We've passed our "number", pay off mortgage and reduce risk?

[CCCA]

This is a question just to get a better sense of the options and attitudes of other mustachians and to help us clarify our thinking about risk and returns as we transition from accumulation to living in FIRE.
 
We've passed our number this past year, due to the latest rally in the stock market.  We're closer to 30x annual spending rather than 25x, so as long as there aren't any catastrophic crashes, we should be in pretty good shape. We also have a decent amount of flexibility to reduce spending or increase our income in FIRE.  Currently, we still have about $400k in mortgage on our primary residence and $300k on our rental property.  I just started FIRE in 2018 and my wife is still working for maybe a year or two. 

We're wondering what people's thoughts are regarding paying off mortgages as we head into the transition to FIRE- status, since at this point, I guess it makes more sense to be loss averse than trying to maximize gains.   Here's how we're viewing things:

Pros to paying off mortgage:

• Take money out of the stock market (lots in AAPL), reducing downside risk in the next downturn
• Reduce our spending so we feel more mustachian :)  Mortgage makes up ~30% of our annual spending.

Cons to paying off mortgage:

• Reduced expected returns (3.25% paying off mortgage vs. market returns)
• Money in taxable accounts that we can access would be accompanied by large LT capital gains, so it would be hard to access without paying 15% tax.  We only have about 30k of space below threshold between 0% and 15% cap gains tax.
• It would significantly reduce the amount of our taxable investments so we'd have to rely on transferring money from 401k's to IRA's and then to Roth.

This second con is one of the biggest barriers to doing anything different than we are now.  Since the remaining amount of the mortgage is pretty large, we would realize a pretty large chunk of gains (several hundred thousand dollars) and pay a lot of taxes.  Once my wife is not working and we are fully FIRE, we'll have a bit more freedom to sell these taxable stocks and not pay taxes on the gains.  I guess inertia and the pain of taxes might keep us on our current path.

I guess this is sort of an indirect question about asset allocation now that we are at/close to FIRE.  I suppose another means of reducing risk is just to shift towards a heavier bond allocation (though also has the same issue with taxes).

I look forward, as always, to having an enlightening and informative discussion.

[skip207]

This is something I have been thinking about lately.  We have our own house which will have c.150k mortgage left when we FIRE and rental with about 20k.  Could continue with the mortgage (its in our FIRE Calcs) but we could also pay it off early thus saving probably IRO 40k interest over the last 10 years it has to run.  But who knows what the markets will do.

Still not fully decided but leaning to sticking with the mortgages!

[ZiziPB]

I've been thinking about this as well, although in my case it doesn't make sense to do it at all as I will be selling my house and moving when I FIRE in a few months.  And I've been told that selling investments to take advantage of the market gains is market timing! 

In your case CCCA, instead of paying off the mortgage, you should make sure that your asset allocation is commensurate with the risk you are comfortable taking.  It sounds like you have too much money in a single company's stock instead of a broad index fund? 

I guess this is sort of an indirect question about asset allocation now that we are at/close to FIRE.  I suppose another means of reducing risk is just to shift towards a heavier bond allocation (though also has the same issue with taxes).

Rebalancing doesn't necessarily mean realizing a taxable gain.  You could simply increase your bond/fixed asset allocation in your 401k/IRA and leave the taxable account alone.

[tomorrowsomewherenew]

I'm not normally a fan of taking money out of the market to pay off mortgages, however in your case, I think I would take some out. Utilize whatever space you have in the 15% bracket so you can pay 0% capital gains, and put that toward whatever mortgage has the higher interest rate. I would not pay a 15% or 20% capital gains tax to do it, though.

[BFGirl]

I'm not normally a fan of taking money out of the market to pay off mortgages, however in your case, I think I would take some out. Utilize whatever space you have in the 15% bracket so you can pay 0% capital gains, and put that toward whatever mortgage has the higher interest rate. I would not pay a 15% or 20% capital gains tax to do it, though.

This is what I would probably do. 

[LWYRUP]

I intend to keep my mortgage as long as possible during road to FI and in between FI and RE.  But I would want to eliminate all debt before true RE in order to reduce risk. 

I'll probably end up doing some sort of modified RE (start business, work part time, etc.) so not sure how everything will shake out.  But if it was hang-up-the-cleats RE I would want to own where I lived outright. 

[Lulee]

Not sure, but don't you have to consider the rental property mortgage completely differently in your analysis?  Assuming you're making a profit on the rental, that mortgage is just another business expense.  Reducing that expense would increase the taxable profits, making this analysis a bit more complex.

You didn't, at least within this post, talk about you and your wife's long term goals after she finishes working.  If you're planning on staying in your home for the foreseeable future as opposed to selling up and moving to a LCOL area, that could make a big difference in your analysis.

Along with tomorrowsomewherenew's suggestion, can you during the transitional period cut other spending to the bone and throw those savings at your personal mortgage?  Even if you go what feels like really bare bones in your spending for a year or two, it could make a big dent in that mortgage and any other debts you might have.  The added plus is that it would also make you feel better about your what you truly need for post-FIRE spending going forward.

[1962colreb]

Im all in favor of reducing unneeded risk. Perhaps you could sell the rental to help
payoff the mortgage on the house ? Without seeing the total picture it’s hard to really
know what to propose.

[TheAnonOne]

The math says keep the mortgage. 

Assuming you pay off the full 700k for illustration... and the entire sum is subject to 15%

You are going to PAY $805,000 (after tax, assuming you can keep it to 15%), you are basically paying $105,000 to feel good about not having a mortgage.

That same $805,000 will generate $2,600 a month for the rest of your life, or left to grow at a measly 5% return over 30 years, will be something like $3.5MIL

--------------------------------------------------------------------------------

The math says keep the mortgage, but you don't have to. Just know, and accept the trade off.

[honeyfill]

Health care subsidies are another issue to think about.  Your wife is working so I assume she has coverage but at some point you will have to go to the ACA(unless you qualify for medicare or have coverage from your employer)  If you use up all your lower taxed assets to pay down your mortgages, your MAGI might be over the subsidy limits. 

[the_fixer]

Could you focus on paying the one you plan to live in down with your wife's income over the next year or two that she is working?

Personally I plan to have the house paid off when we retire. I am not paying any extra since we have a 2.875 apr but it should be close to paid off by the time we FIRE.

I am risk adverse more than many and having it paid off will make me feel better as I know my housing needs are covered unless something really strange happens.



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[aceyou]

If it were me I'd become mortgage free. 

I plan to retire in 13 years.  Three years ago I refinanced to a 15-year note so, so it has 12 years remaining.  I did that purposely so that I'd have a zero in the liability column upon FIRE. 

For those saying that paying off the mortgage decreases your expectation...the math says they are correct to say that. 
However, what they often leave out is that paying the mortgage decreases your variance.  There is value in decreased variance, especially when you've already "won" the game of being FI. 

Either way, you have won the game and will be fine.  Don't fret, and celebrate your upcoming FIRE!!!!

[marty998]

Agreed - you cannot put a price on the freedom that comes from not owing anything to anyone.

[Catbert]

I'm not normally a fan of taking money out of the market to pay off mortgages, however in your case, I think I would take some out. Utilize whatever space you have in the 15% bracket so you can pay 0% capital gains, and put that toward whatever mortgage has the higher interest rate. I would not pay a 15% or 20% capital gains tax to do it, though.

This is what I would probably do.

I'll third this for your primary residence.  As someone else noted your rental property is a different situation b/c of different tax ramifications.

Also you'll need to think about how your taxes will change with the new law.  Will you use the standard deduction?  Will you use it once your wife retires?  Did any thing in the tax law change capital gains taxation?  (I didn't hear anything mentioned regarding cap gains, but is there even a 15% bracket any more)

[LWYRUP]

If it were me I'd become mortgage free. 

I plan to retire in 13 years.  Three years ago I refinanced to a 15-year note so, so it has 12 years remaining.  I did that purposely so that I'd have a zero in the liability column upon FIRE. 

For those saying that paying off the mortgage decreases your expectation...the math says they are correct to say that. 
However, what they often leave out is that paying the mortgage decreases your variance.  There is value in decreased variance, especially when you've already "won" the game of being FI. 

Either way, you have won the game and will be fine.  Don't fret, and celebrate your upcoming FIRE!!!!

Bingo. 

I haven't crunched the numbers over at FIRE calc, but reduced variance = greater capacity for a more stock heavy portfolio = more potential long-term profit.  Personally, the more fixed obligations I had in RE, the more of a margin of safety I'd want to meet them. 

[CCCA]

I'm not normally a fan of taking money out of the market to pay off mortgages, however in your case, I think I would take some out. Utilize whatever space you have in the 15% bracket so you can pay 0% capital gains, and put that toward whatever mortgage has the higher interest rate. I would not pay a 15% or 20% capital gains tax to do it, though.

THis makes the most sense to me.  I think just writing the original post I was able to organize the problem issue in my head (hard to argue that it's a problem if we're talking about asset allocation in FIRE).  :) .


Taxes seems to be the biggest barrier so I will probably pay off one of the mortgages (the home we live in, and plan to live in) fairly slowly (keeping ourselves in the 0% capital gains bracket).  Given how much AAPL has gone up over the years, much of the money we take out will be gains. 


While my wife is still working, we don't have much room for additional income before we pass into the 15% LTCG bracket. 


And one other Con I just thought of: We itemize deductions because mortgage interest and property tax is so expensive in the Bay Area.  This gives us additional space with which to offset our income and keep us in the 0% bracket, especially when we start to do the Roth ladder.  If we pay off the mortgage, we'll have less overall total income allowable before we cross that threshold.

[jsstylos]

Another option is to sell enough stock to fill up the 0% capital gains bucket but reinvest that money (tax-gains harvesting) rather than pay off the mortgage.

[seattlecyclone]

I'm in the same general situation. I have a big mortgage on my primary residence and am planning to FIRE in a year. My wife may or may not continue working. She claims to enjoy it well enough. We have no plans to pay off the mortgage for now. We aggressively paid off the mortgage on our first house, and in hindsight that cost us more than $100k compared to if we had invested the extra payments instead. The interest rate is so low compared to historic levels; I remember online savings accounts paying 5% just before the recession. I'd be shocked if we aren't back there for a good chunk of the next 30 years.

The one thing that does give me a bit of pause is ACA subsidies, should those still exist when we both leave our jobs. Wiping out the mortgage from a taxable account doesn't really change your net worth, but it does reduce the amount of dividend income you receive and the amount of capital gains income that you need to realize to meet your expenses. I'll have to run some numbers to see how much any reduction in subsidies would change the effective interest rate on keeping the mortgage. That may make a difference.

[Norsky]

I recently purchased our retirement home and obtained my first 30yr mortgage to finance it rather than my customary 15 yr mortgage. I did this for 2 reasons.  1) to me the smaller payment provides more flexibility in the years between fire and when we choose to receive SS. We hope to delay 7ntil age 70. 2) the other reason is the mortgage (and property itself) should be a hedge against possibly higher future inflation.

[birdman2003]

Given the thread title, if I was "past" my number I would definitely pay off the mortgage and reduce that risk.

[Dicey]

Do whatever you want, but bear the following in mind:

It's a lot easier to keep the 3.25% mortgage(s) you have now than 1.) Trying to get a new mortgage (should you want one for ANY reason) post-FIRE and 2). There's no guarantee you'll ever see such a good rate again in  your lifetime, whereas the stock market's historical average is significantly higher than that.

[CCCA]

Do whatever you want, but bear the following in mind:

It's a lot easier to keep the 3.25% mortgage(s) you have now than 1.) Trying to get a new mortgage (should you want one for ANY reason) post-FIRE and 2). There's no guarantee you'll ever see such a good rate again in  your lifetime, whereas the stock market's historical average is significantly higher than that.

Thanks for this post! I think I had been thinking about this awhile ago, but it sort of slipped my mind when I posted this thread.  I think this is probably one of the most relevant cons for us for paying off the mortgage. 

[Dicey]

Do whatever you want, but bear the following in mind:

It's a lot easier to keep the 3.25% mortgage(s) you have now than 1.) Trying to get a new mortgage (should you want one for ANY reason) post-FIRE and 2). There's no guarantee you'll ever see such a good rate again in  your lifetime, whereas the stock market's historical average is significantly higher than that.

Thanks for this post! I think I had been thinking about this awhile ago, but it sort of slipped my mind when I posted this thread.  I think this is probably one of the most relevant cons for us for paying off the mortgage.

Happy to help. Congratulations on reaching your number!