Why Do you do ....... AND pay off your mortgage early?

[Slee_stack]

So, what I am hearing is that I should go out, and take a $200k mortgage on my paid off house, and stick it in the stock market in hopes of making an additional 3%, or else be face punched?

Sorry, but this not a one size fits all proposition.  In my 20's, 30's, and early 40's I did have 30 year mortgages, and simultaneously invested 16% into my 401k during this time.  This made a lot of sense, as I had 30 years of potential market gains to take advantage of.   However, now that I am turning 50, and considering retirement in a few years,and I still have my entire 401k invested in index funds, I consider my paid off house and pension as my stable investments.

I fully realize that there is potential to make more money throwing everything I have into the market, however, my risk tolerance is becoming somewhat reduced, as I prefer the security of these lower performing investments over maximizing retruns.

One of the greatest tenants of MMM is 'ENOUGH'.  The idea of increasing your buffer far beyond what you truly need does not make sense, as you already have enough.  Since I already have enough, I'll take a nice size helping of stability, thank you.

I'm afraid you're not hearing correctly.

This thread topic is about paying your mortgage off early (vs investing).

No one is arguing for trying to accumulate MORE than ENOUGH. 

If one is in the ACCUMULATION phase (meaning one doesn't have ENOUGH) and the time horizon is appropriate (thats for the individual to decide, 10 -30 year horizon), the argument is that you will accumulate faster by investing than by pre-paying a mortgage.

If one has no mortgage (paid off), but the time horizon to ENOUGH is still appropriate, then YES, one should take the (low interest) mortgage and invest the balance ifthey want to reach ENOUGH quicker.   If the only argument is 'its too risky', then there is a major disconnect if that same person is planning on a 4% SWR for their retirement.

[BlueHouse]

I'm afraid you're not hearing correctly.

This thread topic is about paying your mortgage off early (vs investing).

eh, says who?  The title doesn't say anything about making a choice NOT to invest. 

I do a lot of silly little things to save money because I just do.  I also max out my retirement accounts, I pay extra into taxable accounts, and I chose to pay down a significant portion of my mortgage for a recast. 

[boarder42]

I'm afraid you're not hearing correctly.

This thread topic is about paying your mortgage off early (vs investing).

eh, says who?  The title doesn't say anything about making a choice NOT to invest. 

I do a lot of silly little things to save money because I just do.  I also max out my retirement accounts, I pay extra into taxable accounts, and I chose to pay down a significant portion of my mortgage for a recast.

If you're paying down your mortgage with funds that could be invested you're choosing not to invest those funds.

[BlueHouse]

I'm afraid you're not hearing correctly.

This thread topic is about paying your mortgage off early (vs investing).

eh, says who?  The title doesn't say anything about making a choice NOT to invest. 

I do a lot of silly little things to save money because I just do.  I also max out my retirement accounts, I pay extra into taxable accounts, and I chose to pay down a significant portion of my mortgage for a recast.

If you're paying down your mortgage with funds that could be invested you're choosing not to invest those funds.

Fair enough Boarder42, you got me there. But I'm meeting my asset allocation goals on my personal investment policy, so I'll give myself a pass this one time.

[FIT_Goat]

Not having enough was a big factor in my change of mind on this.  I do not have enough to pay off my entire mortgage, at the moment.  Not only does paying the minimum accelerate the time when I would have enough, but it also provides me with cash that I can use if things hit the fan.  The way I was going, I was going to have to avoid major emergencies for almost a decade, because I would have little cash outside of my retirement assets.

[EnjoyIt]

I think the big disconnect is that we are making the comparison between paying down debt and investing in equities. It is not a fair comparison. The real comparison should be between paying down debt vs purchasing debt. Obviously buying equities should theoretically outperform debt. It has higher risk and higher risk should have higher returns.

[FIreDrill]

I think the big disconnect is that we are making the comparison between paying down debt and investing in equities. It is not a fair comparison. The real comparison should be between paying down debt vs purchasing debt. Obviously buying equities should theoretically outperform debt. It has higher risk and higher risk should have higher returns.

But this is a perfectly reasonable comparison for those of us that set our asset allocation to 100% equities.

Sent from my SM-G935F using Tapatalk

[BlueHouse]

But this is a perfectly reasonable comparison for those of us that set our asset allocation to 100% equities.  Which I bet is most of us in this thread.

Where do you get your data on which you make bets?  Cuz, nope, not me

[FIreDrill]

But this is a perfectly reasonable comparison for those of us that set our asset allocation to 100% equities.  Which I bet is most of us in this thread.

Where do you get your data on which you make bets?  Cuz, nope, not me

Haha, I thought I was replying to the "DONT payoff your Mortgage Club" thread!

Fixed the obviously wrong part of my statement above.

I do wonder what the Asset Allocation of the active participants in that thread is.  Probably not 100% equities but I would guess 85% or higher on the equity front.  Most people participating in that thread are pretty heavy in equities, from what I've seen and heard at least.

Sorry for the mistake on my part :)

[Dicey]

Try it this way, PizzaSteve: It's stupid to blindly "kill the mortgage" before one understands the opportunity cost of doing so, particularly prior to stuffing all tax-advantaged retirement and investment options full to the gills.

If one fully understand which choice costs more in the long run, the decision is theirs to make. But most people don't get the math. Just as index funds weren't well known in the '80's...

I salute boarder42's dogged pursuit of knowledge and enlightenment for all. And if he's a tad abrasive at times, I remind the complainers that this is not the Powder Puff Football League.

[EnjoyIt]

I think the big disconnect is that we are making the comparison between paying down debt and investing in equities. It is not a fair comparison. The real comparison should be between paying down debt vs purchasing debt. Obviously buying equities should theoretically outperform debt. It has higher risk and higher risk should have higher returns.

But this is a perfectly reasonable comparison for those of us that set our asset allocation to 100% equities.  Which I bet is most of us in this thread.

Sent from my SM-G935F using Tapatalk

If you are 100% equities then you are correct.  But I highly doubt most of us are 100% equities.  I'm not.  I am currently 67.5/32.5 and gliding to 60/40.  Realistically I do believe my mortgage is debt that I bought which negates some of the debt I sold (bonds) and with that rationality I am actually at 85/15. Going 100% equities is a whole other thread and we should not discuss it here.

[BoonDogle]

Try it this way, PizzaSteve: It's stupid to blindly "kill the mortgage" before one understands the opportunity cost of doing so, particularly prior to stuffing all tax-advantaged retirement and investment options full to the gills.

If one fully understand which choice costs more in the long run, the decision is theirs to make. But most people don't get the math. Just as index funds weren't well known in the '80's...

I salute boarder42's dogged pursuit of knowledge and enlightenment for all. And if he's a tad abrasive at times, I remind the complainers that this is not the Powder Puff Football League.

No it's not.  It's also not kindergarten.  Seems many in your camp think the definition of enlightenment is when everyone finally agrees with you.  We know "the math". We have done our own modeling and made our decisions based on our situations.  Your welcome to make your case but understand your situation is not everyone's situation.

[mathlete]

Glad to see the infinite mortgage master race is still out in full force.

^_-

[anonymouscow]

I am paying off my mortgage early as well as investing.

I realize I could be making 7% in the stock market vs 3% mortgage.

If the house was paid off I wouldn't take out a home equity loan to invest in the stock market.

Part of it is philosophical, the simpler things are, the better. It's much simpler to just pay off the house in 7 years and not have to worry about it. I don't view the house as a bank or storage of money. Throwing 300 bucks a month extra to the mortgage  isn't that big a deal to me.

Maybe my math is wrong, but
$3,600 a year x 3% x 7 years= $28,412
$3,600 a year x 7% x 7 years= $33,335
So I lose out on $4,923 dollars over 7 years.

[boarder42]

I am paying off my mortgage early as well as investing.

I realize I could be making 7% in the stock market vs 3% mortgage.

If the house was paid off I wouldn't take out a home equity loan to invest in the stock market.

Part of it is philosophical, the simpler things are, the better. It's much simpler to just pay off the house in 7 years and not have to worry about it. I don't view the house as a bank or storage of money. Throwing 300 bucks a month extra to the mortgage  isn't that big a deal to me.

Maybe my math is wrong, but
$3,600 a year x 3% x 7 years= $28,412
$3,600 a year x 7% x 7 years= $33,335
So I lose out on $4,923 dollars over 7 years.

Your math is wrong bc all of that money is sunk in the house now and cannot continue to compound gains over 30 years.

[PizzaSteve]

Your math is wrong bc all of that money is sunk in the house now and cannot continue to compound gains over 30 years.

I didn't check his numbers,  but if you pay down debt, your rate of return does compound, as the cash flow equivalent of saved interest (which just happens to accumulate as home equity).  This occurs at the interest rate.  That is why it is called compound interest.

You are not paying off the house, you are paying down your debt.  The house has been bought.  That transaction is over.  The proper comparison is paying off debt vs investing.

Other than the relatively minor value of a hedge against a real estate value collapse, it actually doesnt matter whether the debt is secured by a home or was unsecured general debt, and auto loan, payday loan or whatever.  It is the rate and term that is relevant.

[boarder42]

Your math is wrong bc all of that money is sunk in the house now and cannot continue to compound gains over 30 years.

I didn't check his numbers,  but if you pay down debt, your rate of return does compound, as the cash flow equivalent of saved interest (which just happens to accumulate as home equity).  This occurs at the interest rate.  That is why it is called compound interest.

You are not paying off the house, you are paying down your debt.  The house has been bought.  That transaction is over.  The proper comparison is paying off debt vs investing.

Other than the relatively minor value of a hedge against a real estate value collapse, it actually doesnt matter whether the debt is secured by a home or was unsecured general debt, and auto loan, payday loan or whatever.  It is the rate and term that is relevant.

Home equity and growth occurs with or without the debt.

[matchewed]

Your math is wrong bc all of that money is sunk in the house now and cannot continue to compound gains over 30 years.

I didn't check his numbers,  but if you pay down debt, your rate of return does compound, as the cash flow equivalent of saved interest (which just happens to accumulate as home equity).  This occurs at the interest rate.  That is why it is called compound interest.

You are not paying off the house, you are paying down your debt.  The house has been bought.  That transaction is over.  The proper comparison is paying off debt vs investing.

Other than the relatively minor value of a hedge against a real estate value collapse, it actually doesnt matter whether the debt is secured by a home or was unsecured general debt, and auto loan, payday loan or whatever.  It is the rate and term that is relevant.

Home equity and growth occurs with or without the debt.

As has been said many times, home equity as a concept is irrelevant to the decision to 'invest' either in debt reduction or stocks.  It is a 'made up concept' banks use as part of their loan approval process.  It has no relevance once the debt  contract is signed, unless there is some provision regarding periodic value assessments and a related debt call provision.

I am tired of responding with someone who doesn't consistently use the accepted definition of words, nor who appears to fully understand accounting and finance concepts.

Think what you like.

No need to be a jerk about it. If you are getting tired of responding, rather than attacking, don't respond. I'm fairly confident that boarder does understand the above concepts but is just coming to different conclusions.

[Goldielocks]

Boarder42

I admit - I did not read 8 pages, please excuse if this is a repeat.

Do you refinance your mortgage every 30 years to keep it to a 30 year amortization schedule, so you can re-invest elsewhere?  e.g 15 year after you purchase a place, do still have a full 30 years amortization left on it?

I don't pre-pay my mortgage .  But I also keep to the original repayment schedule so it would be fully paid off within 30 years.

What do you do?

[matchewed]

Boarder42

I admit - I did not read 8 pages, please excuse if this is a repeat.

Do you refinance your mortgage every 30 years to keep it to a 30 year amortization schedule, so you can re-invest elsewhere?  e.g 15 year after you purchase a place, do still have a full 30 years amortization left on it?

I don't pre-pay my mortgage .  But I also keep to the original repayment schedule so it would be fully paid off within 30 years.

What do you do?

Depending on the interest rate and the market I would totally refinance after 30 years personally. If my mortgage was going to be up in this current environment I'd do it without pause. A mortgage is a great inflation hedge for the future.

[Goldielocks]

Why do you get a fixed rate, rather than a lower variable rate?

[matchewed]

Why do you get a fixed rate, rather than a lower variable rate?

Personally because it may become harder in FIRE to get a mortgage. I'd rather lock in the rate for the long haul than have to attempt to refinance in FIRE.

[Goldielocks]

I looked at that -- I will just carry a mortgage for my home within my RRSP if that happens.   Not fabulous returns, but good as a last resort.


What I am getting at, is why pay up to .8% more on the mortgage rate to get a fixed rate rather than a variable rate, if you all are so decidedly non-risk averse.

The original post was a bit "in your face" about the comparative value of money being the driver for this decision, so why not go all the way?

After all, in the tone of the original post on this thread:
 0.8% x $400k mortgage = $3200 per year
$32k x 30 years = $960k   (not including any compounding, assuming it is always refinanced to keep it to $400k and not paid off).

Isn't $960k worth a little bit more risk that you may not be able to refinance in FIRE, and need to cover your mortgage with your personal savings, or downsize?

[matchewed]

I looked at that -- I will just carry a mortgage for my home within my RRSP if that happens.   Not fabulous returns, but good as a last resort.


What I am getting at, is why pay up to .8% more on the mortgage rate to get a fixed rate rather than a variable rate, if you all are so decidedly non-risk averse.

The original post was a bit "in your face" about the comparative value of money being the driver for this decision, so why not go all the way?

After all, in the tone of the original post on this thread:
 0.8% x $400k mortgage = $3200 per year
$32k x 30 years = $960k   (not including any compounding, assuming it is always refinanced to keep it to $400k and not paid off).

Isn't $960k worth a little bit more risk that you may not be able to refinance in FIRE, and need to cover your mortgage with your personal savings, or downsize?

Because the variable rate mortgage has an inherent unknown in it, the variable rate. It may be good for that 5-7 years but weighed against something that will be good for 30 years? You're basically stating would you take the risk of five to seven years of a lower rate and an unknown rate after that which may be higher and not beneficial rather than a 30 years of a slightly higher than the five to seven?

I'm also uncertain what you're trying to say in that last section with the math. Could you clarify that?

[Goldielocks]

I was trying to match the calculation format of the OP... e.g.

Mowing your own lawn - 30 weekly * 30 weeks a year - 900/year.  and lets assume your mower is free and you pay nothing to maintain it.
Total invested thru mowing your own law over 30 years = 91k

I was showing that getting a variable rate (that you don't pay down, renew every 5 years) is worth at least $96k over 30 years, compared to a fixed 5 year ARM rate (typo! noted! not $960k) and typical 0.8% interest rate difference.

The reason 70% of borrowers choose the variable rate option here is the money difference -- today variable (5 yr closed) is 1.95% versus a 10 year fixed at 3.74% and 25 year fixed at 8.75% (likely to get that under 7%, after typical discounts, but still....).

Personally, if I were to choose a 10 year fixed rate versus my variable rate that I have today, I would pay 1.8% more interest, and it would cost me $216k in interest over 30 years.   (assuming no paydown of mortgage)

My point is that OP is pointedly (aggressively?) "PRO" investing elsewhere than paying down mortgage, (which I agree with for disciplined investors) but disregards another huge mortgage savings opportunity entirely.   

The first big elephant missed in this thread is to just buy a cheaper house (or rent?). -- goes without saying?
The second is to go for the lowest rate, even if it is variable. 

[Dicey]

Perhaps because b42's in the US. A 30 year fixed rate mortgage doesn't renew, it stays constant for 30 whole years. With rates hovering around 4% for 30 freaking years, wouldn't you jump on it too? Two completely different systems. Although 1.95% for five years sounds delicious, we don't really have anything that low.

This is a general comment, not specifically a reply to you, dear GL: I'd like to reiterate that it's fine to prepay a mortgage or buy a house with cash (raises hand). The thing that must be understood is that doing that before availing yourself of every single tax-advantaged retirement option available to you first means that you are not deploying your green soldiers in the most optimal fashion. Once a person understands the math behind the choice they are making, they are free to do whatever the hell they want. Just please take the time to understand the math before you act, people!

[matchewed]

Yeah you seem to have missed some of the base assumptions and are coming from it with a completely different set.

In the US your current best bet is a 30 year mortgage. You can get lower rates with other options but the long term impact is best with the 30 year mortgage.

[Khan]

Yeah you seem to have missed some of the base assumptions and are coming from it with a completely different set.

In the US your current best bet is a 30 year mortgage. You can get lower rates with other options but the long term impact is best with the 30 year mortgage.

30 year fixed rate mortgages are a US only boon, and I think that's why the assumptions herein fall to pieces when considering other locations. On top of other factors such as the 4% rule not exactly working out in this century outside of the US, being able to pick a 30 year time horizon for calculations, of which there has never been a negative one is the only way this works out.

[boarder42]

I was trying to match the calculation format of the OP... e.g.

Mowing your own lawn - 30 weekly * 30 weeks a year - 900/year.  and lets assume your mower is free and you pay nothing to maintain it.
Total invested thru mowing your own law over 30 years = 91k

I was showing that getting a variable rate (that you don't pay down, renew every 5 years) is worth at least $96k over 30 years, compared to a fixed 5 year ARM rate (typo! noted! not $960k) and typical 0.8% interest rate difference.

The reason 70% of borrowers choose the variable rate option here is the money difference -- today variable (5 yr closed) is 1.95% versus a 10 year fixed at 3.74% and 25 year fixed at 8.75% (likely to get that under 7%, after typical discounts, but still....).

Personally, if I were to choose a 10 year fixed rate versus my variable rate that I have today, I would pay 1.8% more interest, and it would cost me $216k in interest over 30 years.   (assuming no paydown of mortgage)

My point is that OP is pointedly (aggressively?) "PRO" investing elsewhere than paying down mortgage, (which I agree with for disciplined investors) but disregards another huge mortgage savings opportunity entirely.   

The first big elephant missed in this thread is to just buy a cheaper house (or rent?). -- goes without saying?
The second is to go for the lowest rate, even if it is variable.

1. this thread assumes we own houses and that the analysis between buying and renting has been done.  obviously you can make that arguement all day but if you have a mortgage i'm assuming you've decided that owning a house is in your best interest

2.  going for the lowest rate even if its variable is bad advice IMO.  what if rates are 12% again in 15 years that greatly changes all the math.  i'm locked at a 3.25 i dont even think you can beat that with a variable rate already today.  and rates likely will just recede to the norm.  around 5-6%. 

to me this is about playing the odds and likely outcomes not the outlier outcomes.  we're currently in an outlier situation with interest rates being so low.  i dont expect it to continue so locking now at an outlier low makes sense in my opinion.

[boarder42]

Yeah you seem to have missed some of the base assumptions and are coming from it with a completely different set.

In the US your current best bet is a 30 year mortgage. You can get lower rates with other options but the long term impact is best with the 30 year mortgage.

I would disagree that a 30 year mortgage produces the best impact. You can drop your interest rate right now 0.80% by going with a 15-year fixed instead of a 30-year fixed.

30 year produces the best impact if you're investing and plan to stay put for 7 years.  the 15 year only comes out ahead sub 7 year.  and the .8% drop wasnt that large when 30 year's were at 3.25%, so the 30 year won in my case after ~5 years of staying put and investing the extra.

[boarder42]

Why do you get a fixed rate, rather than a lower variable rate?

Obtaining a variable rate right now in the U.S. is a horrible idea. Interest rates are at historically low levels and the Fed is beginning to raise interest rates.

https://www.usatoday.com/story/money/2017/03/15/federal-reserve-interest-rates-economy-janet-yellen-mortgages-credit-cards/99186568/

Is it possible rates will not increase, yes. But this would not be the expected or likely outcome over the next few years. I will give you some valuable advice, never bet against the federal reserve.

I wanted to stay out of this debate, but disagree with you in this one.

It is a flawed assumption to claim either of you know what interest rates will do and whether a fixed or variable rate is better.

My personal history is that i used variable rates during my accumulation phase.  Morgage brokers and the press said rates are historically low and wont get lower, each time i financed a home.  The only thing is they did get lower and we saved huge amounts of interest carefully researching and buying the best terms for debt.   I was paying under 3% for the last decade I had a morgage, saving 1-2% vs any fixed rate loan.

I am suprised B42 is willing to hold market risk based in the math (which i agree with) but not willing to explore the nature of capitial costs more rigorously.  A mustacian can self insure for interest rate risk by being able to pay off the morgage at will, due to large savings and savings rates.  If interest rates rise, shift strategy, adapt, spend less and kill the debt.  That is what i always did...lowest rate, invest aggressively, be ready if rates rise to a point i want to kill the loan. 

Eventually we had such good results in investing we just killed the final debt for the joy if doing it, as a very small part of NW.

b/c i'm locked at a 3.25% for 30 years probably lower than most of the variable rates you had.  the risk of rates rising from historic lows now is far greater than when rates were higher.  a 5/1 now is more than my fixed rate.  had i taken a 5/1 for i think 3% at the time of my loan i would be subject to the risk of rising rates.  which appears to be happening as i cant get a 5/1 now for less than my 30 year fixed rate.  that small .25% to take on the risk of my rate being closer to the norm of 5-6% in 5 or even 20 years isnt worth it.  my money is better suited in the market than tied up in my house.

If rates are 12% i'll probably take the variable rate but guess what if rates drop i can go REFI again and again and again.  but if rates rise and i'm variable i dont have the option to go back and get the 3.25% rate.

i'd think a logical/methodical way to go about determining if you should go variable would be to look at the historical avg fixed 30 year mortgage rate and if you can get a lower rate than that you probably should go fixed.  if its higher then variable may likely make sense.  Also market conditions and current fed policy should play a role.  and the fed policy is currently raise rates - which doesnt directly affect the 10 year that the mortgage rates are based on but it does influence it. 

[boarder42]

Why do you get a fixed rate, rather than a lower variable rate?

Obtaining a variable rate right now in the U.S. is a horrible idea. Interest rates are at historically low levels and the Fed is beginning to raise interest rates.

https://www.usatoday.com/story/money/2017/03/15/federal-reserve-interest-rates-economy-janet-yellen-mortgages-credit-cards/99186568/

Is it possible rates will not increase, yes. But this would not be the expected or likely outcome over the next few years. I will give you some valuable advice, never bet against the federal reserve.

I wanted to stay out of this debate, but disagree with you in this one.

It is a flawed assumption to claim either of you know what interest rates will do and whether a fixed or variable rate is better.

My personal history is that i used variable rates during my accumulation phase.  Morgage brokers and the press said rates are historically low and wont get lower, each time i financed a home.  The only thing is they did get lower and we saved huge amounts of interest carefully researching and buying the best terms for debt.   I was paying under 3% for the last decade I had a morgage, saving 1-2% vs any fixed rate loan.

I am suprised B42 is willing to hold market risk based in the math (which i agree with) but not willing to explore the nature of capitial costs more rigorously.  A mustacian can self insure for interest rate risk by being able to pay off the morgage at will, due to large savings and savings rates.  If interest rates rise, shift strategy, adapt, spend less and kill the debt.  That is what i always did...lowest rate, invest aggressively, be ready if rates rise to a point i want to kill the loan. 

Eventually we had such good results in investing we just killed the final debt for the joy if doing it, as a very small part of NW.

b/c i'm locked at a 3.25% for 30 years probably lower than most of the variable rates you had.  the risk of rates rising from historic lows now is far greater than when rates were higher.  a 5/1 now is more than my fixed rate.  had i taken a 5/1 for i think 3% at the time of my loan i would be subject to the risk of rising rates.  which appears to be happening as i cant get a 5/1 now for less than my 30 year fixed rate.  that small .25% to take on the risk of my rate being closer to the norm of 5-6% in 5 or even 20 years isnt worth it.  my money is better suited in the market than tied up in my house.

If rates are 12% i'll probably take the variable rate but guess what if rates drop i can go REFI again and again and again.  but if rates rise and i'm variable i dont have the option to go back and get the 3.25% rate. yes...that is why you are paying more...you are buying expensive interest rate insurance

i'd think a logical/methodical way to go about determining if you should go variable would be to look at the historical avg fixed 30 year mortgage rate and if you can get a lower rate than that you probably should go fixed.  if its higher then variable may likely make sense.  Also market conditions and current fed policy should play a role.  and the fed policy is currently raise rates - which doesnt directly affect the 10 year that the mortgage rates are based on but it does influence it.

2.25 % << 3.25%

missed that...

but still the only thing we can use to gauge the future is the past and what has historically happened.  2.25% ARM loans arent a norm.  7% market gains on avg are.  I bet on probabilities the probability is that the rates will rise over 30 years... the probability is that the market will continue to produce 7% ... both i would say are greater than 70% chances. likely much higher.

[BFGirl]

Why dont we apply math to backtest the expected value of ARMs vs fixed rates and chose the one most likely to succeed based on data,  as opposed to fear of rising interest rates?

I got great ARM loans for decades, especially if you seek out hungry banks and brokers.  Fixed rates are always sold at a premium, as the bank holds the interest rate risk on their books.

Consider yourself facepunched :)

PS swearing off mortgage threads.  Facepunch me if i reply to boarder42

[boarder42]

Why dont we apply math to backtest the expected value of ARMs vs fixed rates and chose the one most likely to succeed based on data,  as opposed to fear of rising interest rates?

I got great ARM loans for decades, especially if you seek out hungry banks and brokers.  Fixed rates are always sold at a premium, as the bank holds the interest rate risk on their books.

PS.  Helpful advice, if you follow this strategy, read the whole morgage contract in detail.  Some tried to include minimum rates when the morgage adjusted.  Some cap the adjustment per year.  You can negotiate these terms (one 7/1 ARM had a great fixed rate for 7 years, then tried to sneak in a 5% minimum rate after the loan adjusted...i made them remove that.  The vbl was 30 year t-bills plus 2.2%, so when it adjusted it fell to under 3%.  I saved 2%+ with that one edit, the bank and broker agreed to (i threatened to walk, if not taken out). Maximum rates can also be negotiated and woukd be a good idea if worried about the scenario above.  Maybe fixed is best for mustacians who will not be working soon.

then do the math and show us i'm all for seeing it.

[undercover]

Haven't read the thread and the only input I have on whether it's better to invest or pay down mortgage is that it's better to invest if past performance is any indication of future results (see end of this post)

I still think that the OP is making a bit of a false equivalency. First, as I think others have pointed out, line drying your clothes, biking to work, or any of the other "super frugal" measures that some go to are not so much always financial related but lifestyle related. Second, the frugal activities mentioned are guaranteed savings, just like paying down the mortgage. Investing is not guaranteed. That is the difference.

If anything, it makes perfect sense. Someone with a low-risk personality would do all they can to save money in the most guaranteed of ways. This is the same only topic boarder42 loves, just wrapped into a different package that this time makes no sense. The real debate is whether to pay down or invest.

Asking why you do completely unrelated things (which, again, IMO are related only based on risk tolerance, so it makes sense) is just deviating from the real subject which has been argued at length over I'm sure thousands of posts since this forum's inception. Is there really any point in keeping it going?

The reason why these threads span 10+ pages and there's never a clear answer is based on one simple fact: NO ONE CAN PREDICT THE FUTURE. You can make projections and use "math" as your ally all you want but at the end of the day they're just projections and you haven't proved anything.

[boarder42]

Haven't read the thread and the only input I have on whether it's better to invest or pay down mortgage is that it's better to invest if past performance is any indication of future results (see end of this post)

I still think that the OP is making a bit of a false equivalency. First, as I think others have pointed out, line drying your clothes, biking to work, or any of the other "super frugal" measures that some go to are not so much always financial related but lifestyle related. Second, the frugal activities mentioned are guaranteed savings, just like paying down the mortgage. Investing is not guaranteed. That is the difference.

If anything, it makes perfect sense. Someone with a low-risk personality would do all they can to save money in the most guaranteed of ways. This is the same only topic boarder42 loves, just wrapped into a different package that this time makes no sense. The real debate is whether to pay down or invest.

Asking why you do completely unrelated things (which, again, IMO are related only based on risk tolerance, so it makes sense) is just deviating from the real subject which has been argued at length over I'm sure thousands of posts since this forum's inception. Is there really any point in keeping it going?

The reason why these threads span 10+ pages and there's never a clear answer is based on one simple fact: NO ONE CAN PREDICT THE FUTURE. You can make projections and use "math" as your ally all you want but at the end of the day they're just projections and you haven't proved anything.

while its very easy to make the statement "you cant predict the future"  many here ~90% plan to use equities and some version of the 4% SWR in FIRE.  which means they have bought into the fact that the stock market past returns are what they plan to use to guide them thru years of FIRE. 

So while its so easy to say well you cant predict the future ... then ok whats your plan.  Save enough in cash to keep up with the worst case of inflation happening annually.  The answer is no b/c you'd never FIRE. 

Paying down a mortgage over time has been proven time and time again to be more risky than investing.  So your risky statement is flawed.  lump sum paying off a mortgage is different and eliminates most of the risk there. 

[boarder42]

Haven't read the thread and the only input I have on whether it's better to invest or pay down mortgage is that it's better to invest if past performance is any indication of future results (see end of this post)

That is not really true. Past performance indicates for some periods of time paying off the mortgage would have resulted in a higher net worth and in some periods of time investing would have produced a higher net worth.

thats incorrect.  your thread on this many other showed the flaw in your data and assumptions.

[boarder42]

Haven't read the thread and the only input I have on whether it's better to invest or pay down mortgage is that it's better to invest if past performance is any indication of future results (see end of this post)

That is not really true. Past performance indicates for some periods of time paying off the mortgage would have resulted in a higher net worth and in some periods of time investing would have produced a higher net worth.

thats incorrect.  your thread on this many other showed the flaw in your data and assumptions.

"Flaw in your data" - Nope, there were no flaws in my data. I used the exact same data that many PhDs such as Robert J. Shiller used.

"Flaw in your assumptions" - There were disagreements on the assumptions that should be used in the calculations but my assumptions were not "flawed". They were not a perfect match with reality but all calculations must make some simplifying assumptions to be able to perform the calculation. The two that took the most heat were investments in taxable accounts will create a tax burden and over the next 30 years there will be inflation. Several of the people in the "don't pay-off your mortgage" crowed wanted to assume no inflation and no taxes. Those are flawed assumptions.

you were using inflation on a one way street to make paying down a mortgage look better when in fact it doesnt work that way it works the exact opposite way.  inflation wasnt in all places of the equation, just where it helped support your claim. 

and the use of some and some for both paydown and invest is incorrect.  Many cases investing wins.  few cases using the data the way you did produced a favorable outcome for the paydown scenario.  its like betting on green on a roulette wheel since as was pointed out we cant predict the future.  so why not bet on the most likely outcome not the outlier. 

I still firmly believe default answer in this forum should be dont pay down your mortgage until whoever the OP is presents reasonable information as to why they should pay it off or shows a complete understanding of what they are sacraficing to pay it down.

[brooklynguy]

The two that took the most heat were investments in taxable accounts will create a tax burden and over the next 30 years there will be inflation.  Several of the people in the "don't pay-off your mortgage" crowed wanted to assume no inflation and no taxes.

With respect to taxes, the assumption that was most objectionable was that taxes would apply to unrealized capital gains, which makes no sense and does not reflect reality.

Inflation will always narrow the gap between two net-worth outcomes over time. If paying-off the mortgage early had a higher average net worth result, adding inflation would reduce the perceived out performance. My calculations were not a "one-way street".

When you factored in inflation, did your analysis account for the fact that the mortgage payments would be decreasing on an inflation-adjusted basis?  I'm not sure if that question was ever resolved in the other thread (and I believe that's the "one-way street" issue boarder is referring to).

[boarder42]

The two that took the most heat were investments in taxable accounts will create a tax burden and over the next 30 years there will be inflation.  Several of the people in the "don't pay-off your mortgage" crowed wanted to assume no inflation and no taxes.

With respect to taxes, the assumption that was most objectionable was that taxes would apply to unrealized capital gains, which makes no sense and does not reflect reality.

Inflation will always narrow the gap between two net-worth outcomes over time. If paying-off the mortgage early had a higher average net worth result, adding inflation would reduce the perceived out performance. My calculations were not a "one-way street".

When you factored in inflation, did your analysis account for the fact that the mortgage payments would be decreasing on an inflation-adjusted basis?  I'm not sure if that question was ever resolved in the other thread (and I believe that's the "one-way street" issue boarder is referring to).

correct. we probably should be debating this there but he left that thread for the most part.

[brooklynguy]

You are correct that you can defer some of your unrealized taxes until you sell your holdings in the future. However, it is completely unrealistic to ignore taxes completely, which many "do not pay-off the mortgage early' individuals do. Yes, my calculation is a simplification of reality but simplifications must be made to keep calculations manageable. While the realization may be aggressive, the rate was very conservative (15%) as taxes on capital gains can be as high as 23.8%.

Most of your returns will almost certainly come in the form of capital gains, as long as you are using broad market stock index funds as your investment vehicle, which is why, as I said in my original objection to that assumption, I believe it does a worse job of reflecting reality than simply ignoring taxes altogether (even putting aside the fact that assuming zero tax liability actually does have the potential to accurately reflect reality (depending on how tax laws change in the future), for frugal mustachians whose income falls below the 15% tax bracket).

Inflation adjusting the mortgage payments would be an inaccurate method as they remain fixed.

That is the reason we advocated for ignoring inflation altogether for purposes of this analysis.  Factoring in inflation on the investment return side but not the mortgage paydown side is what would be inaccurate, and would overstate the benefit of paying down the mortgage loan.  The cFIREsim analysis I posted in the other thread properly accounts for inflation on both sides.

[brooklynguy]

Historically, Most of an investors returns came from dividends not capital appreciation. Historically from 1871 to 2016 capital appreciation 4.35% + dividends of 4.72% = 9.07%.

Ok, that's a good point.  But even that relatively small contribution by capital appreciation towards historical total return constitutes nearly half of it, which means the unrealistic performance drag resulting from your assumption is still pretty significant (and it is then compounded by the one-sided accounting for inflation, which might be a bigger issue).

[boarder42]

Historically, Most of an investors returns came from dividends not capital appreciation. Historically from 1871 to 2016 capital appreciation 4.35% + dividends of 4.72% = 9.07%.

Ok, that's a good point.  But even that relatively small contribution by capital appreciation towards historical total return constitutes nearly half of it, which means the unrealistic performance drag resulting from your assumption is still pretty significant (and it is then compounded by the one-sided accounting for inflation, which might be a bigger issue).

yes if you're going to apply inflation to the investment returns you need to deflate the mortgage payments based on inflation ... my FIXED mortgage payment in 30 years if its 10k per year today ... would be if we assumed avg 1% less than average inflation of 3.2% -  10000/1.022^30 or 5205.  when you account for inflation on the investment gains and make them look worse you have to account for inflation making the mortgage payment smaller. otherwise its an imbalance which doesnt affect the guy who paid it down in 7 years as much as the guy keeping the payment for 30 years.  which is likely a large cause of your results being different from cFIREsim.  this is why we typically just ignore inflation in the calcs.  And since the only year you show a mortgage paydown beating the investing is the hyper inflated 70s i'd say its extemely pertinent to the calc to include it on the payment side. but again betting on low probability based on historic returns. as most cases investing wins and very few cases won when inflation was improperly applied.

[maizefolk]

To review there are two assumptions in Virtus's comparison of stock returns and paying off a mortgage that people in the thread consistently disagreed with:

1. Reducing stock market returns based on the rate of inflation but not inflation adjusting mortgage payments/remaining balance. One really REALLY has to either apply inflation to both sides of that equation or neither.

2. Applying tax every year to unrealized capital gains.* Everyone agrees this one is wrong, the argument is whether it causes significant variance in the final outcome or not.

How big of a difference do these two assumptions make?

#1. The difference between the non-inflation adjusted CAGR of the stock market and the CAGR of the stock market is 9.1% vs 6.9%.

#2. Applying 15% tax every year to unrealized capital gains reduced the CAGR further to 5.87%.

Over the course of a 30 year mortgage, $10k will compound to $125k at 9.1%. After applying capital gains tax at the end, the final value is $108k.  $98k of post tax appreciation. At 5.87% that same $10k would have only compounded to $52k. $42k of post-tax appreciation. Less than half as much.

There are not things than can be hand waved away as inconsequential issues.

I posted my analysis, both graphically and with spreadsheets of results here. Rpr posted their analysis using their own code and using Virtus's spreadsheet after removing the one sided inflation adjustment and taxation of unrealized capital gains every year here. All three found that the only historical year where paying off a 4% mortgage* beat investing in the market was 1925. BG used cFireSim to run the same two scenarios and found no historical year where making extra mortgage payments produced a superior return to investing in the market (here).

*Of course in most years mortgage interest rates would have been higher than 4%.

[matchewed]

To review there are two assumptions in Virtus's comparison of stock returns and paying off a mortgage that people in the thread consistently disagreed with:

1. Reducing stock market returns based on the rate of inflation but not inflation adjusting mortgage payments/remaining balance. One really REALLY has to either apply inflation to both sides of that equation or neither.

2. Applying tax every year to unrealized capital gains.* Everyone agrees this one is wrong, the argument is whether it causes significant variance in the final outcome or not.

How big of a difference do these two assumptions make?

#1. The difference between the non-inflation adjusted CAGR of the stock market and the CAGR of the stock market is 9.1% vs 6.9%.

#2. Applying 15% tax every year to unrealized capital gains reduced the CAGR further to 5.87%.

Over the course of a 30 year mortgage, $10k will compound to $125k at 9.1%. After applying capital gains tax at the end, the final value is $108k.  $98k of post tax appreciation. At 5.87% that same $10k would have only compounded to $52k. $42k of post-tax appreciation. Less than half as much.

There are not things than can be hand waved away as inconsequential issues.

I posted my analysis, both graphically and with spreadsheets of results here. Rpr posted their analysis using their own code and using Virtus's spreadsheet after removing the one sided inflation adjustment and taxation of unrealized capital gains every year here. All three found that the only historical year where paying off a 4% mortgage* beat investing in the market was 1925. BG used cFireSim to run the same two scenarios and found no historical year where making extra mortgage payments produced a superior return to investing in the market (here).

*Of course in most years mortgage interest rates would have been higher than 4%.

Given that disagreements over these two assumptions seem to have giving people a license to right-off my analysis I found some time to work with the inflation.

I updated my model to adjusted Frank's income for inflation. This aligns the model closer with reality. Under the new model his income is adjusted for inflation using the CPI-U index while his portfolio growth is based on real returns. His mortgage is held constant in dollars.



Input
Investment fee 0.18%
Taxes 0.00%
Extra to invest/spend $2,200
CPI-U data before 1911 based on the average for the data set

I'm sorry Virtus but you seem to not grasp that inflation has to be applied equally across the board. It is either applied to all scenarios equally or not applied at all. If you choose to apply it to only one area you are skewing the results.

Do you know why we say you need to do it equally? If I have to pay my bank $200 a month for 30 years in year thirty that money may have an equivalent force of $90. You can't just hold the mortgage in constant dollars while utilizing inflation for everything else.

[maizefolk]

I really think the way you are graphing results makes it harder rather than easier to see the results. But in the same format Virtus used above, here are the results from treating inflation evenhandedly between the mortgage and not taxing unrealized capital gains every year.

Based on 1391 independent start months since 1871. As you can see, there are only a handful of months where paying off the mortgage produced a higher final net worth than investing surplus income in the stock market and even then, the ultimate difference in net worth between the two simulations is quite small.


(Click the image for a full sized graph that is easier to read.)

Code: [Select]

Assumptions:
A starting mortgage of $100k.
$2k of surplus monthly income.
Mortgage paydown: spend all income on the mortgage until it is gone, and then invest in stocks
Index funds: Make the minimum monthly payment on the mortgage and invest the surplus in the stock market.
This model does not include the tax deductibility of mortgage interest (but I can post those results if of interest).


[maizefolk]

Here is the source code if anyone would like to check my math or try modifying some of my assumptions and see how it impacts the final outcome. https://github.com/maizeman/dead_broke/tree/master/mortgage_calcs

[maizefolk]

My calculation did not inflation adjust the mortgage payment because it does not adjust for inflation. It did adjust income and investment values for inflation.

This means your reported final net worths are an (unknown) mixture of "nominal" and "real" dollars. In different years the proportion of real dollars in the total is different. The relative values of real and nominal dollars will also be different in different years.

Between 1965 and 1995 (30 years) inflation was ~5x. Because you adjust for inflation in investment returns you're using constant 1965 dollars for all three decades for that side of your math. That means in the last year (1995), $5 (in 1995 dollars) invested in the stock market will show up as only $1 (in 1965 dollars) in your simulation. Which would be fine. Except that, because you don't inflation adjust the mortgage payment/interest, that $1 of 1965 dollars (worth $5 1995 dollars) in the stock market is given equal weight as $1 (in 1995 dollars) of mortgage interest (worth $0.20 in 1965 dollars).

[NorthernBlitz]

Why do you get a fixed rate, rather than a lower variable rate?

Obtaining a variable rate right now in the U.S. is a horrible idea. Interest rates are at historically low levels and the Fed is beginning to raise interest rates.

https://www.usatoday.com/story/money/2017/03/15/federal-reserve-interest-rates-economy-janet-yellen-mortgages-credit-cards/99186568/

Is it possible rates will not increase, yes. But this would not be the expected or likely outcome over the next few years. I will give you some valuable advice, never bet against the federal reserve.

But the banks know this as well as you do, right?

When we were looking at variable vs fixed in Canada (so terms were much shorter than 30 years), the rule of thumb was that variable always beats fixed. Basically, by going fixed (1) you were paying the bank to take the risk for you, (2) they probably understood how rates would change better than average people and (3) they are the ones that pick the spread between variable and fixed.

As I said above, we bought cash when we moved to the US in part because it was difficult to get a mortgage with no US credit history. So, we didn't really think about short term variable vs. long term fixed when we bought our house. In the current climate, a 30 year fixed with flexible payment options seems like it would be very attractive.

[maizefolk]

But the banks know this as well as you do, right?

When we were looking at variable vs fixed in Canada (so terms were much shorter than 30 years), the rule of thumb was that variable always beats fixed. Basically, by going fixed (1) you were paying the bank to take the risk for you, (2) they probably understood how rates would change better than average people and (3) they are the ones that pick the spread between variable and fixed.

So we've already touched on a few of the differences between mortgages in Canada and the USA, but one people don't bring up as much is the role of Government Sponsored Enterprises (Fannie Mae and Freddy Mac) play in the mortgage market in the USA. Because the federal government won't let these enterprises go bust, lot of the "risk" of extremely long term fixed rate mortgages isn't being carried by the US banks, but by the US taxpayers. Whether that's a good or bad thing is a debate for another time, but it is definitely another reason why mortgage interest rates in the USA are a lot lower than one would guess given the uncertainty of predicting interest rates 30 years into the future.