Author Topic: Should I pay off my mortgage early?  (Read 22748 times)

arebelspy

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Re: Should I pay off my mortgage early?
« Reply #50 on: December 18, 2014, 09:13:44 PM »
We'll see. :)
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sol

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Re: Should I pay off my mortgage early?
« Reply #51 on: December 19, 2014, 07:50:33 PM »
I have very little confidence that you will get a consistent 9% total return by paying off the mortgage, but you are the one with the spreadsheet.

Feel free to run your own numbers, but if paying off your mortgage is going to qualify you for free healthcare in retirement, that benefit alone might be worth more than the lost arbitrage between your mortgage rate and your expected portfolio returns.  No work required there.

The EITC is much more speculative, and also depends on the size of your family.  It's potentially worth a lot to someone with a side gig and a large family, not so much to folks who want to retire to their barcalounger.

The financial aid benefit, like the EITC, is worth more to people with multiple children.  I have three.  My preliminary analysis says we should qualify for at least an extra $4k in grant money per child per year, plus a lower interest rate on whatever loans they might decide to take out.  It's a temporary benefit, just while the kids are in school, but it's still real money.

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I still think it makes sense to carry a mortgage while you are working... I choose to use my discretionary income for investing and leave my 2.875% tax deductible mortgage in place

I'm also carrying my mortgage for as long as I work.  But after I'm retired?  I think I'm going to kick it.

As for that 2.875% tax deductible mortgage, have you calculated how much that is actually worth to you?  We itemize our taxes because we have mortgage interest, but we don't get too far about the standard deduction for a family our size so losing the mortgage interest would just drop us down to the standard deduction rate.  At a 25% marginal rate, we would be giving up maybe a grand a year in tax benefit.

The larger benefit of holding the mortgage, at least in our case, is the increasing equity.  Because the properties are leveraged, appreciation at the (long term expected) rate of inflation translates into like 12% returns every year in extractable home equity, not even accounting for cash flow profit or debt paydown by our tenants.  The rentals have been good to us, and I will be sad to sell them.


sol

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Re: Should I pay off my mortgage early?
« Reply #52 on: December 19, 2014, 10:41:02 PM »
Taking my cues from brooklyn...

let's analyze whether it makes sense to pay off the mortgage solely for the purpose of qualifying for college aid.

Probably not, especially if the kids turn out to be motivated enough to get full ride offers like their old man.  Smartypants children can totally derail financial aid planning.  We could end up with $100k stuck in a 529 plan that we can't get to without paying the penalty.  I'm sufficiently stubborn that I might give it away to a relative before I pay the 10%.

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If you refinance to a 30 year mortgage of $300k with a 4% interest rate, cfiresim tells me that historically the median amount

I think the power of tools like cFIREsim isn't the median projections, but the range of expected values.  I wouldn't be very happy with $800k median but a 40% failure rate.

With that said, I'm not sure I'm following your math.  You're saying that investing $300k for 30 years results in $800k, and that I'd need $170k over 17 years of no mortgage to match the return?  It hardly seems fair to compare a 17 year return to a 30 year return, even in nominal terms.  Did I misunderstand?

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Following the methodology of Go Curry Cracker's excellent analysis, I would guesstimate that even if each of your three kids obtained a completely free ride at an elite private university purely as a result of need-based aid obtained solely because you paid off your mortgage, you still would be likely to come out ahead by taking the opposite path.

That's a good gocurrycracker article, the key point being that current rates of tuition increases aren't sustainable because they're about to get to the point where it's cheaper to retire at 18 than go to college.

But your comparison isn't really surprising.  I don't expect prepaying my mortgage to pay for itself with just 12 years of financial aid.  I expect it pay for itself with 12 years of financial aid, plus 10 years of free/subsidized health care, 10 years of reduced taxes, 10 years of not paying mortgage interest, plus the potential for 10 years of EITC if and when we decide we need the money.  I'd ballpark those numbers at a total of around $300k over 10 to 12 years, for an up front cost of about $200k now, but the xirr on that list is a bitch because if you leave the money invested you have to account for the amortized payments for the duration, and that cuts into your returns too.  So it's not as simple as comparing the profit from $200k invested for 10 years to the $300k of benefits received over 10 years (in which case I would have to earn about 9.6% on my investments).

Since our mortgage will be paid off before kid3 starts college in either case, the decision to prepay or not should probably exclude any financial aid she would receive, which I just realized I've been including.

But since we'll only have 10 years left on the mortgage anyway, that also tends to push me towards prepaying it.  Even more so if the inflation outlook at the decision point still looks reasonably low, like it does today.  That ten years will include all 8 years of college for our older two kids.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #53 on: December 20, 2014, 07:40:34 AM »
I think the power of tools like cFIREsim isn't the median projections, but the range of expected values.  I wouldn't be very happy with $800k median but a 40% failure rate.

With that said, I'm not sure I'm following your math.  You're saying that investing $300k for 30 years results in $800k, and that I'd need $170k over 17 years of no mortgage to match the return?  It hardly seems fair to compare a 17 year return to a 30 year return, even in nominal terms.  Did I misunderstand?

I'm saying that investing $300k for 30 years and using it to service the mortgage payments results in a median leftover portfolio of $800k (in inflation-adjusted terms).  The success rate (i.e., the chances of coming out ahead by keeping the mortgage rather than prepaying it) is 95.65%, with an average leftover portfolio north of $1 million--but I think the median is a more useful number, because it tells you that 50% of those cases had a leftover portfolio of more than $800k.

(To replicate these results, enter $300k as the starting portfolio amount and $17,187 as the annual spending amount, which represents annual principal and interest payments assuming a 4% mortgage rate--obviously, if you can get a cheaper rate, the chances of the investments outperforming the mortgage (and the resulting leftover portfolio after 30 years) will be even higher, and vice versa.  Set the spending plan to "not inflation adjusted" (because it isn't, which is the beauty of the mortgage option), and leave all the other inputs on cfiresim's default settings.  Tinkering with the other variables will adjust the results accordingly--for example, increasing the equity allocation will generally produce even better results.)

So far, this is all still the straight investments/mortgage arbitrage analysis (i.e., not accounting for any of the considerations that led you to start this thread).  The $170k and 17 year figures came in after introducing the variable of financial aid for higher education (but still ignoring all the other "freebies," because I thought you had said that you can probably still obtain most of those by refinancing into a 30-year and lowering your annual outlay).  $170k was my approximation of what that arbitrage benefit is worth to you today, because $170k is the portfolio size you would need to have at the beginning of the 30 year period in order to grow into a portfolio with an expected median ending value of $800k after 30 years--if the financial aid has a present value of less than $170k, it's better to keep the mortgage, and vice versa.  I wasn't ambitious enough to try to approximate the then-present value of the arbitrage benefit at multiple points spread across the 17 years from the time you retire until the time your youngest kid finishes college (i.e., the period during which you would actually be receiving the financial aid), but it is obviously something much higher than $170k in nominal terms.

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But your comparison isn't really surprising.  I don't expect prepaying my mortgage to pay for itself with just 12 years of financial aid.  I expect it pay for itself with 12 years of financial aid, plus 10 years of free/subsidized health care, 10 years of reduced taxes, 10 years of not paying mortgage interest, plus the potential for 10 years of EITC if and when we decide we need the money.  I'd ballpark those numbers at a total of around $300k over 10 to 12 years, for an up front cost of about $200k now, but the xirr on that list is a bitch because if you leave the money invested you have to account for the amortized payments for the duration, and that cuts into your returns too.  So it's not as simple as comparing the profit from $200k invested for 10 years to the $300k of benefits received over 10 years (in which case I would have to earn about 9.6% on my investments).

You can isolate each of the freebie variables and do an analysis similar to the one above to determine if the mortgage pays for itself with respect to that variable.  Like EscapeVelocity, I'm surprised that your numbers are coming out the way they are.  For my situation, looking at healthcare in isolation (since ACA subsidies were my primary concern when I thought about this), the math favors keeping the mortgage.  My non-houses expenses are pretty close to yours, but my mortgage balance is much higher and my family size is one kid smaller, which means if anything your situation should pose even less risk of missing out on ACA subsidies.  However, I've been doing this math on the back of an envelope rather than an excel spreadsheet, so I stand to be corrected if I'm wrong.

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But since we'll only have 10 years left on the mortgage anyway, that also tends to push me towards prepaying it.  Even more so if the inflation outlook at the decision point still looks reasonably low, like it does today.  That ten years will include all 8 years of college for our older two kids.

Yes, if the "to pay off or not to pay off" comparison were limited to the 10 year time horizon I would probably reach the same conclusion as you.  But I'm talking about the alternative path of refinancing into a 30 year mortgage.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #54 on: December 24, 2014, 06:29:44 PM »
Sol - something occurred to me when I saw your latest response in the financial aid thread.  When comparing the "mortgage" and "no mortgage" options, are you assuming that under the "mortgage" option, the required mortgage payments translate into a need for additional income on a dollar-for-dollar basis?  Because that's not true--in fact, as long as you will be invested in assets that generate returns primarily through capital appreciation (as I'm sure you will be), your income will, in the early years of your retirement, probably be only negligibly higher under the "mortgage" option (because, as you sell assets to service the mortgage, the bulk of the sale proceeds will represent return of principal, not income (and therefore have no effect on your tax liability or eligibility for income-based benefit programs)).  Over time, your income will drift up as your cost basis decreases, but that may happen slowly enough not to matter (for example, you may become eligible for medicare before you become disqualified for maximum ACA subsidies).

Apologies if you've already properly factored this into your math, but I realized that I had fallen into this trap myself.  In trying to reconstruct my own cost-benefit analysis,* I just dug up the old thread that helped me decide to keep my mortgage.  The back and forth between me and foobar starting at reply #158 is most relevant.  In that thread, I had made the same argument that you are making in this one -- that carrying the mortgage (and investing the proceeds) will significantly increase my income level and thereby have the effect of disqualifying me for ACA subsidies and other (unspecified) means-tested government benefits.  However, foobar correctly pointed out that I was grossly overstating the problem, because, generally speaking, only a small fraction of the withdrawals from a typical stock/bond portfolio will count as income, for a long time into one's retirement (exactly how long will depend on your returns and opportunities to tax loss harvest and/or tax gain harvest).  Foobar made a convincing case that the math will almost always favor keeping the mortgage (assuming a low enough rate, like what's available today), even taking into account the considerations that led you to start this thread.

*The fact that my analysis needed reconstructing tells me that I have to do a better job of keeping track of my own retirement planning, but also makes me doubly glad to have this forum; on top of allowing us all to crowd-source our own retirement planning, it serves as a record to memorialize it for us.

chasesfish

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Re: Should I pay off my mortgage early?
« Reply #55 on: December 24, 2014, 06:43:21 PM »
Everyone's situation is different, I've been watching this argument on personal finance boards for 10 years.  Here's what it comes down to:

If you want to maximize net worth, carry the mortgage and invest the difference.  Over 15+ years, investing the difference mathematically wins at a sub 5% interest rate.

If you have other motives like keeping income low or wanting the psychological relief of not having a house payment, then do what's best for your situation. 

You will never beat the math over a 15 year period

sol

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Re: Should I pay off my mortgage early?
« Reply #56 on: December 24, 2014, 07:50:30 PM »
You will never beat the math over a 15 year period

That definitely used to be true.  The ACA has changed things, though.  This is a new law that significantly changes the incentive structure associated with income management, to the tune of thousands of dollars per year.

When comparing the "mortgage" and "no mortgage" options, are you assuming that under the "mortgage" option, the required mortgage payments translate into a need for additional income on a dollar-for-dollar basis?  Because that's not true--in fact, as long as you will be invested in assets that generate returns primarily through capital appreciation

Yes, I'm assuming a dollar-for-dollar increase, and I think correctly so.  That's because I'm assuming my tax burden from selling assets will be essentially zero anyway.  The ONLY income I'm going to show on my 1040 is the amount of money I convert from my traditional IRA to my Roth IRA as part of my Roth pipeline, which will be based on my anticipated expenses five years in the future.  So until I'm five years away from the end of my mortgage, I have to annually convert an amount that is large enough to pay our living expenses and our mortgage.  If I get rid of the mortgage, I can make smaller conversions, which means I show smaller income.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #57 on: December 24, 2014, 08:36:05 PM »
Yes, I'm assuming a dollar-for-dollar increase, and I think correctly so.  That's because I'm assuming my tax burden from selling assets will be essentially zero anyway.

Your tax burden and your income for purposes of the ACA and other income-based benefit programs are two different things, but that's neither here nor there.

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The ONLY income I'm going to show on my 1040 is the amount of money I convert from my traditional IRA to my Roth IRA as part of my Roth pipeline, which will be based on my anticipated expenses five years in the future.  So until I'm five years away from the end of my mortgage, I have to annually convert an amount that is large enough to pay our living expenses and our mortgage.  If I get rid of the mortgage, I can make smaller conversions, which means I show smaller income.

If you keep the mortgage, you are also keeping the investments that could have been used to pay off the mortgage but will instead be used to service the mortgage, so why does your Roth pipeline need to be any higher than if the mortgage were paid off?  Either way, your Roth pipeline simply needs to be enough to pay your non-mortgage living expenses.  Your mortgage expenses will either (under one scenario) not exist or (under the other scenario) be covered by the investments that continue to exist because you chose not to pay off the mortgage.

Davids

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Re: Should I pay off my mortgage early?
« Reply #58 on: January 18, 2015, 12:59:32 PM »
I would consider the strong possibility that if we have a Republican President in 2016 along with a Republican control House and Senate there will be a lot of changes or possible repealing of ACA.

milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #59 on: January 18, 2015, 04:22:14 PM »

I would consider the strong possibility that if we have a Republican President in 2016 along with a Republican control House and Senate there will be a lot of changes or possible repealing of ACA.

Good luck with that outcome.

Demographics are destiny.

The Republicans as currently formulated are strictly an off year party.

powskier

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Re: Should I pay off my mortgage early?
« Reply #60 on: July 31, 2015, 06:29:22 PM »
Thanks for all the thoughts on her Sol , Brooklynguy and others.
Great thread. much to ponder.......

ShoulderThingThatGoesUp

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Re: Should I pay off my mortgage early?
« Reply #61 on: August 02, 2015, 04:33:56 AM »

I would consider the strong possibility that if we have a Republican President in 2016 along with a Republican control House and Senate there will be a lot of changes or possible repealing of ACA.

Good luck with that outcome.

Demographics are destiny.

The Republicans as currently formulated are strictly an off year party.

I think another Democratic administration is likely, but Clinton is an awful candidate, and the ACA has not delivered on its goals. Even a Democratic administration might change it.

BlueHouse

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Re: Should I pay off my mortgage early?
« Reply #62 on: August 02, 2015, 05:59:38 AM »
I would consider the strong possibility that if we have a Republican President in 2016 along with a Republican control House and Senate there will be a lot of changes or possible repealing of ACA.
Just like a republican-appointed Chief Justice of scotus would kill it off ? 

Dee18

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Re: Should I pay off my mortgage early?
« Reply #63 on: August 02, 2015, 06:08:07 AM »
Sol, you don't have to pay a penalty on the 529 money if the reason you don't need it is that your children get grants/scholarships.  I am fortunately in that position now. You can withdraw up to the amount of the scholarship each year.  Only income tax will be owed.  I was also told that I can have the money paid to the child. (It was funded by my father for her, so in my case I feel it is her money, not mine.). I can do that over the 4 years of undergrad while her income is low enough she won't pay taxes on it. And then she can use it for her expenses not covered by the 529 (such as transportation) or even fund her own Roth (up to the amount of income earned in her very part time job) or set it aside to be used for grad school (if she goes).  Of course, that requires trusting a 19 year old with a lot of money. 

TomTX

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Re: Should I pay off my mortgage early?
« Reply #64 on: August 02, 2015, 06:36:01 AM »


The only requirement to qualify for the EITC is to have some earned income.  Any amount works, but it maxes out if you make like $12k/year.  We may or may not go down that road in retirement.


$13,700 to $23,300 will get an MFJ family with 3 kids the max ($6143) EITC for 2015. $5411 is all you get if you make $12k.

http://www.irs.gov/publications/p596/ar02.html#d0e5388


Edit: Ha! Didn't realize this was a necro-thread.
« Last Edit: August 02, 2015, 06:47:28 AM by TomTX »