receives a certain (in the example, 7%) investment return, in order to demonstrate numerically that investing at a higher return is better than paying a mortgage with a lower interest rate.

This is correct. Ideally you'd want to somehow figure out a way to marry this with the discussion that brooklynguy and skyrefuge are having about cFIREsim. Only then can you include asset allocation in the calculations, and you'd also get an estimated success rate for the plan as a whole. That would be really neat to see.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 25, 2015, 07:54:00 PM
Here is what *I* want cFIREsim to tell me, where, if "A" is not implementable, then I'll settle for the next one on the list, and so on:

A) A visitor from the future to tell me that my retirement worked perfectly, where I never wanted for money, and died with $1 to my name.
B) A time machine that sends versions of me into the past, and tells me that "1871 skyrefuge" through "1970 skyrefuge" all would have made it successfully and happily through their retirements.
C) A time machine that sends a Generic Money-Spender into the past, and tells me that "1871 GMS" through "1970 GMS" don't run out of money.

Note that each step down comes at the cost of decreased accuracy in the prediction of my actual life path. "A" is the ultimate, because it removes all concern about whether the future is likely to resemble the past. "B" doesn't tell me anything about the future, but it tells me how *I* would have done in the past, with my desires and behaviors and flexibility in the face of differing economic conditions. "C", believe it or not, is what cFIREsim actually does ("whoa....")

I definitely would prefer version "A", but I'm not convinced that version "B" is better.  I think the version "C" that we actually have may be the more accurate predictor of future success, because it isn't biased by outdated information.  The success rate that B-Level cFIREsim spits out for our hypothetical pocket calculator nut will underestimate his actual chances of success, because it thinks pocket calculators are more expensive than they really are (or, more accurately, its success rate was determined on the basis of many cycles where pocket calculators were more expensive than they are today and will be in the future).

Quote
And so similarly, a one-off B-Level cFIREsim for a leveraged-investing-via-mortgage nut would also be possible. If I was such a nut and had the choice of using a B-Level cFIREsim or a C-Level cFIREsim, of course I would choose the B-Level, because it would provide a more accurate prediction of my actual life path than C-Level. It would still be a terrible prediction, since, unlike an A-Level cFIREsim, it can't actually know the future. But that doesn't mean I'd say "pfft, since it's not as good a A-Level, I'm just gonna stick with C-Level".

So I can imagine a C-plus-Level cFIREsim, that sits between C-Level and B-Level, where there would be optional fields for "percentage of expenses directed to mortgage payments" and "percentage of expenses directed to pocket calculators". In fact, the variable spending method options are already a significant step in the direction of C-plus-Level, as they allow the user to incorporate some of their personal behaviors into the simulation, making Generic Money-Spender slightly less-generic.

Ok, to take this back to where we started, I think we can agree that, assuming the leveraged-investing-via-mortgage version of C-plus-(or B-minus?)-Level cFIREsim does do a better job of predicting the success of leveraged-investing-via-mortgage, then that version of cFIREsim would also do a better job of predicting the success of any spending plan.  When you ask cFIREsim to tell you the likelihood that your investments will outperform your mortgage, you are really just asking it to tell you the chances of portfolio success for a specific spending plan that happens to match the amortization schedule of a certain mortgage that could be obtained today.  It doesn't matter if the dollars withdrawn from your portfolio in connection with that spending plan are being used to make mortgage payments, or to purchase beef, or to be doused in kerosene and set on fire.  So, if cFIREsim were tweaked to incorporate prevailing-mortgage-rate-information into the historical dataset it uses to calculate success rates, and that tweak improved its predictive ability regarding leveraged-investing-via-mortgage, then that tweak would also improve its predictive ability regarding sustainable withdrawal rates in general.  Which takes us back to my original point, that your hypothesis really has nothing to do with the mortgage issue, and has broader application to WR success rates generally.  In other words, if it's too optimistic to look at all historical periods to determine the success rate of a spending plan based on today's low mortgage rates (instead of looking only at those historical periods with similarly low-interest-rate-environments at the start date), then the same is true for any spending plan.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 25, 2015, 08:20:43 PM
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.

Scenarios 2 & 3 are identical through year 23, correct?  Then, to pay the mortgage, you either withdraw a large amount at once (scenario 3) or smaller amounts every month (scenario 2).

In scenario 3 you have a withdrawal rate of (30000 + 57000) / 820000 = 10.6% in your first year due to the large lump sum payment.  But that's ok because it lasts only 1 year and then you drop to something <4% for years after that. 

Similarly, scenario 2 has the higher withdrawal rate you note, but only for seven years.  That's ok because after the mortgage is paid you drop to something <4% for years after that.

By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege.  So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 25, 2015, 09:10:02 PM
Sweet swirling onion rings! You're right! It doesn't matter if you drag out your mortgage payment in scenario 2 or lump sum pay it in scenario 3 because the underlying assets for FIRE assuming a paid off mortgage are there already. I had to make some graphs to visualize it, but it'll roughly look like the attached pictures.

By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege.  So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.

Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 25, 2015, 09:37:00 PM
Nice charts!

The discussion in http://forum.mrmoneymustache.com/welcome-to-the-forum/trying-to-get-a-better-understanding-of-that-%2725-times-annual-spending%27-rule/, particularly kaizen soze's post #10, helped clarify some things in my head.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 25, 2015, 09:45:49 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 10:36:24 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!

I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.

Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.

But I think it would be more interesting and useful to see how it actually fared historically

And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner).  I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk

See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm

http://dqydj.net/sp-500-return-calculator/


Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 25, 2015, 10:56:51 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!

I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.

Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.

But I think it would be more interesting and useful to see how it actually fared historically

And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner).  I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk

See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm

http://dqydj.net/sp-500-return-calculator/

In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing.  We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 11:10:05 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!

I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.

Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.

But I think it would be more interesting and useful to see how it actually fared historically

And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner).  I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk

See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm

http://dqydj.net/sp-500-return-calculator/

In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing.  We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.

The high in rates was actually 1980 (it didn't work starting then for 30yrs either).

Look at the data and come to your own conclusions

It seems a bit illogical to use historical data to assume future equity returns to calculate perceived safe withdrawal rates and other investment strategies but not use the data staring you in the face for mortgage vs equity returns.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 11:16:36 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!

I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.

Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.

But I think it would be more interesting and useful to see how it actually fared historically

And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner).  I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk

See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm

http://dqydj.net/sp-500-return-calculator/

In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing.  We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 11:37:38 PM
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.

Bingo!  :D   Do we have another convert to "keep the mortgage"?  ;)

It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.

Also, I loved this:
Sweet swirling onion rings!

I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.

Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.

But I think it would be more interesting and useful to see how it actually fared historically

And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner).  I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk

See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm

http://dqydj.net/sp-500-return-calculator/

In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing.  We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing

With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Cressida on March 25, 2015, 11:43:15 PM
Do we have another convert to "keep the mortgage"?  ;)

Probably. After all the talk on this topic over the past few days, I have certainly revised my opinion. I'm not going to prepay my mortgage as it stands now (we recently refinanced to a 15-year and put some money in to get the loan below jumbo level; I'm not sorry for that part, although I'm sure some will disagree). Instead, I've added the mortgage amount to my stache threshold for FI. I haven't decided if I would pay off the mortgage at that point - so I guess you can color me not ENTIRELY converted), but I'm certainly more comfortable with the idea of investing the cash rather than paying down the mortgage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 25, 2015, 11:44:59 PM
Quote from: TheNewNormal2015

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing

This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?

Quote
With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets

Thanks, but this requires a registration/subscription which I don't have.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 25, 2015, 11:50:56 PM
Do we have another convert to "keep the mortgage"?  ;)

Probably. After all the talk on this topic over the past few days, I have certainly revised my opinion. I'm not going to prepay my mortgage as it stands now (we recently refinanced to a 15-year and put some money in to get the loan below jumbo level; I'm not sorry for that part, although I'm sure some will disagree). Instead, I've added the mortgage amount to my stache threshold for FI. I haven't decided if I would pay off the mortgage at that point - so I guess you can color me not ENTIRELY converted), but I'm certainly more comfortable with the idea of investing the cash rather than paying down the mortgage.

cressida -- The 15 year is a great way to go especially, if you got a sub 3% rate. But don't prepay anymore. For those that commit to a shorter term, they benefit from the lower interest rate.

http://thefinancebuff.com/borrow-30-year-and-invest-the-difference.html (http://thefinancebuff.com/borrow-30-year-and-invest-the-difference.html)

From the linked article:
Quote
Note this is not a typical “should I prepay my mortgage or invest” situation. Merely prepaying your mortgage does not lower the rate on the entire outstanding balance. You get the lower rate on the whole balance only when you make a firm commitment to make a higher monthly payment each and every month. It’s a gift to the committed.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 25, 2015, 11:56:59 PM
Quote from: TheNewNormal2015

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing

This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?

Quote
With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets

Thanks, but this requires a registration/subscription which I don't have.

That's unfortunate

I don't feel comfortable copy/pasting the data if they want to keep it to subscribers only

I guess it is up to each individual to decide how he wants to interpret the data provided.  I have a feeling many will just want to continue to believe what they want and keep their head in the sand.

I wonder whether that type of cognitive bias would be categorized under "Ostrich Effect"
Title: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 26, 2015, 01:52:42 AM
TheNewNormal2015 -- there are many roads to Dublin as they say. Pick whichever works for you.

I was able to read that article. Thanks for the link. Unfortunately, that article does not say very much about long term returns of the market following a period of low interest rates. All it says, is that there is a strong relationship between the interest rate and the return from securities for that year.

There are a couple of possibilities.

I. Interest rates remain depressed for quite a while, say the next thirty years. Could happen, e.g. Japan. In this case stock returns would also be muted over this entire duration. In such a case everything is bad, stocks, bonds, etc.

II. Loose monetary policies eventually lead to higher inflation. And in periods of higher inflation, stocks have a lower real return. But I would assume that interest rates would rise and people with investable assets could presumably get CDs which would definitely pay more than the lower interest rate that are locked with low mortgages from now. 





Sent from my iPad using Tapatalk
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 26, 2015, 04:43:25 AM
I guess it is up to each individual to decide how he wants to interpret the data provided.  I have a feeling many will just want to continue to believe what they want and keep their head in the sand.

I wonder whether that type of cognitive bias would be categorized under "Ostrich Effect"

Data from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html.  X-axis is the beginning year of the 30 year period.
(http://s16.postimg.org/wfy99fegl/screenshot_1.png)

From http://www.dailywealth.com/2248/housing-bust-is-over.  This was the only chart I found (after an admittedly short search) with data pre-1971.  Note that it ends ~2012, and rates have continued low (or lower) since then.
(http://s16.postimg.org/3tdmil7n9/screenshot_2.png)

I leave it to someone else to put everything on one graph if interested. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 05:22:27 AM
It seems a bit illogical to use historical data to assume future equity returns to calculate perceived safe withdrawal rates and other investment strategies but not use the data staring you in the face for mortgage vs equity returns.

In my view, it's exactly the opposite.  It seems illogical to use historical data to assume future equity returns for the purpose of determining perceived safe withdrawal rates but not use the same historical data to assume future equity returns for the purpose of determining the advisability of leveraged-investing-via-a-mortgage-having-today's-low-rate.  This is exactly the debate skyrefuge and I have been going back and forth about.  I completely agree that there may be reasons to think that current indicators could possibly be signs that future returns will be lower than historical returns (even though I'm not sure if that's actually true and don't share the level of pessimism some people, like Pfau, have on that question), but once you make an assumption about the sub-performance of future returns, that affects your perceived SWR just the same as your perceived advisability of leveraged-investing-via-mortgage.  If the next 30 years don't produce returns high enough to outperform today's low rate mortgages, then anyone retiring today on anything higher than an extremely-low WR is in a boatload of trouble.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: boarder42 on March 26, 2015, 06:26:58 AM
i was in the wrong post. I like this post much better gonna follow here ... though i'm already a convert by basically digging up all this info my self.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 07:07:13 AM
TheNewNormal2015 -- there are many roads to Dublin as they say. Pick whichever works for you.

I was able to read that article. Thanks for the link. Unfortunately, that article does not say very much about long term returns of the market following a period of low interest rates. All it says, is that there is a strong relationship between the interest rate and the return from securities for that year.

There are a couple of possibilities.

I. Interest rates remain depressed for quite a while, say the next thirty years. Could happen, e.g. Japan. In this case stock returns would also be muted over this entire duration. In such a case everything is bad, stocks, bonds, etc.

II. Loose monetary policies eventually lead to higher inflation. And in periods of higher inflation, stocks have a lower real return. But I would assume that interest rates would rise and people with investable assets could presumably get CDs which would definitely pay more than the lower interest rate that are locked with low mortgages from now. 





Sent from my iPad using Tapatalk

Scenario II seems to require market timing and dramatic asset allocation shifting to work.  How does one determine when to move to CDs?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Retire-Canada on March 26, 2015, 07:13:14 AM
When I first started out I wanted a 30yr mortgage because the payments were low.

As I became for money conscious I was horrified by how much interest I was paying and I wanted to hammer that down as fast as possible. Because debt and interest was bad.

Now that I am deep into FIRE planning I'm back to wanting a long mortgage because I realize I can probably make more money investing my savings than to pay down my mortgage. And that cash flow is more important than killing debt if the interest on the debt is low.


My situation:

- I live in a high COL area and just bought a house so I would need 10yrs of focused effort to pay my mortgage off.

- I want to start downshifting in 2016 and be working less than half-time by 2020 so paying off the mortgage and saving for FI are not compatible.

- I'm in Canada with a prime - 0.75% variable $350K mortgage starting a new 5yr term. I can lock into a 5yr fixed rate at anytime I want, but until then I am not protected against rate increases.

- I can pay down $75k/yr extra without penalty and in 2020 I can pay the balance from my investments if I want to.

- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.

-- Vik
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 26, 2015, 07:19:40 AM
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return.  Typically the times that the market did not perform well were the times that the US had high inflation. If you keep your mortgage you actually are better off with high inflation as your payment is locked in. Cfiresim does this already, but it appears that others are doing it themselves which I think is great. The more people understand how their investments fair with inflation, how keeping low cost fixed debt helps their success, how equity appreciation vs. dividend return doesn't matter, how to structure their portfolio for longterm success, and other knowledge about their portfolio management the better off they will be.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 07:32:38 AM
It seems a bit illogical to use historical data to assume future equity returns to calculate perceived safe withdrawal rates and other investment strategies but not use the data staring you in the face for mortgage vs equity returns.

In my view, it's exactly the opposite.  It seems illogical to use historical data to assume future equity returns for the purpose of determining perceived safe withdrawal rates but not use the same historical data to assume future equity returns for the purpose of determining the advisability of leveraged-investing-via-a-mortgage-having-today's-low-rate.  This is exactly the debate skyrefuge and I have been going back and forth about.  I completely agree that there may be reasons to think that current indicators could possibly be signs that future returns will be lower than historical returns (even though I'm not sure if that's actually true and don't share the level of pessimism some people, like Pfau, have on that question), but once you make an assumption about the sub-performance of future returns, that affects your perceived SWR just the same as your perceived advisability of leveraged-investing-via-mortgage.  If the next 30 years don't produce returns high enough to outperform today's low rate mortgages, then anyone retiring today on anything higher than an extremely-low WR is in a boatload of trouble.

The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.

It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).

If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum

Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward.  For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 26, 2015, 07:36:28 AM

- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.

-- Vik

You are Canadian so you are different....  Well at least your access to a 30 year fixed rate mortgage is non existent, but your comment is consistent with a lot of people. The problems with this comment is it fails to take into acount the asset side of the equation. Your FI does not drop by $250k. As you are building up your asset you are getting closer to FI. If your assets are returning more than your mortgage interest rate then you are getting to the finishline quicker by keeping your mortgage.

The second fallacy is that your mortgage payment includes principal payments. This should not be listed as an expense. You are moving money from one pocket to the other. Ie taking money out of investments to pay down a debt. The downside is the money that could have been invested could earn more than the mortgage payment. On a longterm scale this has happened every time over the past 144 years on a 30 year time frame. With your short timeframe is gets more complicated, but it is still something to consider.

The third area is liquidity, which if it all hits the fan having investments vs a partially paid off house provides a provides the funds to live off of while the world is coming back online.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 07:43:35 AM
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return. 

The link I provided above does calculate total returns on the S&P with dividends reinvested.

Typically the times that the market did not perform well were the times that the US had high inflation.

I am not sure this statement is correct for pre-war data, and is mixed at best for post-war.  The two largest selloffs in market history from peak to trough were during periods of low or negative inflation.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Scandium on March 26, 2015, 07:45:35 AM
Quote from: TheNewNormal2015

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing

This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?

Quote
With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets

Thanks, but this requires a registration/subscription which I don't have.

I didn't find either of those particularly worrying, even if the hypothesis is correct (which several commenter don't think it is). Like you said they are only concerned with 1 and 5 year returns. I couldn't care less. In fact I'm rubbing my hands at the thought of a 5 year bear market now as I just started maxing out my 401k! I'd prefer 10 years of low returns, then 10 years of 20%+ CAGR then I retire. Deal? kthxbye.

And the oldest article is from 2012, so we should be almost 3 years into this 5 year slump?

If you're retiring today maybe it could be a concern, but even then 5 years is not really much to worry about if the market return in years 5+ are greater.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 07:50:16 AM
I leave it to someone else to put everything on one graph if interested.

MDM, thank's for digging up this data.  One point to keep in mind when comparing historical mortgage rates to historical investment performance is that the US mortgage market was not always quasi-government-subsidized the way it is today, so the mortgage rates in the early part of the last century may overstate the relationship between prevailing mortgage rates and the overall interest rate environment (fixed rate, 30-year mortgages also weren't always available, but that I don't think matters for purposes of the analysis).  We can also examine the correlation between investment performance and another proxy for the interest rate environment, such as a treasury yield benchmark as NewNormal suggested, to control for the effect of quasi-gov't-subsidization of mortgage rates.

If anyone can find a data source with historical rates going back as far as MDM's chart that gives the actual numbers broken down by year, I would be willing to do the gruntwork of mortgage vs. investment return performance analysis (especially now that cfiresim is back online), but not until tonight or later in the week (my slow period at work that has allowed me to (over)contribute to the forum the past few days has now come to an end).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 26, 2015, 07:57:01 AM
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return. 

The link I provided above does calculate total returns on the S&P with dividends reinvested.

Typically the times that the market did not perform well were the times that the US had high inflation.

I am not sure this statement is correct for pre-war data, and is mixed at best for post-war.  The two largest selloffs in market history from peak to trough were during periods of low or negative inflation.

Can you provide the link again?  Sorry I must have missed that one. The economist articles you linked were all talking about real returns not nominal returns. Inflation was huge in many years, which a mortgage would hedge that. I saw MDM's graphs of 30 year nominal returns and noticed that it never dropped to 4%. Do you believe that the graphs that MDM posted are incorrect?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 08:11:41 AM
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return. 

The link I provided above does calculate total returns on the S&P with dividends reinvested.

Typically the times that the market did not perform well were the times that the US had high inflation.

I am not sure this statement is correct for pre-war data, and is mixed at best for post-war.  The two largest selloffs in market history from peak to trough were during periods of low or negative inflation.

Can you provide the link again?  Sorry I must have missed that one. The economist articles you linked were all talking about real returns not nominal returns. Inflation was huge in many years, which a mortgage would hedge that. I saw MDM's graphs of 30 year nominal returns and noticed that it never dropped to 4%. Do you believe that the graphs that MDM posted are incorrect?

http://dqydj.net/sp-500-return-calculator/

There has never been a 30yr period (albeit since 1928) where we have had sub 4% equity returns.

But then again we have never before in history had negative bond yields and it seems to be a growing trend in Europe.

Seems like a lot of "first time ever" events have been happening the last decade or two across all asset classes, from the tech bubble to the housing crash to the current bond bubble.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 08:17:35 AM
Quote from: TheNewNormal2015

Low real rates = low equity returns

http://www.economist.com/blogs/buttonwood/2013/02/investing

This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?

Quote
With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets

Thanks, but this requires a registration/subscription which I don't have.

I didn't find either of those particularly worrying, even if the hypothesis is correct (which several commenter don't think it is). Like you said they are only concerned with 1 and 5 year returns. I couldn't care less. In fact I'm rubbing my hands at the thought of a 5 year bear market now as I just started maxing out my 401k! I'd prefer 10 years of low returns, then 10 years of 20%+ CAGR then I retire. Deal? kthxbye.

And the oldest article is from 2012, so we should be almost 3 years into this 5 year slump?

If you're retiring today maybe it could be a concern, but even then 5 years is not really much to worry about if the market return in years 5+ are greater.

I didn't see several commenters say the hypothesis in the article(s) is incorrect - where is that?

If the data in the article is correct, it might be useful to look at what 30yr returns have been when the first 1-5yrs of the period were low due to negative real rates
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 08:57:06 AM
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.

It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).

If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum

Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward.  For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)

My point (in both my response to you and my ongoing debate with skyrefuge) is that the argument that using today's low mortgage rate's in conjunction with using all historical investment performance data constitutes "cherry-picking" is not limited to the question of whether it makes sense to take out a mortgage today and invest the proceeds.  It is equally applicable to the question of whether it makes sense to retire today on a planned 4%, or 3%, or 0.01% WR and expect your retirement to be successful, because it's addressing the larger question of what we can expect future returns to be.

I think you agree with this.  I keep harping on it only because the discussion in this thread, I believe, actually revolves around the question of whether it makes sense to pay off fixed-rate, low-interest, long-term debt assuming that MMM-style early retirement is possible in the first place.  Some of the same people who gleefully plan their 4%-SWR-based retirements simultaneously pay off their sub-4% 30-year mortgages believing it increases the safety of their retirement plan, but those two notions are necessarily, logically inconsistent (but that conclusion is not at all self-evident or intuitive--it takes a very firm grasp of the math and underlying economics to understand why it is so).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 09:01:15 AM
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.

It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).

If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum

Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward.  For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)

My point (in both my response to you and my ongoing debate with skyrefuge) is that the argument that using today's low mortgage rate's in conjunction with using all historical investment performance data constitutes "cherry-picking" is not limited to the question of whether it makes sense to take out a mortgage today and invest the proceeds.  It is equally applicable to the question of whether it makes sense to retire today on a planned 4%, or 3%, or 0.01% WR and expect your retirement to be successful, because it's addressing the larger question of what we can expect future returns to be.

I think you agree with this.  I keep harping on it only because the discussion in this thread, I believe, actually revolves around the question of whether it makes sense to pay off fixed-rate, low-interest, long-term debt assuming that MMM-style early retirement is possible in the first place.  Some of the same people who gleefully plan their 4%-SWR-based retirements simultaneously pay off their sub-4% 30-year mortgages believing it increases the safety of their retirement plan, but those two notions are necessarily, logically inconsistent (but that conclusion is not at all self-evident or intuitive--it takes a very firm grasp of the math and underlying economics to understand why it is so).

I do agree with you and see your point

I guess I just never thought 4% was a perceived SWR *in this environment*, and didn't realize it was so rigidly adhered to and accepted
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on March 26, 2015, 09:19:55 AM
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.

It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).

If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum

Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward.  For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)

My point (in both my response to you and my ongoing debate with skyrefuge) is that the argument that using today's low mortgage rate's in conjunction with using all historical investment performance data constitutes "cherry-picking" is not limited to the question of whether it makes sense to take out a mortgage today and invest the proceeds.  It is equally applicable to the question of whether it makes sense to retire today on a planned 4%, or 3%, or 0.01% WR and expect your retirement to be successful, because it's addressing the larger question of what we can expect future returns to be.

I think you agree with this.  I keep harping on it only because the discussion in this thread, I believe, actually revolves around the question of whether it makes sense to pay off fixed-rate, low-interest, long-term debt assuming that MMM-style early retirement is possible in the first place.  Some of the same people who gleefully plan their 4%-SWR-based retirements simultaneously pay off their sub-4% 30-year mortgages believing it increases the safety of their retirement plan, but those two notions are necessarily, logically inconsistent (but that conclusion is not at all self-evident or intuitive--it takes a very firm grasp of the math and underlying economics to understand why it is so).

I do agree with you and see your point

I guess I just never thought 4% was a perceived SWR *in this environment*, and didn't realize it was so rigidly adhered to and accepted

It is accepted, it is not rigidly adhered to. It may be more conjecture than fact but I think most people who get to the level of having saved enough to have a 4%SWR, understand what a SWR is, and can figure out withdrawal strategies and the like also understands nuance and flexibility.

That being said the general rules of thumb we're saying here can be turned on their head when the numbers change. The numbers have yet to change, if they even do.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BarkyardBQ on March 26, 2015, 10:53:45 AM

- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.

-- Vik

You are Canadian so you are different....  Well at least your access to a 30 year fixed rate mortgage is non existent, but your comment is consistent with a lot of people. The problems with this comment is it fails to take into acount the asset side of the equation. Your FI does not drop by $250k. As you are building up your asset you are getting closer to FI. If your assets are returning more than your mortgage interest rate then you are getting to the finishline quicker by keeping your mortgage.

The second fallacy is that your mortgage payment includes principal payments. This should not be listed as an expense. You are moving money from one pocket to the other. Ie taking money out of investments to pay down a debt. The downside is the money that could have been invested could earn more than the mortgage payment. On a longterm scale this has happened every time over the past 144 years on a 30 year time frame. With your short timeframe is gets more complicated, but it is still something to consider.

The third area is liquidity, which if it all hits the fan having investments vs a partially paid off house provides a provides the funds to live off of while the world is coming back online.

Our expenses would drop by 20%, and FI target would drop by 25%.

We're keeping our mortgage, most likely for 30 years. However, in 5 years we will have enough to meet our expenses if we don't have a mortgage. It would take approx 18 more months of working to save and invest to be able to withdrawal 4% just to pay the mortgage. I could instead work for 12 months or less to pay the mortgage off in cash and permanently reduce our savings target and future expenses. It makes a bit of sense to calculate your FI target minus a mortgage and see how much time it saves work for paying off the mortgage after you reach your No Mortgage FI target.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on March 26, 2015, 11:18:31 AM
Somebody was talking about the great investors who are saying that the future returns are going to be lower than the past.  I am not sure who they were talking about, but I don't disagree with the yields being lower in the future, but to be clear those that I consider to be wise long term investors are all saying that they believe that the nominal yields will be in excess of 4%. 

Warren Buffett's take on the 30 year mortgage
http://www.bloomberg.com/news/articles/2014-10-07/buffett-says-no-brainer-to-get-mortgage-to-short-rates
You would think that people would be lining up now to get mortgages to buy a home,” Buffett said today at a conference hosted by Fortune magazine in Laguna Niguel, California. “It’s a good way to go short the dollar, short interest rates. It is a no-brainer. But so far home construction pickup has been slower than I had anticipated.”

His belief is that nominal yields will be in the 6-7% range.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a1.neDMy8DEU
"The economy, as measured by gross domestic product, can be expected to grow at an annual rate of about 3 percent over the long term, and inflation of 2 percent would push nominal GDP growth to 5 percent, Buffett said. Stocks will probably rise at about that rate and dividend payments will boost total returns to 6 percent to 7 percent, he said."

I believe that Wade Pfau has said 4-6 percent nominal returns for a conservative portfolio and greater than that for a normal estimate is what he uses. I will have to find the article(s)where he talks about that.  If others have credible sources that believe that the market is going to be lower than 4% over the next 30 years that would be very interesting to discuss as it would severely impact SWR for all members.   

Just to be clear, if the stock market returns less than 4% over the next 30 years then a safe withdrawal Rate would be in the 1% range for a long term retirement. So those who believe that the market will return less than 4% and are paying down their mortgage and are being safe with a 3% SWR.  Your portfolio will fail if we do not hit a 4% portfolio return.  Many failure scenarios relate to having high inflation.  A 30 year fixed rate mortgage creates a hedge to eliminates inflation risk.   
 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Mississippi Mudstache on March 26, 2015, 11:30:51 AM
I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - and some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: BarkyardBQ on March 26, 2015, 11:41:06 AM
If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.

Very true. We're both in education with 403/457/IRA/1-HSA... We have 70k left on our mortgage. We could pay it off this year...it would cost us ~$10,000 of incomes taxes alone before even calculating the op-cost of not investing it.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Retire-Canada on March 26, 2015, 11:52:49 AM

- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.

-- Vik

You are Canadian so you are different....  Well at least your access to a 30 year fixed rate mortgage is non existent, but your comment is consistent with a lot of people. The problems with this comment is it fails to take into acount the asset side of the equation. Your FI does not drop by $250k. As you are building up your asset you are getting closer to FI. If your assets are returning more than your mortgage interest rate then you are getting to the finishline quicker by keeping your mortgage.

The second fallacy is that your mortgage payment includes principal payments. This should not be listed as an expense. You are moving money from one pocket to the other. Ie taking money out of investments to pay down a debt. The downside is the money that could have been invested could earn more than the mortgage payment. On a longterm scale this has happened every time over the past 144 years on a 30 year time frame. With your short timeframe is gets more complicated, but it is still something to consider.

The third area is liquidity, which if it all hits the fan having investments vs a partially paid off house provides a provides the funds to live off of while the world is coming back online.

I'm pretty sure we are saying the same thing.

Now that I am deep into FIRE planning I'm back to wanting a long mortgage because I realize I can probably make more money investing my savings than to pay down my mortgage. And that cash flow is more important than killing debt if the interest on the debt is low.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 11:58:39 AM
Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.

And if your situation allows you to obtain the benefit of tax deductions for mortgage interest during any portion of the 30-year period, that lowers the hurdle rate even further.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Runge on March 26, 2015, 12:43:21 PM
Nice charts!

The discussion in http://forum.mrmoneymustache.com/welcome-to-the-forum/trying-to-get-a-better-understanding-of-that-%2725-times-annual-spending%27-rule/, particularly kaizen soze's post #10, helped clarify some things in my head.

It's pretty awesome that I came up with the exact same formula that kaizen did, and I didn't even know that thread existed. And it makes total sense. Math rules.

@ars. I've been a "don't pay extra to mortgage" person for a while, but seeing the math behind such reasoning confirms my choice. Yes it course it's assuming a flat CAGR which isn't super realistic, and it assumes investment returns are larger than your mortgage rate. It's always good to run the numbers for your personal situation, get a good grasp on the risk trade-offs for various scenarios, and then optimize.

Currently it's looking like the lowest risk avenue to minimize fire rate within the realm of this discussion is to ride out a 30 year mortgage and invest any extra, never paying extra on the mortgage. All the while the investments are in a balanced, diversified portfolio designed accordingly to your desired risk level. If you're investing in, for example the bogleheads 3-fund portfolio, then it would take a complete market self destruction for you to lose all your money. If that happened, then there's bigger problems... Otherwise, in a worst case scenario, you still have money you can pull out of investments, maybe selling at a loss, to pay of your expenses.

 There's no guarantee that you'll be able to drawdown on house equity in that situation, plus you'll still be paying interest on the money you pull out at what I guess is a higher rate than you'd get in the markets.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: CorpRaider on March 26, 2015, 12:46:48 PM
Yeah, with taxes and inflation its just about a no-brainer for a 30 year.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on March 26, 2015, 12:55:05 PM
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.

Scenarios 2 & 3 are identical through year 23, correct?  Then, to pay the mortgage, you either withdraw a large amount at once (scenario 3) or smaller amounts every month (scenario 2).

In scenario 3 you have a withdrawal rate of (30000 + 57000) / 820000 = 10.6% in your first year due to the large lump sum payment.  But that's ok because it lasts only 1 year and then you drop to something <4% for years after that. 

Similarly, scenario 2 has the higher withdrawal rate you note, but only for seven years.  That's ok because after the mortgage is paid you drop to something <4% for years after that.

By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege.  So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.

Aren't you opening yourself up to a larger sequence of returns risk by starting your retirement seven years with a much higher withdrawal rate?

We are talking about average 30 year CAGRs to match the term of the mortgage, but let's remember that in the short term the market return could be quite ugly.

In scenario 3 I would disagree that is a 10%+ withdrawal rate because that withdrawal really happens at the moment of retirement, not IN retirement.

However for scenario 2, the 5%+ is very much IN retirement and increases sequence of return risk.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 26, 2015, 01:12:34 PM
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.

Scenarios 2 & 3 are identical through year 23, correct?  Then, to pay the mortgage, you either withdraw a large amount at once (scenario 3) or smaller amounts every month (scenario 2).

In scenario 3 you have a withdrawal rate of (30000 + 57000) / 820000 = 10.6% in your first year due to the large lump sum payment.  But that's ok because it lasts only 1 year and then you drop to something <4% for years after that. 

Similarly, scenario 2 has the higher withdrawal rate you note, but only for seven years.  That's ok because after the mortgage is paid you drop to something <4% for years after that.

By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege.  So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.

Aren't you opening yourself up to a larger sequence of returns risk by starting your retirement seven years with a much higher withdrawal rate?

We are talking about average 30 year CAGRs to match the term of the mortgage, but let's remember that in the short term the market return could be quite ugly.

In scenario 3 I would disagree that is a 10%+ withdrawal rate because that withdrawal really happens at the moment of retirement, not IN retirement.

However for scenario 2, the 5%+ is very much IN retirement and increases sequence of return risk.

No because it's not really a 7% SWR, it just looks that way.  If you took out a lump sum and paid it off, your SWR suddenly drops to 4%.  That's because it's a fixed cost that will end, plus some is going to principal.

See my earlier post with the math example (1.1MM vs. 1MM and having a 100k mortgage).  In that example your SWR isn't 4.5% versus 4%, though it looks that way, because it's actually a leverage on the 100k invested.  The interest you're paying isn't living expenses, it's interest on the leverage  of that extra 100k.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 26, 2015, 01:30:35 PM

I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.


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Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 01:35:39 PM

I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.


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If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on March 26, 2015, 01:37:40 PM

I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.


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If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.

Why? If you need a place to live and owning a home is optimally better than renting in a financial sense how does your maxing of tax deferred accounts matter in that determination?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Cressida on March 26, 2015, 01:44:36 PM
Do we have another convert to "keep the mortgage"?  ;)

Probably. After all the talk on this topic over the past few days, I have certainly revised my opinion. I'm not going to prepay my mortgage as it stands now (we recently refinanced to a 15-year and put some money in to get the loan below jumbo level; I'm not sorry for that part, although I'm sure some will disagree). Instead, I've added the mortgage amount to my stache threshold for FI. I haven't decided if I would pay off the mortgage at that point - so I guess you can color me not ENTIRELY converted), but I'm certainly more comfortable with the idea of investing the cash rather than paying down the mortgage.

cressida -- The 15 year is a great way to go especially, if you got a sub 3% rate.

Yeah - it's exactly 3%. Which is a lot better than it was.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 26, 2015, 01:48:28 PM


If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.

Don't you think the advice above depends on the situation?

A hypothetical employee (married) working for a state organization earns roughly 50k and has access to both a 403b and a 457k with a total contribution limit of 36k and an IRA of 11k. Should they max out all of them? What will they live on?


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Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 01:48:50 PM

I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.


Sent from my iPad using Tapatalk

If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.

Why? If you need a place to live and owning a home is optimally better than renting in a financial sense how does your maxing of tax deferred accounts matter in that determination?

I'm assuming one would be putting down at least a 20% deposit.

Paying down high interest debt or living off of savings in order to fund tax deferred accounts (with potential employer match) would potentially be a better use of that chunk of capital.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheNewNormal2015 on March 26, 2015, 01:53:36 PM


If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.

Don't you think the advice above depends on the situation?

A hypothetical employee (married) working for a state organization earns roughly 50k and has access to both a 403b and a 457k with a total contribution limit of 36k and an IRA of 11k. Should they max out all of them? What will they live on?


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They can and theoretically should live on the down payment savings to fund tax deferred accounts.

If I were in that situation I would rent the cheapest place possible and live as frugally as possible while maxing tax deferred accounts - only when I could fund them all and still save enough for a down pmt would I then purchase a primary residence.

But in the situation you described, I might be in a situation to FIRE before I have a chance to own a home (which is not a requirement).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 26, 2015, 01:55:09 PM
Aren't you opening yourself up to a larger sequence of returns risk by starting your retirement seven years with a much higher withdrawal rate?
Good question.  Maybe.  Maybe not.  Don't know if this particular scenario has been backtested with Trinity study methodology, but see the next section.

Quote
We are talking about average 30 year CAGRs to match the term of the mortgage, but let's remember that in the short term the market return could be quite ugly.
Sure can be.  Over 7 years, however, even the worst results don't look too bad so the sequence of returns risk mentioned above seems very low.  Data from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html.  X-axis is the beginning year of the 7 year period.
(http://s16.postimg.cc/sk7wa5cdx/screenshot_3.png)

Quote
In scenario 3 I would disagree that is a 10%+ withdrawal rate because that withdrawal really happens at the moment of retirement, not IN retirement.

However for scenario 2, the 5%+ is very much IN retirement and increases sequence of return risk.
Scenarios 2 and 3 have exactly the same amount of money when the decision to retire occurs - agreed?

One can then immediately withdraw a large chunk of that money to pay off the mortgage (scenario 3) or continue to pay the mortgage using monthly withdrawals (scenario 2).  Both are, effectively, happening "in" retirement.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 26, 2015, 01:58:49 PM
A hypothetical employee (married) working for a state organization earns roughly 50k and has access to both a 403b and a 457k with
a total contribution limit of 36k and an IRA of 11k. Should they max out all of them? What will they live on?

The point wasn't "max them out and then starve" it was that when you haven't maxed them out, prepaying the mortgage is likely leaving money on the table.

Naturally you'll need to eat, and invest whatever you can.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: rpr on March 26, 2015, 02:11:07 PM
^^^ ARS -- got it.  Thanks.


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Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on March 26, 2015, 02:13:43 PM
Why on earth would payment need to be made using the passive return of the investment?

Because once I am retired that will be the only source of cash flow to make the payment.  That was my point -- I understand that if you have the capability to make the mortgage payments, it is optimal to keep the mortgage outstanding as long as you can invest in assets that outperform the mortgage rate.  But for an early retiree with no income other than investment returns, the investment really needs to earn enough to cover the entire mortgage payment (not just the interest portion) or you simply won't have the cash to make the mortgage payment (and that's when you start to run the risk of needing to sell assets in down years to make the mortgage payments).

No, this is not true.

Did you read what I said?  You can draw down on the principal (of the amount that you'd have used to pay the mortgage off, not your other stache).

Let say you have 1MM portfolio and 300k mortgage (scenario A)

Or you can pay that mortgage off and have 700K portfolio, no mortgage (scenario B).

And we'll say that you need 700k portfolio to live on.  You're saying option B is the only viable one if the interest earned on the 300k doesn't cover the full mortgage payment (principal + interest).  I'm saying you can use the interest earned from the 300k, and withdraw some of the 300k, to make that payment.  Then you're transferring that extra in your stache to extra equity (via the principal part of your payment) in the house.

You were already willing to draw down the whole 300k in scenario B, in scenario A you will draw it down slowly as well (and either way you're living on the income from the 700k, that doesn't change, and doesn't get drawn down in either scenario), but as long as that 300k is earning more interest in your portfolio than you are paying on your mortgage, then the longer you keep it as part of that portfolio, instead of equity not earning anything (or rather, earning the rate of the mortgage interest), the more you'll have in the end.  In scenario A you'll end up with more money overall.

Do you understand now why your premise that it has to cover the full payment isn't valid (because you can use those funds you would have used to pay it all off to instead draw down on slowly)?  :)

Ok, here is the example from earlier in this thread.

The whole premise of this discussion is that LONG TERM stock market returns are greater than current long term (30 year) mortgage rates.

This works great as long as you continue to refi to 30 years at low rates before you retire.

The problem comes in when you hit your FI number and the time to mortgage payoff is now 10 years (or thereabouts).  Well in 10 year periods the stock market can go completely sideways or even down.  The 10 years between Jan 1, 2000 to Dec 31, 2009 yielded an S&P500 CAGR with dividends of -0.99%.  So there goes you easy money leverage plan!  You would have been better off just paying off the mortgage on FIRE day.

This is critical to understand.  If you don't match the loan term to the necessary stock market term to protect against volatility you can really screw this up!

Here is an illustration of the effect of time on expected stock market returns from A Random Walk Guide to Investing.  As you can see, in the short term it's anyone's guess what you'll get and negative returns are a definite possibility.  If you don't have the time to ride these out you could end up in trouble:

(http://www.getrichslowly.org/images/randomwalk1.jpg)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 26, 2015, 02:29:27 PM
Can you provide the link again?  Sorry I must have missed that one. The economist articles you linked were all talking about real returns not nominal returns. Inflation was huge in many years, which a mortgage would hedge that. I saw MDM's graphs of 30 year nominal returns and noticed that it never dropped to 4%. Do you believe that the graphs that MDM posted are incorrect?
I'll be the first to admit that they could be incorrect.  I think they are correct or would not have posted them, but....

Here is the method (I think I) used:
1) Start with the data from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html, specifically the spreadsheet downloadable from that site.  To tomsang's point, in that spreadsheet "The annual returns (http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/variable.htm) on stocks ... are estimated by adding the price appreciation during the year to the dividends ... paid ... during the year."
2) Convert the annual percent returns to ratios by adding 1.
3) Compute (http://www.investopedia.com/terms/c/cagr.asp) the Compound Annual Growth Rate (CAGR) over n years by multiplying n ratios, taking the nth root, and subtracting 1.
4) Plot the results.

I did spot check the numbers against the S&P 500 Return calculator (http://dqydj.net/sp-500-return-calculator/) linked previously, using December to December numbers.  The match is not exact: close enough for me to think the charts are useful enough for the discussion at hand, but someone may be able to do better.

Spreadsheet attached.  Spot checks are in column N of the first tab.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 02:33:26 PM
The whole premise of this discussion is that LONG TERM stock market returns are greater than current long term (30 year) mortgage rates.

This works great as long as you continue to refi to 30 years at low rates before you retire.

I'm not following your point.  It works great as long as you lock in a low-interest rate, period (before or after retirement).  Low rates are available now, so now is a good time to do it.  If someone has 10 years left on their mortgage at a time when rates are high, they should not refinance, and it may very well make sense to pay off the remaining mortgage balance once the remaining life to maturity is only 10 years because you no longer have decades for market returns to outpace your mortgage rate.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: matchewed on March 26, 2015, 02:41:28 PM

I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.


Sent from my iPad using Tapatalk

If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.

Why? If you need a place to live and owning a home is optimally better than renting in a financial sense how does your maxing of tax deferred accounts matter in that determination?

I'm assuming one would be putting down at least a 20% deposit.

Paying down high interest debt or living off of savings in order to fund tax deferred accounts (with potential employer match) would potentially be a better use of that chunk of capital.

Meh...

You have to live somewhere, the question about the 20% deposit on buying house shouldn't be weighed against investment but against renting a house or other variations of the "shelter problem". You're trying to take an aspect of cost related to living itself and trying to optimize investment with it... that's like saying maybe I should just buy ramen because I can optimize my investments better. Well maybe you could but you still have to eat, and if you can't subsist solely on ramen or are someone who doesn't like ramen or someone who values yummy food then you're doing yourself a disservice. It's one thing to optimize your debt vs. investing when neither of those are essentials, but shelter is an essential, optimize the essential itself within it's own context then take that remaining money and optimize that.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on March 26, 2015, 02:41:37 PM
The whole premise of this discussion is that LONG TERM stock market returns are greater than current long term (30 year) mortgage rates.

This works great as long as you continue to refi to 30 years at low rates before you retire.

I'm not following your point.  It works great as long as you lock in a low-interest rate, period (before or after retirement).  Low rates are available now, so now is a good time to do it.  If someone has 10 years left on their mortgage at a time when rates are high, they should not refinance, and it may very well make sense to pay off the remaining mortgage balance once the remaining life to maturity is only 10 years because you no longer have decades for market returns to outpace your mortgage rate.

My point is this strategy does not work with short/medium term returns (<=10yrs) so if you are going into retirement with a mortgage loan, even at a low rate, you risk losing money over that last 10 years.  So a good case for paying the mortgage off at that time can be made in this case.

In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 26, 2015, 02:49:07 PM
My point is this strategy does not work with short/medium term returns (<=10yrs) so if you are going into retirement with a mortgage loan, even at a low rate, you risk losing money over that last 10 years.  So a good case for paying the mortgage off at that time can be made in this case.

In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.

I admit I haven't studied (or even looked at) MDM's spreadsheet, but in the body of this thread I don't think anyone has argued that this strategy works on a short-term horizon.  As you said, the whole point of this strategy is that it's for the long-term.  With a 7-year time horizon, I wouldn't bet on market returns outpacing my mortgage rate either, even if it were low.  But someone going into retirement with 7 years left on their loan at a time when rates are super-low (like now) can refinance into a 30-year and get the (very likely) optimal result we've been talking about in this thread.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 26, 2015, 02:51:47 PM
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
Here we get to the root of many (most? all?) of the disagreements.  sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return.  Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.

Each of these perspectives is defensible, based on one's risk tolerance. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 26, 2015, 02:58:05 PM
My point is this strategy does not work with short/medium term returns (<=10yrs) so if you are going into retirement with a mortgage loan, even at a low rate, you risk losing money over that last 10 years.  So a good case for paying the mortgage off at that time can be made in this case.

In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.

I admit I haven't studied (or even looked at) MDM's spreadsheet, but in the body of this thread I don't think anyone has argued that this strategy works on a short-term horizon.  As you said, the whole point of this strategy is that it's for the long-term.  With a 7-year time horizon, I wouldn't bet on market returns outpacing my mortgage rate either, even if it were low.  But someone going into retirement with 7 years left on their loan at a time when rates are super-low (like now) can refinance into a 30-year and get the (very likely) optimal result we've been talking about in this thread.

You guys are agreeing.  :)  Doug's point was that you may need to keep refinancing when rates are low to push out the payoff of your mortgage, before you FIRE.  I agree - the longer you can keep cheap money, the more likely you'll come out ahead.

Some people aren't comfortable with that.  They ask "would you take out a mortgage on a paid off house to invest?"  And my answer is "hell yes, at today's rates" -- but they obviously value what they view as safety/security (and the feelings thereof) differently than I do (and how I think it's safer to hold the mortgage).

That's okay.

But the point of "it works better on long timeframes, so you may have to refi to move out your timeframe" is valid.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on March 26, 2015, 03:06:19 PM
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
Here we get to the root of many (most? all?) of the disagreements.  sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return.  Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.

Each of these perspectives is defensible, based on one's risk tolerance.

Exactly.  I also agree this is likely the source of most of the disagreement through this thread.

Over a 30 year period, I'm completely comfortable betting on >4% returns.  Less than 10 years the odds aren't nearly so heavily in your favor.

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 26, 2015, 03:35:01 PM
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
Here we get to the root of many (most? all?) of the disagreements.  sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return.  Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.

Each of these perspectives is defensible, based on one's risk tolerance.

Exactly.  I also agree this is likely the source of most of the disagreement through this thread.

Over a 30 year period, I'm completely comfortable betting on >4% returns.  Less than 10 years the odds aren't nearly so heavily in your favor.

It's not as ridiculously weighted in your favor, but it's still in your favor.  What's the median 10-year return?  Though, of course, the current environment comes a lot more into play then.  It's all a lot of guesswork.  :)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: boarder42 on March 26, 2015, 07:35:39 PM
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage.   Well there is plenty of sub 3% CAGRs on that 7 year chart.  With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
Here we get to the root of many (most? all?) of the disagreements.  sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return.  Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.

Each of these perspectives is defensible, based on one's risk tolerance.

Exactly.  I also agree this is likely the source of most of the disagreement through this thread.

Over a 30 year period, I'm completely comfortable betting on >4% returns.  Less than 10 years the odds aren't nearly so heavily in your favor.

It's not as ridiculously weighted in your favor, but it's still in your favor.  What's the median 10-year return?  Though, of course, the current environment comes a lot more into play then.  It's all a lot of guesswork.  :)

well you would also have to weigh the tax implications of paying off a 7-10 year chunk of your mortgage.  Taking out a large chunk of money for this could alter tax brackets etc.  likely not but if it does a lump some pay off could be even worse.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 27, 2015, 02:30:21 PM
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.

Ok, for anyone interested, I just spent more time in cfiresim than I'd care to admit trying to answer this question and here's what I found:

1.  The highest mortgage rate with an absolute 100% historical success rate using cfiresim's default investment parameters (i.e., 75/25 stock/bond allocation and 0.18% expense ratio) is 1.88%.  But the conservative anti-leveraged-investing-via-mortgage crowd shouldn't get too excited yet, because the success rate remains in the 99% range for much higher mortgage rates (it's the single pesky 1929 start year that keeps preventing us from achieving absolute 100% success), and the success rate is still in excess of 95% for a mortgage rate of 4.0% (it is 95.65%, to be precise).  Moreover, see the penultimate paragraph below for an explanation of why these success rates may be seriously understating the actual historical success rates.

2.  Interestingly, a 100% historical success rate could be achieved for higher mortgage rates by increasing the bond portion of the portfolio's asset allocation.  The highest mortgage rate I could find having a 100% historical success rate using a non-default investment allocation was 3.15%, and it required an investment allocation of between 20-25% equities (and 75-80% bonds).  I think this can be explained by the fact that low equity exposure was needed for the 1929 start year (which was obviously a very bad year for stocks) to clear the hurdle for investments to outperform the mortgage rate, combined with the fact that each year's principal + interest outlay in a mortgage's amortization schedule represents a relatively large percentage of the mortgage's initial principal balance for all but the cheapest of mortgages.

For the above cfiresim testing, I used the methology I described in post # 292 above (http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg599940/#msg599940) (i.e., enter the annual principal + interest payments required by the mortgage's amortization schedule and set the spending plan to "not inflation adjusted").

However, if you run a cfiresim test using an assumed fixed investment return (instead of actual historical data) in an amount equal to the mortgage's interest rate, cfiresim reports failure.  For example, the annual principal + interest outlay on a $1M mortgage having a 4% interest rate is $57,289.80.  When you run a cfiresim simulation with a $1M starting portfolio and annual non-inflation-adjusted spending of $57,289.80 and set the investment return to 4% constant market growth, that should result in perfect success with a portfolio ending balance of exactly zero dollars.  Instead, cfiresim reports failure, with a portfolio ending balance of negative $150k.  I think this is most likely due to cfiresim's assumptions about the timing of the portfolio withdrawals, which probably don't line up with the monthly payment schedule required by a mortgage.  In any event, I think this means that this methodology of testing the historical leveraged-investing-via-mortgage success rate materially misstates the actual historical success rate, and I'm not sure but I believe the misstatement will usually (or always?) constitute an understatement of the actual success rate.

Thoughts, comments, and objections relating to this analysis are welcome.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on March 27, 2015, 03:01:43 PM
Thanks for doing the legwork!

the success rate is still in excess of 95% for a mortgage rate of 4.0% (it is 95.65%, to be precise)

If you have those sims saved, a few quick Qs:
What's the median portfolio difference for paying off the mortgage versus investing the lump sum at a 4% mortgage rate (and 3%) for that matter?

In other words, how much money are the people paying off the mortgage leaving off the table, on average (in today's dollars)?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on March 27, 2015, 03:02:15 PM
Ok, for anyone interested, I just spent more time in cfiresim than I'd care to admit trying to answer this question and here's what I found:
...
...with a portfolio ending balance of negative $150k.  I think this is most likely due to cfiresim's assumptions about the timing of the portfolio withdrawals, which probably don't line up with the monthly payment schedule required by a mortgage.
...
Thoughts, comments, and objections relating to this analysis are welcome.
Nice work!

I can get Excel to reproduce the -$150K, but someone (e.g. bo_knows) will have to confirm the cfiresim mechanics.

Take the table below, copy & paste into cell A1, then copy the last row down through year 31.  Yes, 31 - at least that's where I see the -$150K.

Assumptions here in Excel (and in cfiresim?):
 - spending occurs up front while returns occur on the amount left after spending. 
 - a negative balance generates $0 return.

The first row in the table below is irrelevant - I just used it to compare monthly (cell A4=12) vs. annual (cell A4=1) amortization.

1000000300.0412=PMT(C1/D1,B1*D1,-A1)=E1*D1
YearStart bal.SpendNetAfter growth
1100000057289.8=B4-C4=ROUND(D4+MAX(D4*$C$1,0),2)
2=E4=C4=B5-C5=ROUND(D5+MAX(D5*$C$1,0),2)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on March 27, 2015, 03:33:26 PM
If you have those sims saved, a few quick Qs:
What's the median portfolio difference for paying off the mortgage versus investing the lump sum at a 4% mortgage rate (and 3%) for that matter?

In other words, how much money are the people paying off the mortgage leaving off the table, on average (in today's dollars)?

I don't have any of the sims saved (because I'm too paranoid to log in to cfiresim on my office computer, but not too paranoid to use cfiresim on my office computer, which I'll admit makes no sense), but it's easy enough to reproduce the sims to answer that question.

For a 4% mortgage rate (and sticking with cfiresim's default investment settings), for every $100k of mortgage paid off or not obtained, the historical median amount left on the table was $266k (in inflation-adjusted dollars).  For a 3% mortgage rate, that number was $368k.

That was the point I made in that same post #292 above describing the cfiresim methodology, that the historical investor who would have been able to take out a $200k mortgage with a 4% rate but chose not to would have left at least $532 THOUSAND DOLLARS on the table half of the time.  Of course, the actual historical investor would not have been able to do so, because such low mortgage rates were not available, which led to all the debate in this thread about the appropriateness of using historical investment performance data but not historical mortgage rates.

I also once used the same data to try to get sol to see the light and recognize the overwhelming probability of the optimality of this approach even when taking into account its potential effects on eligibility for means-tested government benefits and similar considerations (http://forum.mrmoneymustache.com/ask-a-mustachian/should-i-pay-off-my-mortgage-early/msg485370/#msg485370), but I don't think I was successful :)

Of course, if you adjust the relevant variables in favor of higher returns (such as increasing the equity allocation or decreasing the expense ratio), the amount left on the table is correspondingly higher.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on April 05, 2015, 12:26:50 PM
Another member was asking me about the calculator that I put together awhile back.  I have a number of versions and I want to make sure that the version that I believe has the correct formula is out there for people to play with.  If you see areas that are not working, need changing or are confusing let me know.

Note I also locked out the Math tab, but if you want to play with it the password is MMM.

Thanks,

Tom
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheBeeKeeper on April 06, 2015, 07:10:14 AM
I've spent a long time reading this interesting thread, and now I'm having second thoughts!

We are planing on taking 200K in 15 year mortgage fixed 3% .
We could get 30 year at 3.9%

one of my hesitations now is that we will most likely not live in this house for more than 10 years.
I'm still leaning towards the 15 year, but from reading the thread I'm more confused now..
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: boarder42 on April 06, 2015, 07:21:55 AM
Bee Keeper 

http://michaelbluejay.com/house/15vs30.html

enter your info hear.  break even is usually around 6-7 years.  cant believe you cant get a lower than 3.9% fixed rate on the 30.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TheBeeKeeper on April 06, 2015, 07:40:41 AM
Thanks boarder42! This is helpful.

the 3.9% is with no closing costs . I could get 3.675 with closing costs (about 5-6K$)

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on April 06, 2015, 08:54:36 AM
Thanks boarder42! This is helpful.

the 3.9% is with no closing costs . I could get 3.675 with closing costs (about 5-6K$)

Penfed is currently at 3.375% for a 30 year conforming.  https://penfed.org/30-Year-Fixed-Mortgage/
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 06, 2015, 06:56:16 PM
So many questions. Tomsang, I took your most recent sheet and added a tab for SWR with no mortgage and a mortgage at 60 months. Wouldn't I need a larger portfolio to cash flow the mortgage payment for 30 years vs. it paid off?

INVEST THE MONEY   
   
CASH FLOW   
   
4% SWR   
   
60 Month Retire extra cash no more   
   4% SWR
P&I   3145
ANNUAL EXPENSES   37740
SWR   25
BALANCE REQUIRED   943500
   
ADDITIONAL ANNUAL EXPENSES   30000
SWR   25
BALANCE REQUIRED   750000
   
TOTAL PORTFOLIO REQUIRED   1693500

vs....

PAYOFF THE MORTGAGE FIRST   
THEN INVEST THE REST   
CASH FLOW   
   
4% SWR   
MORTGAGE BALANCE   0
60 Month Retire extra cash no more   
   4% SWR
P&I   0
ANNUAL EXPENSES   0
SWR   25
BALANCE REQUIRED   0
   
ADDITIONAL ANNUAL EXPENSES   30000
SWR   25
BALANCE REQUIRED   750000
   
TOTAL PORTFOLIO REQUIRED   750000

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 06, 2015, 07:31:12 PM
Attachment with sheet above.

Question: My mortgage paid off requires a lower Investment Portfolio at 60 Months and a net loss of $21m between the two options. I'm trying to figure out the scenario if I retire early and give up on the future extra cash how that impacts the plan. Basically which plan offers the out the fastest.

10 years 56,000 loss but then the cash flow catches up on the reverse return but I won't be working at that point and will need to start drawing down the investment.   

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 06, 2015, 08:09:25 PM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 06, 2015, 08:21:24 PM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?
Am having some trouble following the assumptions being used.  E.g.,
 - Is there income from a job at any time in these scenarios?  If so, when (if ever) does it stop?
 - Do the mortgage payments start at the same time retirement starts?  If not, when (number of months before or after retirement) do they start?
 - If the house is paid off with a lump sum, does that happen at the same time retirement starts?  If not, when (number of months before or after retirement) is the lump sum paid?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on April 06, 2015, 10:37:19 PM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?

dabears847 - In the worksheet that I created, the various years of 1,5, 10, 15, 20, 25, 30 are summarized on the input tab with the gain or loss calculated in Column J with the formula D-C.  You can go to the Math Tab and see the benefit by month in Column V if you want to view it by month.

I think that some of the confusion is that you are not understanding the formulas that are built into the calculator.  It appears that you are trying to create or calculate what is already calculated.  Let's go through how it works.

Title A: Mortgage Paydown Traditional. This just a standard amortization schedule for a loan.  This is calculating the loan to term as defined on the input sheet which Column B rows 5-8 and cell c6 is the monthly amount.

Title B: Investment.   This is the calculation of an investment account earning the yield that is input on the Input sheet which flows to B13.  With the monthly additional investment coming from cell B10.

Column P: Is if you liquidated all of your investments and paid any taxes as calculated in title C or Column N and paid down your mortgage.  This show what the mortgage would be once your investments were liquidated.

Column S: Is the calculation of your mortgage payment and your extra payments reducing your mortgage balance.  Note that once the mortgage balance is eliminated the formula has it grabbing the investment yield.  So if you go to the example as it is set up to row 222 column T you will see the loan balance going negative.  What that means is that the loan is paid off and all future mortgage payments and future extra payments are all being invested at the investment yield as input by you and listed as B13 and monthly yield at C13.

Column V:  Is just comparing the what the mortgage would be if you paid down your mortgage each month as calculating in Column T minus Column P which is your standard mortgage balance minus the amount of money in your investment account.  A positive number shows the benefit of keeping your mortgage a negative shows the loss of keeping your mortgage. 

So as you can see if your investment yield is greater than your mortgage, then at any point in time you can liquidate your investments and use the proceeds to pay down your mortgage and be better off.  If you enter a capital gains rate then the investment yield needs to be greater than the mortgage rate to have a positive impact. As noted usually you can manage your capital gains to minimize or eliminate the tax under the current tax law.

Hopefully, this helps explain the calculator
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 11:47:05 AM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?
Am having some trouble following the assumptions being used.  E.g.,
 - Is there income from a job at any time in these scenarios?  If so, when (if ever) does it stop?
 - Do the mortgage payments start at the same time retirement starts?  If not, when (number of months before or after retirement) do they start?
 - If the house is paid off with a lump sum, does that happen at the same time retirement starts?  If not, when (number of months before or after retirement) is the lump sum paid?
similar to what I'm trying to determine. The equation assumes I'll be working for the loan terms, 180 or 360 months as example. I've been trying to look at this from additional angles such retirement in  5 yes, 10yrs., etc.

If I do a lump sum in  5 or 10 yrs. I better be in the money or all the risk is for not.

My gains were only 21,000 in five years which isn't much for risk reward.

The group appears to be proposing keeping the mortgage for the full term. If I did that, the calculation appears to show a loss of investment of $550,000 with the the no early payoff plan. This assumes I'll be working though.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 11:52:46 AM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?

dabears847 - In the worksheet that I created, the various years of 1,5, 10, 15, 20, 25, 30 are summarized on the input tab with the gain or loss calculated in Column J with the formula D-C.  You can go to the Math Tab and see the benefit by month in Column V if you want to view it by month.

I think that some of the confusion is that you are not understanding the formulas that are built into the calculator.  It appears that you are trying to create or calculate what is already calculated.  Let's go through how it works.

Title A: Mortgage Paydown Traditional. This just a standard amortization schedule for a loan.  This is calculating the loan to term as defined on the input sheet which Column B rows 5-8 and cell c6 is the monthly amount.

Title B: Investment.   This is the calculation of an investment account earning the yield that is input on the Input sheet which flows to B13.  With the monthly additional investment coming from cell B10.

Column P: Is if you liquidated all of your investments and paid any taxes as calculated in title C or Column N and paid down your mortgage.  This show what the mortgage would be once your investments were liquidated.

Column S: Is the calculation of your mortgage payment and your extra payments reducing your mortgage balance.  Note that once the mortgage balance is eliminated the formula has it grabbing the investment yield.  So if you go to the example as it is set up to row 222 column T you will see the loan balance going negative.  What that means is that the loan is paid off and all future mortgage payments and future extra payments are all being invested at the investment yield as input by you and listed as B13 and monthly yield at C13.

Column V:  Is just comparing the what the mortgage would be if you paid down your mortgage each month as calculating in Column T minus Column P which is your standard mortgage balance minus the amount of money in your investment account.  A positive number shows the benefit of keeping your mortgage a negative shows the loss of keeping your mortgage. 

So as you can see if your investment yield is greater than your mortgage, then at any point in time you can liquidate your investments and use the proceeds to pay down your mortgage and be better off.  If you enter a capital gains rate then the investment yield needs to be greater than the mortgage rate to have a positive impact. As noted usually you can manage your capital gains to minimize or eliminate the tax under the current tax law.

Hopefully, this helps explain the calculator
I'm good with the worksheet and formulas. Just looking for perspective. For instance, my risk reward calculation 21,000 gains/349,000 portfolio balance/5 years , the difference is not millions. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 12:04:57 PM
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...

Investment Balance/Benefit Gain/Years?
Am having some trouble following the assumptions being used.  E.g.,
 - Is there income from a job at any time in these scenarios?  If so, when (if ever) does it stop?
 - Do the mortgage payments start at the same time retirement starts?  If not, when (number of months before or after retirement) do they start?
 - If the house is paid off with a lump sum, does that happen at the same time retirement starts?  If not, when (number of months before or after retirement) is the lump sum paid?
similar to what I'm trying to determine. The equation assumes I'll be working for the loan terms, 180 or 360 months as example. I've been trying to look at this from additional angles such retirement in  5 yes, 10yrs., etc.

If I do a lump sum in  5 or 10 yrs. I better be in the money or all the risk is for not.

My gains were only 21,000 in five years which isn't much for risk reward.

The group appears to be proposing keeping the mortgage for the full term. If I did that, the calculation appears to show a loss of investment of $550,000 with the the no early payoff plan. This assumes I'll be working though.
My apologies for not making my question clearer: dabears847, I was trying to understand what assumptions you are using.

tomsang's point that "if your investment yield is greater than your mortgage, then at any point in time you can liquidate your investments and use the proceeds to pay down your mortgage and be better off" is a fact.  It's a pure mathematical fact, so I don't understand "loss" as in "a loss of investment of $550,000."

Of course, tomsang's quote starts with a small but important word: "if".  That takes us into the realm of risk/reward analysis, in which the only wrong answers are the ones not in accord with the assumptions one makes - thus the question about assumptions....
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 01:51:26 PM
I posted the input grid results which show my scenario only returning a gain of 21,000 in five years.  This is a 1.2% annualized return over the accelerated mortgage payoff. 1.2% risk vs reward.

In 30 years the value is in acceleration of the mortgage payoff generating a greater return of $550,000 due to the extra cash flow. At the 15 year marker  the value shifts to mortgage accelerated payoff.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 02:01:21 PM
In 30 years the value is in acceleration of the mortgage payoff generating a greater return of $550,000 due to the extra cash flow. At the 15 year marker  the value shifts to mortgage accelerated payoff.
Are you saying that if you have a $500K mortgage balance at 4%, and $500K available cash, and an investment opportunity that will return 7%, and a choice between
 a) paying the mortgage in a lump sum so you have a paid mortgage but no more investable funds
 b) investing the money and withdrawing as needed to pay the mortgage so you end up with a paid mortgage plus money left over in the investment
that option a) is better than option b)?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 02:13:49 PM
Dabears - I found something similar to you what you are saying, but I think what we are thinking and what TomSang's spreadsheet is doing are different beasts.  But heck if I can explain it!  I'm gonna go garden and figure out a way to say what I'm thinking.  Ha!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 02:19:06 PM
Not so much, the newer excel sheet with my inputs show results in favor of the a fast payoff of the mortgage and then investing the cash flow compounding those extra dollars for 30 years. This results in a larger stash of $550,000 vs straight investing without extra principal.

I'm not working that long so I'll need to find a way to pull the extra principal payments in scenarios which reflect the change in cash flow.

What are your thoughts on the impact on savings withdrawal rates with mortgage vs without? Mine go from needing 750,000 without mortgage to 1.7mm with mortgage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 02:28:14 PM
DaBears - I found the same, except on a smaller scale.

For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25) 

So while I technically come out ahead in my investment account if I don't pay it off, it's not by much, and I need a larger investment account to FIRE.

I'm with you - not sure that the risk is worth the reward and if we work a few months longer to make up the difference....it's months of our lives.   I will work 5 more months - heck - a bunch of people end up in the one more year syndrome, what's 5 more months?


DaBears - correct me if I'm wrong - the way you did it assumes that you still have the "snowball" for all of the 30 years, right?  So it assumes the person is working for the entire 30 year term?

Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 02:45:12 PM
What are your thoughts on the impact on savings withdrawal rates with mortgage vs without? Mine go from needing 750,000 without mortgage to 1.7mm with mortgage.
For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25) 
All you "need" (assuming we believe the Trinity Study) is E/SWR + B, where
E = Expenses in Retirement
SWR = Safe Withdrawal Rate (e.g., 4%)
B = Remaining mortgage balance (i.e., the unpaid principal)

Do you see why you don't need to have the sum of remaining monthly P+I payments in your retirement stash?  You need only the sum of remaining monthly P payments.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 03:08:51 PM
Nope, I don't understand.  Not saying you are wrong (and I have not followed this whole thread!) but why don't I need to make the interest portion of my mortgage payment after I retire? 


Edited -  LOL I get what you are saying now - but that's assuming I make the emotional decision to payoff the rest of my mortgage when I could be making better returns in the market.  Right?  I was assuming that we keep our mortgage forever, because we could theoretically make more in the market - because that's the logical choice.  ;-)
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on April 07, 2015, 03:15:21 PM
I believe this assumes you pay the interest out of your investment gains.

The problem with that approach is that over short to mid-term periods (0-10 years), your investment returns could be negative or zero even if over long terms (30 years) they are 7%.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 03:31:22 PM
Nope, I don't understand.  Not saying you are wrong (and I have not followed this whole thread!) but why don't I need to make the interest portion of my mortgage payment after I retire?
Good question!  Assuming you continue to pay monthly, you absolutely do continue to make the interest portion of the mortgage payment.  But let's review the assumptions:
You start your retirement with amount E/SWR + B, where
   E = Expenses in Retirement
   SWR = Safe Withdrawal Rate (e.g., 4%)
   B = Remaining mortgage balance (i.e., the unpaid principal)

1) You could simply take the amount B and pay off the mortgage, or
2) You can leave amount B invested.  Because it pays you a higher return than you pay on the mortgage, you have more than enough to cover the P+I payments each month.

E.g., a $100K mortgage at 3.5% over 30 years needs a $449.04 payment each month.  $100K invested with a 7% return gives you $100K*7%/12=$583.33 the first month.  Subtract the $449.04 and you have $100,134.29.  Your investment balance continues to grow while your mortgage balance shrinks. 

That's the math, given the assumptions.

There is the separate issue (as noted many times above, including sirdoug007's recent note) about the risk analysis of "how much of a short term decline can I stand"?

It gets confusing when we have both "What's the math?" and "What's the risk?" discussions at the same time.  Make sense?


Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on April 07, 2015, 04:05:51 PM
To be clear, this strategy has a very high likelihood of success IF you are in it for the long haul.

I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Portfolio: 100% stocks
Expense Ratio: 0.05%
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)

The success rate is 97.39% (fails 3 out of 115 periods).  Those periods start in 1928, 1929, and 1930.  All other periods, including the bad ones in the mid 1960's do very well with a median ending portfolio of $498,335.

Now that is 30 years.  If you don't keep your mortgage and corresponding investments that long you can have different results.  Here is a 10 year run.  After 10 years the remaining mortgage balance would be about $77k.  The cases starting in 1999/2000 are pretty ugly! 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 04:19:30 PM
I'm *this* close to understanding.  LOL.  So in my example above, I need a cool million instead of 900K to retire without paying off my mortgage (Oh goodness, I write that and still worry I don't get it! LOL).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 05:11:17 PM
Yes - I've got examples on my journal.  But I need to revise it a bit based on what MDM taught me!  My numbers are not exactly like MDM's hypothetical (4.25% rate on mtg) so that might be lead to some differences for me personally. 
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 05:13:30 PM
DaBears - I found the same, except on a smaller scale.

For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25) 

So while I technically come out ahead in my investment account if I don't pay it off, it's not by much, and I need a larger investment account to FIRE.

I'm with you - not sure that the risk is worth the reward and if we work a few months longer to make up the difference....it's months of our lives.   I will work 5 more months - heck - a bunch of people end up in the one more year syndrome, what's 5 more months?


DaBears - correct me if I'm wrong - the way you did it assumes that you still have the "snowball" for all of the 30 years, right?  So it assumes the person is working for the entire 30 year term?

Hello,
Glad someone is worried about the same things as I. Yes I did the plan based on a 15 year payoff plan and it was right around then the excel sheet (Tomsang's sheets) stated it was better for me long term to payoff the mortgages.

Risk as others mentioned with a higher than recommended SWR concerns me as well. I'm guessing the years of downturn make for a stressful household knowing the plan is at risk from depleting the investment account to pay the mortgage.   
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 05:23:15 PM
To be clear, this strategy has a very high likelihood of success IF you are in it for the long haul.

I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Portfolio: 100% stocks
Expense Ratio: 0.05%
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)

The success rate is 97.39% (fails 3 out of 115 periods).  Those periods start in 1928, 1929, and 1930.  All other periods, including the bad ones in the mid 1960's do very well with a median ending portfolio of $498,335.

Now that is 30 years.  If you don't keep your mortgage and corresponding investments that long you can have different results.  Here is a 10 year run.  After 10 years the remaining mortgage balance would be about $77k.  The cases starting in 1999/2000 are pretty ugly!

This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.

15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.

What was happening at the end of your post?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 05:36:26 PM
I'm *this* close to understanding.  LOL.  So in my example above, I need a cool million instead of 900K to retire without paying off my mortgage (Oh goodness, I write that and still worry I don't get it! LOL).
If the unpaid mortgage principal is $100K - yes, you have got it!
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 05:37:42 PM
For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25) 

Are you taking into consideration you will also need the cash to own your house free-and-clear?  Seems like you would need 900K + cost of house in your first example that I bolded.
I believe "without a mortgage" means "if the mortgage is already paid off."
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on April 07, 2015, 05:54:04 PM
I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.

Note that sirdoug007's example starts with a 5.388% withdrawal rate and "only" $100K.  Given the success demonstrated in cfiresim, it's not clear how one justifies the need for $134,700, let alone $214,200. 

E.g., run the numbers for a 15 year $100K loan at 3.5%, withdrawing from a $100K investment returning 7% for the monthly payments.  After 15 years the investment will still have $58,306 and the mortgage will be paid.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Neustache on April 07, 2015, 06:10:31 PM
I reran the numbers based on our situation and my new (thanks to MDM!) understanding and it does make a larger difference - now hubby is working 21 months longer than he would have under my previous math (assuming I needed all the P and I payments). 

For me this was all a mental exercise anyways.  We are, so far, paying off the mortgage anyways because that's what DH (who makes all the income!) wants to do! Although after the day he had today, 21 months might seem way too long - but he's also very risk averse so it may not sway him.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 06:27:00 PM
Not so much, the newer excel sheet with my inputs show results in favor of the a fast payoff of the mortgage and then investing the cash flow compounding those extra dollars for 30 years. This results in a larger stash of $550,000 vs straight investing without extra principal.

I'm not working that long so I'll need to find a way to pull the extra principal payments in scenarios which reflect the change in cash flow.

What are your thoughts on the impact on savings withdrawal rates with mortgage vs without? Mine go from needing 750,000 without mortgage to 1.7mm with mortgage.
So I've rerun the scenarios with a 30 year mortgage to compare and I would need $250,000 more in retirement assets to make the plan work with a SWR of 4%. Not sure how I feel about having to refi my lower 15 year rates for a higher 30 year rate to then have to save more money so that I could go the path of investing instead of just paying off the house.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 07, 2015, 06:51:52 PM
You shouldn't need any more than your original amount + whatever the amount you'd put into the mortgage would be. It should not delay time to FIRE, only speed it up.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 07, 2015, 07:03:02 PM
I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.

Note that sirdoug007's example starts with a 5.388% withdrawal rate and "only" $100K.  Given the success demonstrated in cfiresim, it's not clear how one justifies the need for $134,700, let alone $214,200. 

E.g., run the numbers for a 15 year $100K loan at 3.5%, withdrawing from a $100K investment returning 7% for the monthly payments.  After 15 years the investment will still have $58,306 and the mortgage will be paid.
Hmmm... gears are turning... Is the success rate due to the locked in costs for 30years and inflation of 3% But I'm still stuck on the idea that I'm taking a higher level of risk when I could withdraw at 4% SWR with 250,000 less with savings.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 07, 2015, 07:36:55 PM
I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.

Note that sirdoug007's example starts with a 5.388% withdrawal rate and "only" $100K.  Given the success demonstrated in cfiresim, it's not clear how one justifies the need for $134,700, let alone $214,200. 

E.g., run the numbers for a 15 year $100K loan at 3.5%, withdrawing from a $100K investment returning 7% for the monthly payments.  After 15 years the investment will still have $58,306 and the mortgage will be paid.
Hmmm... gears are turning... Is the success rate due to the locked in costs for 30years and inflation of 3% But I'm still stuck on the idea that I'm taking a higher level of risk when I could withdraw at 4% SWR with 250,000 less with savings.

So the thing is, you also have all that money tied up in the house.  So your 4% includes all that idle money.

When you have the mortgage, and that money invested, your WR looks like it's higher, cause you have higher expenses, but a lot of that mortgage payment is shifting some of that extra money in your stache into principal of the house.  It's not actually an expense (it's just creating dead equity, which you're clearly fine with, if you're okay paying off the whole thing).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on April 08, 2015, 05:31:43 AM
I think one point of confusion is that people are using cfiresim with the 4% SWR for normal expenses, then adding in the mortgage payment and additional investment money while leaving inflation adjustment of withdrawals turned on.

This is WRONG, because the mortgage payment is fixed. If you allow inflation adjustment on the whole withdrawal you end up simulating a mortgage payment that increases 2-3% per year (whatever your inflation estimate is.) If you pick a 3% inflation rate, your estimate of the mortgage payment at Year 30 will be more than double what it really is.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: sirdoug007 on April 08, 2015, 09:00:30 AM
The lack of inflation adjustment in mortgages is critical to the success of investing over making more mortgage payments.

In the example above, with a 30 year mortgage the success rate is 97.39%. 

If the annual payment amount was inflation adjusted, the success rate falls to 70.43%!

If you are not modeling that correctly you are going to get results that are far from correct.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: tomsang on April 08, 2015, 09:42:43 AM

Hello,
Glad someone is worried about the same things as I. Yes I did the plan based on a 15 year payoff plan and it was right around then the excel sheet (Tomsang's sheets) stated it was better for me long term to payoff the mortgages.

The workbook or any workbook would show it was better to keep the mortgage if the projected investment return is greater than the mortgage rate.  So I am not sure what you mean by my workbook shows that it is better to pay off the mortgage early unless you put an investment yield lower than your mortgage rate.

My workbook is not that exciting, but it appeared a lot of people did not understand the concept that if you choose to invest vs. paying off the mortgage that you would have the investment to fund your retirement, payoff your mortgage or anything else.  It seemed like some people were only looking at the mortgage and the mortgage payment without understanding that a portion of the mortgage payment is paying down the mortgage so not really an expense.(Taking money from one pocket and putting in the other pocket).  A 30 year fixed rate mortgage is an amazing hedge against inflation.  Inflation is one of the killers of retirement.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: dabears847 on April 08, 2015, 07:29:42 PM
I've been running the calcs on cfiresim with three scenarios and I'm seeing the opportunity with a 30 year mortgage.

1. 15 year Mortgages have a big failure rate with investing all the dollars and paying p&I minimum
2. 30 year 96% success rate with big balance at end of thirty years 2.1MM
3. Accelarted Mortgage Payoff with 75,000 balance at end of payoff has 100% success rate and 474,000 balance at 30 years
4. tbd, Rental Income with Payoff cash flow and investing, once the rentals are paid off then the cash can be invested.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 08, 2015, 09:31:11 PM
4. tbd, Rental Income with Payoff cash flow and investing, once the rentals are paid off then the cash can be invested.

Answer:  Can you invest the money you would be using to prepay the mortgage into something that earns higher than the mortgage rate?  Then you should come out ahead with a large balance the vast majority of the time.

It's just simple leverage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: brooklynguy on April 09, 2015, 06:56:10 AM
To be clear, this strategy has a very high likelihood of success IF you are in it for the long haul.

I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Portfolio: 100% stocks
Expense Ratio: 0.05%
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)

The success rate is 97.39% (fails 3 out of 115 periods).  Those periods start in 1928, 1929, and 1930.  All other periods, including the bad ones in the mid 1960's do very well with a median ending portfolio of $498,335.

Also keep in mind that the true advantage of this strategy (based on historical data) may be even higher than the outrageously high success reported by cFIREsim, because cFIREsim may be materially understating the actual historical success rate and/or average ending portfolio values obtained by employing this strategy (as described in posts 440 and 442 above).
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: boarder42 on April 09, 2015, 08:23:26 AM
http://www.cnbc.com/id/102570850

finally some common sense. to some level...
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 09, 2015, 09:14:11 AM
http://www.cnbc.com/id/102570850

finally some common sense. to some level...

Giving that advice to the mainstream is dangerous, because they won't save the difference.  All of the listed points (retirement accounts, emergency fund, and credit card debt) are definitely good things to do before pre-paying the mortgage though.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on April 11, 2015, 01:48:18 PM
I'm wondering about how the success rate looks if you only use this strategy once the (stock) market has dropped 25%. Or 40%.

The equity in the house could be considered "dry powder" which could be used to purchase equities when they are on sale.

Yes, this edges onto market timing territory, but for me I would need something like that to make it worthwhile (emotionally) to slow down paying off the house.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: arebelspy on April 11, 2015, 03:34:22 PM
I'm wondering about how the success rate looks if you only use this strategy once the (stock) market has dropped 25%. Or 40%.

The equity in the house could be considered "dry powder" which could be used to purchase equities when they are on sale.

Yes, this edges onto market timing territory, but for me I would need something like that to make it worthwhile (emotionally) to slow down paying off the house.

Once it's trapped in the house, it can be hard to get it out.  If you're into market timing, stick it in a CD that's just below your mortgage rate, so you're losing only a tiny bit of money, then dump it in the market when it drops.  Or CD rates rise, and you end up ahead.

I don't time the market like that, but if you do think we're due for a big drop (and that the market is overvalued), keeping the funds liquid for that seems much better than putting it into your house's low rate fixed mortgage.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: TomTX on April 13, 2015, 02:09:10 PM
Agreed that it is hard (or at least costly) to get cash back out - which is why I am not taking equity back out of my house, nor am I paying extra.

If there is a stock crash, it could be worth the closing costs to get money back out of the house for investment.
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: boarder42 on April 14, 2015, 06:06:36 AM
Agreed that it is hard (or at least costly) to get cash back out - which is why I am not taking equity back out of my house, nor am I paying extra.

If there is a stock crash, it could be worth the closing costs to get money back out of the house for investment.

there are many no/low cost REFI companies out there.  i havent paid closing costs once and have REFI'd 5x
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: ljsurfer2002 on May 19, 2015, 05:10:00 PM
Lots of good info in this thread, but now I have to really think about putting a $180,000 windfall from grandparent life insurance into the $260,000 left in house principle (30-year fixed loan at 3.5% which still has 28 years left on it) or investing that amount into vanguard index funds (which will have a higher return above 3.5%)... I still feel like paying off the house ASAP is better, to allow for FI sooner, right? Maybe after the principle gets down to 80,000 really ramping up hard all the payments that would have gone to 401k / Roth IRA and have it go to Principle instead (i've been contributing to Roth IRA / 401k for 10+ years now and have a current value of $170,000 at the age of 34. I feel like I can cool those contribution jets for a few years to help get the house down to near paid off ...

thoughts ?
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: MDM on May 19, 2015, 05:46:14 PM
Lots of good info in this thread, but now I have to really think about putting a $180,000 windfall from grandparent life insurance into the $260,000 left in house principle (30-year fixed loan at 3.5% which still has 28 years left on it) or investing that amount into vanguard index funds (which will have a higher return above 3.5%)... I still feel like paying off the house ASAP is better, to allow for FI sooner, right?
Wrong.  Apparently the good info in this thread hasn't been absorbed....
Title: Re: Paying off Mortgage Early – How bad is it for your FI Date?
Post by: Faraday on May 19, 2015, 09:19:02 PM
Lots of good info in this thread, but now I have to really think about putting a $180,000 windfall from grandparent life insurance into the $260,000 left in house principle (30-year fixed loan at 3.5% which still has 28 years left on it) or investing that amount into vanguard index funds (which will have a higher return above 3.5%)... I still feel like paying off the house ASAP is better, to allow for FI sooner, right? Maybe after the principle gets down to 80,000 really ramping up hard all the payments that would have gone to 401k / Roth IRA and have it go to Principle instead (i've been contributing to Roth IRA / 401k for 10+ years now and have a current value of $170,000 at the age of 34. I feel like I can cool those contribution jets for a few years to help get the house down to near paid off ...

thoughts ?

ljsurfer2002:
The math, using cfiresim or other means, favors not paying off the mortgage and investing every single penny you would otherwise put toward the mortgage, into investments yielding above your mortgage rate. Whether or not YOU should do that depends on your situation:

1) How old are you? Are you young enough to enjoy the profits of a 30 year investment strategy?
2) How stable is your income? Can you make those house payments the entire time you are investing?
3) How's your cash flow? Does your mortgage payment take up so much of your monthly paycheck that you couldn't invest even if you wanted to?
4) Do you get any special benefits from the home you are talking about? Is it one-of-a-kind, or worth way more than you owe, or a neighborhood you MUST be in? That is, are you SURE you would keep the house for 30 years and not want to leave it?

Now, I'm doing both at the same time. I'm investing about 35% of my inc