Paying off Mortgage Early – How bad is it for your FI Date?

[SnackDog]

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.

[aj_yooper]

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! 

[MorningCoffee]

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.

[arebelspy]

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.

[MorningCoffee]

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!

[oldtoyota]

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.

[aj_yooper]

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?

[matchewed]

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.

[arebelspy]

+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!  :)

[aj_yooper]

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.”

[arebelspy]

Do you have an actual argument, or just a logical fallacy?

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.

[aj_yooper]

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.

[matchewed]

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.

[aj_yooper]

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.

[tomsang]

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.   

[matchewed]

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.

[sherr]

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.

[Mr Mark]

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.

[tomsang]

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

[FrugalZony]

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.

[arebelspy]

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.

[ender]

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.

[matchewed]

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.

[jrhampt]

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. 

[oldtoyota]

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).

[matchewed]

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?

[arebelspy]

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.

[DoubleDown]

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.

[arebelspy]

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.

[tomsang]

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

 

[totoro]

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.

[tomsang]

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!!!!

[arebelspy]

That's exactly what it is! 

Great post tomsang, awesome way to think of it.

[fiveoclockshadow]

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.

[Marmot]

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

[aj_yooper]

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. 

[RadicalPersonalFinance]

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/

[fiveoclockshadow]

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.

[dudemize]

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). 

[oldtoyota]

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?

[oldtoyota]

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!

[tomsang]

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.

[arebelspy]

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!

[orpheus]

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

[tpozywio]

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

[arebelspy]

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.)

[tomsang]

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/

[aj_yooper]

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/

[tomsang]

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!!!!

[Mr Mark]

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.