Author Topic: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff  (Read 22033 times)

Cheddar Stacker

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #50 on: July 30, 2014, 01:23:32 PM »
Sunk profits are just like sunk costs - they're in the past and shouldn't influence your decision making looking forward.

I agree with this completely. My comment was not to imply an attitude of "hey I won for the first 25 years so who cares about the last 5", it was more a comment on how little this should matter at that point.

You have substantially reduced the length of time, and the length of your lever after 25 years. A smaller lever by its' nature creates a smaller impact.

If you've planned your FIRE and everything has gone fairly well, 5 years of mortgage payments should be maybe 2% of your portfolio? So I would say it's a 53% chance you will come out ahead on this 2% of your asset allocation. It's a gamble, but a very small one, and I agree it's up to each person to decide. 25 years post FIRE I hope to be too busy with life to worry about the impact this will have on my success.

dragoncar

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #51 on: July 30, 2014, 01:43:40 PM »
Great job managing your money and a very smart question!

The money smart long term strategy in your situation is to invest at 9% and pay at 3%.   The numbers work very nicely over 30 year periods.   Over 60 years,  which I consider a "lifetime" you would have an extra 5 million dollars assuming you kept the mortgage around 150K.  If you just pay off the home you might have 1 million in home value.   So the question might be,  would you rather have 5 million or 1 million to pass on to your heirs.   Good stewardship takes many, many years but it is the seed of the small acorn that grows into the giant oak tree.  (I know cliché)

Shorter term consider these options.   1.  Switch to an interest only mortgage with 20% equity.  That changes your scenario significantly.   (not a variable but a 7-15 year interest only)  2.  Your home is too big and too expensive.  (many of us on this site are included in this including MMM) So consider downsizing or renting something smaller.   3.  Post FI you may have the opportunity to move to an area like mine where 100K buys a nice home on rolling wooded acres.   Or you may decide to travel for a couple of years.  So you may consider listing your home now at a value 15% above similar homes.  You might get lucky.   

If you don't want to move, because let's face it we are habit creatures,  I would seriously consider option 1.    If you choose it,  remember you can always change your mind down the road.   

That said you may have a problem that many of the FIs have in that you didn't mention long term care insurance, LTCI.    If you don't have this you should consider it a need and not a want.   It is expensive.  But if you don't have LTCI then you should  reserve in excess of 1 million per person for this.   That wouldn't cover a long term nursing home fully at a 4% return but would minimize the risk.   Otherwise you may be fooling yourself with the "independent" term as you would be relying on Medicaid to cover nursing home care.

Submitted respectfully and just MHO. 
 
Sunk profits are just like sunk costs - they're in the past and shouldn't influence your decision making looking forward.

I agree with this completely. My comment was not to imply an attitude of "hey I won for the first 25 years so who cares about the last 5", it was more a comment on how little this should matter at that point.

You have substantially reduced the length of time, and the length of your lever after 25 years. A smaller lever by its' nature creates a smaller impact.

If you've planned your FIRE and everything has gone fairly well, 5 years of mortgage payments should be maybe 2% of your portfolio? So I would say it's a 53% chance you will come out ahead on this 2% of your asset allocation. It's a gamble, but a very small one, and I agree it's up to each person to decide. 25 years post FIRE I hope to be too busy with life to worry about the impact this will have on my success.

I think I saw this advice in that other epic thread, and it's good.  You should get a sticky for this info.  Even though I fully admit I'm going straight up clown house very soon.


Sunk profits are just like sunk costs - they're in the past and shouldn't influence your decision making looking forward.

I agree with this completely. My comment was not to imply an attitude of "hey I won for the first 25 years so who cares about the last 5", it was more a comment on how little this should matter at that point.

You have substantially reduced the length of time, and the length of your lever after 25 years. A smaller lever by its' nature creates a smaller impact.

If you've planned your FIRE and everything has gone fairly well, 5 years of mortgage payments should be maybe 2% of your portfolio? So I would say it's a 53% chance you will come out ahead on this 2% of your asset allocation. It's a gamble, but a very small one, and I agree it's up to each person to decide. 25 years post FIRE I hope to be too busy with life to worry about the impact this will have on my success.

Another way to look at this is that the emotional "peace of mind" part of the equation starts to look pretty hefty compared to the diminishing benefit of carrying "small" mortgage.  I've definitely paid off low interest rate loans when I had just 1-2 years worth of payments left on an amount that was already a fraction of my emergency fund.  I wouldn't do that for a loan that's a significant fraction of my NW though.
« Last Edit: July 30, 2014, 01:46:27 PM by dragoncar »

defenestrate

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #52 on: July 30, 2014, 02:03:23 PM »


This is true, but only if there is great discipline in following the strategy. Lets say that you had a $190,000 mortgage in its 17th year in the year 2000 with a 3.5% rate. At this point the loan balance is ~$113,000. From 2000-2013 you live through two bear markets (using the S&P 500) from 2000-2002 and 2008.

If you kept the $113,000 invested, and paid the mortgage from this principal each year, you would end up with a balance of $21,000 in 2013. Is $21,000 a lot? Sure it is, but is it worth holding onto the balance to reap that benefit? Remember, this is a future value of $21,000--the present value of that money (using a 3% inflation rate) is ~$15,000. Is $15,000 really worth carrying the leverage? Probably not.

   loan   113000      
   Mortgage Payment   ($6,650.03)   
                         Portfolio Balance   Additions from portfolio to principal
17   2000   -9.03%   $96,144.02    ($6,382.03)
18   2001   -11.85%   $78,101.15    ($6,605.40)
19   2002   -21.97%   $54,295.39    ($6,836.59)
20   2003   28.36%   $63,041.25    ($7,075.87)
21   2004   10.74%   $63,163.61    ($7,323.52)
22   2005   4.83%   $59,567.21    ($7,579.85)
23   2006   15.61%   $62,217.15    ($7,845.14)
24   2007   5.48%   $58,979.56    ($8,119.72)
25   2008   -36.55%   $30,771.12    ($8,403.91)
26   2009   25.94%   $32,101.66    ($8,698.05)
27   2010   14.82%   $30,209.45    ($9,002.48)
28   2011   2.10%   $24,193.33    ($9,317.57)
29   2012   15.89%   $21,387.76    ($9,643.68)
30   2013   32.15%   $21,612.85    ($9,981.21)
                                    ($112,815.01)

I don't get it.  You're saying in probably one of the worst market scenarios you can devise, you still come out $15,000  ahead?  $15,000 is more than zero, and you got all that liquid money for 13 years absolutely free on top of that?  And that's a bad thing?

No--it is a good thing, and it is probably how I would roll the dice. However, there are a lot of other assumptions in this. The investor has to be disciplined enough not to sell, not to "dip into" this money to cover expenses during the worst years, and I ignored all transaction costs, taxes, and the like in this analysis.

My point is that there are a lot of ways to hurt your ER by additional exposure to the stock market, and a paid off mortgage is a hedge. If I were to go into ER, I would likely keep my mortgage--but I would also have a plan on what to do given worst case scenarios--and I would probably have a bunch of side gigs. I think your house should be treated as a "bond" in ER, and your allocation to your house should equal your risk profile.

dragoncar

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #53 on: July 30, 2014, 02:14:21 PM »

No--it is a good thing, and it is probably how I would roll the dice. However, there are a lot of other assumptions in this. The investor has to be disciplined enough not to sell, not to "dip into" this money to cover expenses during the worst years, and I ignored all transaction costs, taxes, and the like in this analysis.

My point is that there are a lot of ways to hurt your ER by additional exposure to the stock market, and a paid off mortgage is a hedge. If I were to go into ER, I would likely keep my mortgage--but I would also have a plan on what to do given worst case scenarios--and I would probably have a bunch of side gigs. I think your house should be treated as a "bond" in ER, and your allocation to your house should equal your risk profile.

True... we have to remember we're talking about people who have the funds to pay off their mortgage, and not people who justify mortgages they cannot pay off based on low interest rates.

Tyler

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #54 on: July 30, 2014, 02:30:07 PM »
I think you articulated this clearly in your thoughtful explanation, but just wanted to throw this out there to prevent anyone from drawing the wrong conclusion from your analysis.

It's a gamble, but a very small one, and I agree it's up to each person to decide. 25 years post FIRE I hope to be too busy with life to worry about the impact this will have on my success.

Yep! We're on the same page.
« Last Edit: July 30, 2014, 02:31:38 PM by Tyler »

Tyler

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #55 on: July 30, 2014, 03:05:14 PM »
I think you are missing the crucial point that at the end of a mortgage most of the monthly payment is going to principal. It is not an expense.

Reusing an earlier metaphor, think of it this way. Using double-entry accounting, every transfer between pockets has one withdrawal and one deposit. The total combined value is unchanged, but the individual pocket contents do.

For the purpose of evaluating the benefit of investing your mortgage balance, think of the invested equivalent to your mortgage balance as a segregated pocket from all of your other investments from which you also pay your mortgage. Your principal payment absolutely reduces the money available to invest, so it should be considered an expense from that investment pocket even as it is also income to the equity pocket. It's an important concept, as it affects your investment returns.

« Last Edit: July 30, 2014, 04:28:42 PM by Tyler »

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #56 on: July 30, 2014, 04:59:34 PM »
I think you are missing the crucial point that at the end of a mortgage most of the monthly payment is going to principal. It is not an expense.

Reusing an earlier metaphor, think of it this way. Using double-entry accounting, every transfer between pockets has one withdrawal and one deposit. The total combined value is unchanged, but the individual pocket contents do.

For the purpose of evaluating the benefit of investing your mortgage balance, think of the invested equivalent to your mortgage balance as a segregated pocket from all of your other investments from which you also pay your mortgage. Your principal payment absolutely reduces the money available to invest, so it should be considered an expense from that investment pocket even as it is also income to the equity pocket. It's an important concept, as it affects your investment returns.

I think you nailed it.  You are transferring dollars from one pocket to the other.  When you pay off your mortgage or any debt with a sub 4% rate, you are taking dollars out of a portfolio that is projected to pay at 7%+ and locking in a rate of 3.5%.  If you believe that you can not get above 3.5% over your portfolio life, then you are saying that your SWR is below 1%.  If you are saying that you are comfortable with a 3% SWR you are saying that you are anticipating earning 6%+.  Therefore investing in paying off your mortgage at 3.5% is pushing back your FI and increasing your liquidity risk.  Suboptimal returns while taking on higher liquidity risks is not a positive combination. 

The rules of thumb or old wives' tales about paying off your mortgage were based on mortgage rates that we in the 7% - 20% range.  Today, the government is throwing money at the citizens to spark the economy.  Take the free money!  You can see the math that 3.5% is significantly below historical returns, within 2% of inflation, and will not be around for long. 

dragoncar

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #57 on: July 30, 2014, 06:30:06 PM »

If you believe that you can not get above 3.5% over your portfolio life, then you are saying that your SWR is below 1%.  If you are saying that you are comfortable with a 3% SWR you are saying that you are anticipating earning 6%+. 

There's on glitch in this logic.  Perhaps you are OK with a 3% SWR because you expect to earn 3% and have 0% inflation.  Or maybe you expect to earn 2% and have deflation.   In which case the mortgage should be paid off.

PeteD01

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #58 on: July 30, 2014, 06:39:49 PM »
I think you are missing the crucial point that at the end of a mortgage most of the monthly payment is going to principal. It is not an expense.

Reusing an earlier metaphor, think of it this way. Using double-entry accounting, every transfer between pockets has one withdrawal and one deposit. The total combined value is unchanged, but the individual pocket contents do.

For the purpose of evaluating the benefit of investing your mortgage balance, think of the invested equivalent to your mortgage balance as a segregated pocket from all of your other investments from which you also pay your mortgage. Your principal payment absolutely reduces the money available to invest, so it should be considered an expense from that investment pocket even as it is also income to the equity pocket. It's an important concept, as it affects your investment returns.

I think you nailed it.  You are transferring dollars from one pocket to the other.  When you pay off your mortgage or any debt with a sub 4% rate, you are taking dollars out of a portfolio that is projected to pay at 7%+ and locking in a rate of 3.5%.  If you believe that you can not get above 3.5% over your portfolio life, then you are saying that your SWR is below 1%.  If you are saying that you are comfortable with a 3% SWR you are saying that you are anticipating earning 6%+.  Therefore investing in paying off your mortgage at 3.5% is pushing back your FI and increasing your liquidity risk.  Suboptimal returns while taking on higher liquidity risks is not a positive combination. 

The rules of thumb or old wives' tales about paying off your mortgage were based on mortgage rates that we in the 7% - 20% range.  Today, the government is throwing money at the citizens to spark the economy.  Take the free money!  You can see the math that 3.5% is significantly below historical returns, within 2% of inflation, and will not be around for long.

Free money available to invest in equities and it can't possibly go wrong....
Sounds too good to me.

aj_yooper

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #59 on: July 30, 2014, 06:44:10 PM »
I'm hearing a lot of optimism re market returns and hope it all works out that way, but Wade Pfau has some other thoughts on SWR and returns here:  http://www.marketwatch.com/story/retirement-inflation-taxes-blunt-4-rule-2013-08-20

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #60 on: July 30, 2014, 11:10:16 PM »
I'm hearing a lot of optimism re market returns and hope it all works out that way, but Wade Pfau has some other thoughts on SWR and returns here:  http://www.marketwatch.com/story/retirement-inflation-taxes-blunt-4-rule-2013-08-20

Did you read his article?  He is saying that a conservative portfolio is out performing 3.5%, with equity having a 6% expected return and bonds having a 3.5% expected return. So paying off your mortgage at 3.5% is hurting your ability to retire. His conservative assumptions are showing a SWR OF 1.5%. If you are saying that your portfolio will not achieve you 3.5% mortgage rate, then you should be using a SWR of 1% or less. His article is also talking a lot about the effects of inflation. A 30 year fixed mortgage is a great hedge against inflation.

Page 2 of the article.
"Moderate expectations:

7% stock returns, 4% bond returns, 3% inflation rate, 15% tax rate, pass away by age 90 (77% of people)

Spending Rate: 3.2%

Conservative expectations:

6% stock returns, 3.5% bond returns, 3.5% inflation rate, 20% tax rate, pass away by age 100 (98.5% of people)

Spending Rate: 1.5%"

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #61 on: July 30, 2014, 11:21:34 PM »

If you believe that you can not get above 3.5% over your portfolio life, then you are saying that your SWR is below 1%.  If you are saying that you are comfortable with a 3% SWR you are saying that you are anticipating earning 6%+. 

There's on glitch in this logic.  Perhaps you are OK with a 3% SWR because you expect to earn 3% and have 0% inflation.  Or maybe you expect to earn 2% and have deflation.   In which case the mortgage should be paid off.

I would respectively disagree. I am stating all the history and all of the models show a balanced portfolio outperforming inflation by 3% or so.  The SWR is at 4% or less as history has shown that the worst stretch of 30 years has returned 7%+. When you back out inflation and the risk of a meltdown right after retirement you get to the 4% range.

The only way that a mortgage should be paid off in the sub 4% range is if you expect 30 years of deflation. The best case scenario would be huge inflation as a 30 year fixed mortgage is a perfect hedge against inflation. When your investment income is tracking inflation +3% and your mortgage expense is locked down tight for 30 years, you would be set. Inflation is your friend with a large portfolio and a 30 year fixed rate sub 5% mortgage. Sub 4% is just gravy.

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #62 on: July 30, 2014, 11:50:08 PM »


The fact that most of the payment is allocated to principal does not change this analysis.  You are still paying x% (whatever your mortgage rate happens to be) on the outstanding principal balance.  Tyler's point is that at any given time, you need to analyze whether keeping the remaining balance outstanding makes sense.  25 years into paying the mortgage (i.e., with a 5 year horizon left), the answer may be no.  But, as I said in my post immediately above, this still argues for opting to keep the mortgage outstanding during the years when you have a long horizon to maturity.

I think you hit on a huge issue. When evaluating your balance sheet you should be structuring it for success over the portfolio life not the specific investment life. We are creating a portfolio that needs to survive 40+ years. So the final years of a mortgage have no relevance to your longterm portfolio. If your portfolio is expected to achieve 6%+ and your debt is costing 3.5% then you should keep the debt or expand the debt at those rates. I think locking in the gain makes sense when the differential between the costs of borrowing and the expected investment yield is less than 1%. Currently the difference is greater than 3.5% or a 100% potential upside over the longterm 30 year investment returns, indicating that there is significant upside to keep the 3.5% 30year fixed rate loan. It is a great hedge against inflation.

dragoncar

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #63 on: July 31, 2014, 12:40:07 AM »

If you believe that you can not get above 3.5% over your portfolio life, then you are saying that your SWR is below 1%.  If you are saying that you are comfortable with a 3% SWR you are saying that you are anticipating earning 6%+. 

There's on glitch in this logic.  Perhaps you are OK with a 3% SWR because you expect to earn 3% and have 0% inflation.  Or maybe you expect to earn 2% and have deflation.   In which case the mortgage should be paid off.

I would respectively disagree. I am stating all the history and all of the models show a balanced portfolio outperforming inflation by 3% or so.  The SWR is at 4% or less as history has shown that the worst stretch of 30 years has returned 7%+. When you back out inflation and the risk of a meltdown right after retirement you get to the 4% range.

The only way that a mortgage should be paid off in the sub 4% range is if you expect 30 years of deflation. The best case scenario would be huge inflation as a 30 year fixed mortgage is a perfect hedge against inflation. When your investment income is tracking inflation +3% and your mortgage expense is locked down tight for 30 years, you would be set. Inflation is your friend with a large portfolio and a 30 year fixed rate sub 5% mortgage. Sub 4% is just gravy.

To clarify, I'm not saying historical data supports extended deflation.  But a rational person could expect that to be the case.  If you knew we were going to go Japan-style, it might make sense to pay off your low rate mortgage. 

brooklynguy

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #64 on: July 31, 2014, 06:55:12 AM »
I think you hit on a huge issue. When evaluating your balance sheet you should be structuring it for success over the portfolio life not the specific investment life. We are creating a portfolio that needs to survive 40+ years. So the final years of a mortgage have no relevance to your longterm portfolio. If your portfolio is expected to achieve 6%+ and your debt is costing 3.5% then you should keep the debt or expand the debt at those rates. I think locking in the gain makes sense when the differential between the costs of borrowing and the expected investment yield is less than 1%. Currently the difference is greater than 3.5% or a 100% potential upside over the longterm 30 year investment returns, indicating that there is significant upside to keep the 3.5% 30year fixed rate loan. It is a great hedge against inflation.

No.  When evaluating whether it's better to deploy capital towards repaying the mortgage or making investments, you need to consider whether the expected return on the investments will outperform the mortgage during the remaining life of the mortgage.  In the case of a mortgage with 5 years left to maturity, that's 5 years, not 40+ years.  (Actually, it's less than 5 years, because it's the remaining weighted average life to maturity (which factors in amortization) that is relevant, but let's ignore that detail for simplicity's sake.)  You are going to need that capital to repay the mortgage in 5 years.  (It doesn't matter that your overall portfolio is designed to last 40+ years -- we are only talking about the portion of your portfolio that could be used to repay the mortgage.)   If you had a lump sum that you needed to spend in 5 years on a down payment or whatever, would you put that money in the market?  It's the same type of analysis.

But with today's extremely low rate mortgages, in 25 years (when you have 5 years left on the mortgage), you may be able to put your money in a CD or other highly safe investment instead of paying off the mortgage and still come out ahead.

Scandium

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #65 on: July 31, 2014, 07:38:39 AM »
Extending this. Say I have less than 5-10 years left on my mortgage when I retire, and as is my case will have a balance of $150k and something like $300k equity in my house (or more). Should I then take out a new 30 year mortgage and 20% down (maybe <$100k) wherever I retire? And put the equity left over into my portfolio? Or is it better to just keep it and pay it off in the remaining time and be mortgage free at some point in retirement?

I'd like the security of having a paid off house, but realize it's not optimal financially. It does lock up a lot of money in a illiquid asset.

Cheddar Stacker

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #66 on: July 31, 2014, 08:27:53 AM »
Extending this. Say I have less than 5-10 years left on my mortgage when I retire, and as is my case will have a balance of $150k and something like $300k equity in my house (or more). Should I then take out a new 30 year mortgage and 20% down (maybe <$100k) wherever I retire? And put the equity left over into my portfolio? Or is it better to just keep it and pay it off in the remaining time and be mortgage free at some point in retirement?

I'd like the security of having a paid off house, but realize it's not optimal financially. It does lock up a lot of money in a illiquid asset.

Some people here have discussed getting a brand new 30 year mortgage right before retirement and investing any equity. If you're going to do it, don't do it after you retire since it will be harder to obtain a loan.

Just make sure you know what you're doing here. Debt (leverage) is a lever that amplifies profits and losses. On the way up you will feel great, but on the way down it will seem like the end of the world. This isn't exclusive to the situation you described, it's just amplified by it. The swings will be more volatile, and you have to be willing to hold at the bottom and not sell.

There's also this argument. This thread is worth a read if you're considering doing this. A few quotes:

I like his idea of "when you've won the game, stop playing."
It's not that you are no longer comfortable with the safety of your earlier asset allocation, it's more that you have new, safer option that wasn't available before.

The general thoughts from this thread and the linked article are if you've already accumulated "enough" you should begin to think about lowering your risks since you no longer need the rewards those risks provide.

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #67 on: July 31, 2014, 08:47:31 AM »

No.  When evaluating whether it's better to deploy capital towards repaying the mortgage or making investments, you need to consider whether the expected return on the investments will outperform the mortgage during the remaining life of the mortgage.  In the case of a mortgage with 5 years left to maturity, that's 5 years, not 40+ years.  (Actually, it's less than 5 years, because it's the remaining weighted average life to maturity (which factors in amortization) that is relevant, but let's ignore that detail for simplicity's sake.)  You are going to need that capital to repay the mortgage in 5 years.  (It doesn't matter that your overall portfolio is designed to last 40+ years -- we are only talking about the portion of your portfolio that could be used to repay the mortgage.)   If you had a lump sum that you needed to spend in 5 years on a down payment or whatever, would you put that money in the market?  It's the same type of analysis.

But with today's extremely low rate mortgages, in 25 years (when you have 5 years left on the mortgage), you may be able to put your money in a CD or other highly safe investment instead of paying off the mortgage and still come out ahead.

The difference is that when buying a home in five years you have a liquidity event occurring at a specific date. If you are comfortable pushing off the date a year or two in the case of a portfolio correction then it may make sense to invest your money in your desired portfolio. If not then you would have a portfolio that does not maximize longterm yields, but minimizes short term odds of loss. This is a fine strategy for short term, but you would be slaughtered by inflation over long periods of time.

In the case of your mortgage, there is not a liquidity event. You are structuring your finances for longterm success. The models already take into account the odds of success. If you are liquidating investments based on short term potential returns you would have your entire portfolio in bonds, which would be bad for your longterm success.

You are proposing market timing vs. longterm portfolio planning.

brooklynguy

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #68 on: July 31, 2014, 09:05:34 AM »

No.  When evaluating whether it's better to deploy capital towards repaying the mortgage or making investments, you need to consider whether the expected return on the investments will outperform the mortgage during the remaining life of the mortgage.  In the case of a mortgage with 5 years left to maturity, that's 5 years, not 40+ years.  (Actually, it's less than 5 years, because it's the remaining weighted average life to maturity (which factors in amortization) that is relevant, but let's ignore that detail for simplicity's sake.)  You are going to need that capital to repay the mortgage in 5 years.  (It doesn't matter that your overall portfolio is designed to last 40+ years -- we are only talking about the portion of your portfolio that could be used to repay the mortgage.)   If you had a lump sum that you needed to spend in 5 years on a down payment or whatever, would you put that money in the market?  It's the same type of analysis.

But with today's extremely low rate mortgages, in 25 years (when you have 5 years left on the mortgage), you may be able to put your money in a CD or other highly safe investment instead of paying off the mortgage and still come out ahead.

The difference is that when buying a home in five years you have a liquidity event occurring at a specific date. If you are comfortable pushing off the date a year or two in the case of a portfolio correction then it may make sense to invest your money in your desired portfolio. If not then you would have a portfolio that does not maximize longterm yields, but minimizes short term odds of loss. This is a fine strategy for short term, but you would be slaughtered by inflation over long periods of time.

In the case of your mortgage, there is not a liquidity event. You are structuring your finances for longterm success. The models already take into account the odds of success. If you are liquidating investments based on short term potential returns you would have your entire portfolio in bonds, which would be bad for your longterm success.

You are proposing market timing vs. longterm portfolio planning.

I don't understand what you are saying.  We are talking about whether it is better to take a lump sum and use it to pay off your mortgage or use it to invest in the market.  When comparing those two options, you need to decide whether you think the investments will outperform the mortgage during the life of the mortgage.  Why do you think you don't have a liquidity event when repaying your mortgage?  If you invest the money, you need to liquidate those investments to pay the mortgage at maturity (and at each amortization date along the way).  And if you only have 5 years before maturity, it would be risky to invest in the market on the assumption that the market will return more than your mortgage rate during those 5 years.  With a longer life to maturity, the odds are (substantially) higher that the market will outperform the mortgage.

You seem to be confusing different concepts.  You structure your portfolio to satisfy your expenses and last for your entire lifetime.  But we are only talking about whether it makes sense to take a lump sum equal to your mortgage balance (which presumably is only a fraction of your total portfolio) and either (i) use it to pay off your mortgage or (ii) invest it and keep the mortgage outstanding.
« Last Edit: July 31, 2014, 09:11:30 AM by brooklynguy »

Scandium

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #69 on: July 31, 2014, 10:55:05 AM »
Extending this. Say I have less than 5-10 years left on my mortgage when I retire, and as is my case will have a balance of $150k and something like $300k equity in my house (or more). Should I then take out a new 30 year mortgage and 20% down (maybe <$100k) wherever I retire? And put the equity left over into my portfolio? Or is it better to just keep it and pay it off in the remaining time and be mortgage free at some point in retirement?

I'd like the security of having a paid off house, but realize it's not optimal financially. It does lock up a lot of money in a illiquid asset.

Some people here have discussed getting a brand new 30 year mortgage right before retirement and investing any equity. If you're going to do it, don't do it after you retire since it will be harder to obtain a loan.

Just make sure you know what you're doing here. Debt (leverage) is a lever that amplifies profits and losses. On the way up you will feel great, but on the way down it will seem like the end of the world. This isn't exclusive to the situation you described, it's just amplified by it. The swings will be more volatile, and you have to be willing to hold at the bottom and not sell.

There's also this argument. This thread is worth a read if you're considering doing this. A few quotes:

I like his idea of "when you've won the game, stop playing."
It's not that you are no longer comfortable with the safety of your earlier asset allocation, it's more that you have new, safer option that wasn't available before.


The general thoughts from this thread and the linked article are if you've already accumulated "enough" you should begin to think about lowering your risks since you no longer need the rewards those risks provide.

Yes, those are good points. The safety of lower expenses is valuable, and more flexibilty in downturns (on average returns are higher than interest, but if there are 3,4 or 8 years when that's not the case it might hurt). In retirement that might be worth it, whereas it is not when I'm 30. For me personally I think finishing the mortgage before or shortly after retirement is a good combo of returns now and safety later in life.

SDREMNGR

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #70 on: July 31, 2014, 08:54:03 PM »
This is easy.  If you think we are in a bubble right now then pay off mortgage,  if you don't,  then don't prepay it off.  Also, if your interest rate is at or below 4%, then let inflation eat away at your mortgage over time. 

Bob W

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #71 on: August 16, 2014, 09:16:34 AM »
Typically people forget that they can draw down on the principal of their investments to pay their monthly mortgage payment.  If you are retiring on a 4% SFR, then you are saying that your investments will be in excess of 4% over 30+ years.  The models probably indicate that you will be having investment returns in the 7%+.  I made an excel spreadsheet to show this for another topic.

Lots of discussion in this thread.
http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/
nice point
!

What exactly is the principal of an investment? I hear this once in a while but nobody has ever been able to give me an explanation that made any sense beyond mental accounting. I'm serious, this concept can be extremely dangerous for an investor but is probably off topic in this thread.

My grandmother, who died at 100, in the last days of her life asked my father if he had "touched the principal" of her investment--to which my father smartly said "no." The idea of principal is only one held by individuals who have relatively low financial knowledge, and on the other spectrum, financial professionals trying to take advantage of the first group. Sadly, it is a concept that even places like vanguard use to describe financial performance. For us, our principal is whatever we have in the bank at any given time, it can rise and fall, but when we make decisions about our capital (principal) we should treat every dollar the same.

So perhaps "principal" can be seen as a discriminatory slur in finance. It treats the dollar originally invested different than the subsequent dollars earned on the investment. All dollars should be equally valued and embraced--irrespective of how they found their way into our portfolio.

I accept all dollars, and treat them all the same, as a principal...equal treatment of all dollars.

Bob W

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #72 on: August 16, 2014, 03:59:41 PM »
Can someone explain to me why  I live in a home 3 times the size I need?  Is it all marketing and ego?   Why did I buy a home when renting is no risk and cheaper.  Why am I so irrational on this?  I have a 200 sq ft dinning room I've never used and a basement I never visit.   And I don't think I'm alone here?

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #73 on: August 16, 2014, 04:39:03 PM »
Can someone explain to me why  I live in a home 3 times the size I need?  Is it all marketing and ego?   Why did I buy a home when renting is no risk and cheaper.  Why am I so irrational on this?  I have a 200 sq ft dinning room I've never used and a basement I never visit.   And I don't think I'm alone here?

Sounds off topic for this forum. Why don't you start another forum about your house and we can provide you the needed face punches:)

missj

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #74 on: August 16, 2014, 04:51:56 PM »
I'm quite inexperienced when it comes to understanding investing, taxation leveraging etc. but correct me if I'm wrong in the following line of thought:

if you leverage your mortgage to earn potentially higher returns in the stock market you leave open the possibility (albeit small)of being homeless someday.  Especially true if you are disabled or of advanced age and COULD NOT return to work if you needed to.

when you've got everything in the market, you could potentially lose everything.  If you've at least got your house paid off you could always rent a room or sell your blood to pay property taxes and then you've at least got something.

I know we are just talking about risk/reward ratio and individual risk tolerances here, but it seems like there should be a logical minimum thresh hold to how much risk we're willing to take and a roof, 4 walls and a bed seems like a wise minimum.

Now, if you're still working it makes a little more sense because you could always just work longer than you had hoped to offset the risk. But full on retiring with a mortgage seems extra risky.

Example:  My dad is in banking.  He is 61 and doesn't plan to retire any time soon because he loves his job and he is the boss.  With only a couple years left to pay on his mortgage, he decided to refi to a 15 yr fixed mortgage at 2 something percent and invest the difference in the market.  Leverage at it's best since he is still working, still plans on working and if push came to shove and he lost his entire portfolio he could just work the full 15 years.

Compare that to my husband's parents.  After they paid off their home, they both retired within a year or 2.  after being retired several years they sold their house and moved out of state and bought a new construction McMansion on a 30yr fixed 3 something percent loan because they could "earn more than 3% in the market" which is all fine and dandy unless the market takes a turn for he worst in which case they could lose it all and don't even have their jobs to fall back on.  Not to mention they'll be in their 90s before the loan matures. It's now possible (albeit unlikely) that they could end up with no house and no jobs in their 70s  80s or 90s living off social security and nothing else because 100% of their net worth is in the market.   It seems silly to me.

missj

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #75 on: August 16, 2014, 05:15:04 PM »

The general thoughts from this thread and the linked article are if you've already accumulated "enough" you should begin to think about lowering your risks since you no longer need the rewards those risks provide.

this is a good point, that I was awkwardly trying to articulate in my last post.

I'm a poker player, and good tournament strategy is such that you take risks early on to build up a big stack which is extremely likely to see you through to the final table.  But once you've successfully built that big stack, you MUST switch gears and your #1 concern becomes protecting that stack while managing to slowly increase it to keep up with the ever rising blinds and antes. (equivalent to inflation).  That is how tournaments are won, NOT by going balls out every hand but by taking calculated risks and then protecting the proceeds.

At some point, more money won't increase your quality of life nearly as much as the risk is worth.  Where is that point?  It will be different for everybody but if you cannot imagine a point that would exist for you, you are playing a very dangerous game.

My dad had a friend who retired early and owned 6 luxury homes across the world in luxurious places.  He carried mortgages on all of them and "leveraged" that money in the market.  in 2010 he lost everything and had to move back into his "primary residence" which was protected through bankruptcy court, but even that had a mortgage.  His primary residence is a very modest home similar to the one I grew up in.  Now he, his wife and his son and grandchildren all live in this 1 house together because his son had taken a very similar (though smaller scale) investment approach to his father.  Pretty sad.

My dad, on the other hand, lost pretty big in the great recession as well.  He lost over 700,000 but he was hedged and didn't go bankrupt at least.  Now, he's almost back to where he was.  So he basically suffered a 6 year set back in his financial goals, while his friend lost it all.

I think owning real property (not digital shares of real property) is an important piece of diversification.
« Last Edit: August 16, 2014, 05:18:27 PM by missj »

aj_yooper

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #76 on: August 16, 2014, 05:38:51 PM »
misssj, you make good points!

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #77 on: August 16, 2014, 06:02:04 PM »

My dad had a friend who retired early and owned 6 luxury homes across the world in luxurious places.  He carried mortgages on all of them and "leveraged" that money in the market.  in 2010 he lost everything and had to move back into his "primary residence" which was protected through bankruptcy court, but even that had a mortgage.  His primary residence is a very modest home similar to the one I grew up in.  Now he, his wife and his son and grandchildren all live in this 1 house together because his son had taken a very similar (though smaller scale) investment approach to his father.  Pretty sad.

My dad, on the other hand, lost pretty big in the great recession as well.  He lost over 700,000 but he was hedged and didn't go bankrupt at least.  Now, he's almost back to where he was.  So he basically suffered a 6 year set back in his financial goals, while his friend lost it all.

I think owning real property (not digital shares of real property) is an important piece of diversification.

You do understand that your dad's friend was not investing prudently by any measure, he was living beyond his means. There is a big difference between owning 6 luxury homes and investing in stocks, bonds and other diversified assets.

Paying off your 3.5% mortgage is suboptimal for ER, but if it make you sleep better than go with the slow but steady approach.  Equating it to your dad's friend seems wildly off. He was clearly living above his means and too heavily concentrated in real estate and leaverage.

missj

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #78 on: August 16, 2014, 06:43:30 PM »

You do understand that your dad's friend was not investing prudently by any measure, he was living beyond his means. There is a big difference between owning 6 luxury homes and investing in stocks, bonds and other diversified assets.

Paying off your 3.5% mortgage is suboptimal for ER, but if it make you sleep better than go with the slow but steady approach.  Equating it to your dad's friend seems wildly off. He was clearly living above his means and too heavily concentrated in real estate and leaverage.

You're right, it's an extreme example on purpose.  But the man (erroneously) believed he was prudent.  Believed he couldn't lose it all.

The real intent of my opinion being, at some point in your accumulation journey you should get that feeling of having "enough" at which time risking the entire nest egg to get a little more doesn't seem worth the risk as it won't really increase your quality of life.  That "enough" point will be different for everyone, but that point SHOULD exist for each investor.

If homes were purely investment vehicles that we didn't need for any other purpose besides investment, then sure, make decisions based entirely on highest return.  But because we are humans who do have basic needs that must be met, a little different approach seems prudent.  If we are dealing with robots or computer models then yes, leverage the heck out of low rate debt as there is no human cost associated with losing it all.

Warren buffet seems like a pretty smart guy, and I don't know for sure, but I'll bet he doesn't carry a mortgage on his primary residence so he can leverage that capital in the market.  I could be wrong, he might do exactly that, but my hunch is that it's paid off.
« Last Edit: August 16, 2014, 06:47:56 PM by missj »

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #79 on: August 16, 2014, 06:54:15 PM »
Warren Buffet loves leverage. The reason he loves the insurance companies is that he collects premiums today and pays out in the future. He loves to take your money and pay you in the future. He was a big proponent of buying a houses because debt was so cheap.

His house is probably paid off because when you have $60 billion the benefits of having a $600k mortgage aren't there. Just like I don't waste my time picking up pennies.

missj

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #80 on: August 16, 2014, 07:22:37 PM »
Warren Buffet loves leverage. The reason he loves the insurance companies is that he collects premiums today and pays out in the future. He loves to take your money and pay you in the future. He was a big proponent of buying a houses because debt was so cheap.

His house is probably paid off because when you have $60 billion the benefits of having a $600k mortgage aren't there. Just like I don't waste my time picking up pennies.

right, or in other words he feels like he has "enough" and doesn't need to bother leveraging the place where he hangs his hat.

I getcha, I do.  I think the concept of leveraging your mortgage is wise in some situations, and unwise in others.  But just because the math says leveraging produces the highest possible return (given certain assumptions) doesn't mean you automatically should.
« Last Edit: August 16, 2014, 07:35:52 PM by missj »

aj_yooper

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #81 on: August 16, 2014, 07:25:46 PM »
So, Tomsang, should all investments or assets be leveraged (e.g., using margin loans, hedged funds, ETFs) in order not to be suboptimal?

tomsang

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #82 on: August 16, 2014, 08:02:27 PM »
If you can get loans sub 4% or even sub 5% 30 year non callable loan then the math says yes. If you are using a SWR of 4% by definition you are saying your investments will be in the 7%+ range to outperform inflation.

If you are paying off your 4% 30 year fixed rate mortgage early then you should not retire until your SWR is 1%.

The math doesn't just say it provides the highest return, it also say at 4% you are safer with a mortgage as you have a perfect hedge against inflation.

If you feel like there is going to be longterm stagnation then the math says you should sell your house and rent.

And yes. If your stache is so large that you have a 2% SWR and you don't want the hassle of a mortgage payment then yes pay it off. If you are trying to buy your freedom then the math says keep it if you are using a 4% SWR. 

dragoncar

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #83 on: August 18, 2014, 09:12:02 PM »

You do understand that your dad's friend was not investing prudently by any measure, he was living beyond his means. There is a big difference between owning 6 luxury homes and investing in stocks, bonds and other diversified assets.

Paying off your 3.5% mortgage is suboptimal for ER, but if it make you sleep better than go with the slow but steady approach.  Equating it to your dad's friend seems wildly off. He was clearly living above his means and too heavily concentrated in real estate and leaverage.

You're right, it's an extreme example on purpose.  But the man (erroneously) believed he was prudent.  Believed he couldn't lose it all.

The real intent of my opinion being, at some point in your accumulation journey you should get that feeling of having "enough" at which time risking the entire nest egg to get a little more doesn't seem worth the risk as it won't really increase your quality of life.  That "enough" point will be different for everyone, but that point SHOULD exist for each investor.

If homes were purely investment vehicles that we didn't need for any other purpose besides investment, then sure, make decisions based entirely on highest return.  But because we are humans who do have basic needs that must be met, a little different approach seems prudent.  If we are dealing with robots or computer models then yes, leverage the heck out of low rate debt as there is no human cost associated with losing it all.

Warren buffet seems like a pretty smart guy, and I don't know for sure, but I'll bet he doesn't carry a mortgage on his primary residence so he can leverage that capital in the market.  I could be wrong, he might do exactly that, but my hunch is that it's paid off.

Sounds like it worked out pretty well for him in the end.  Got to live a rockstar lifestyle and ended up in the same house he would have had if he had lived prudently.

missj

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #84 on: August 18, 2014, 10:18:48 PM »

You do understand that your dad's friend was not investing prudently by any measure, he was living beyond his means. There is a big difference between owning 6 luxury homes and investing in stocks, bonds and other diversified assets.

Paying off your 3.5% mortgage is suboptimal for ER, but if it make you sleep better than go with the slow but steady approach.  Equating it to your dad's friend seems wildly off. He was clearly living above his means and too heavily concentrated in real estate and leaverage.

You're right, it's an extreme example on purpose.  But the man (erroneously) believed he was prudent.  Believed he couldn't lose it all.

The real intent of my opinion being, at some point in your accumulation journey you should get that feeling of having "enough" at which time risking the entire nest egg to get a little more doesn't seem worth the risk as it won't really increase your quality of life.  That "enough" point will be different for everyone, but that point SHOULD exist for each investor.

If homes were purely investment vehicles that we didn't need for any other purpose besides investment, then sure, make decisions based entirely on highest return.  But because we are humans who do have basic needs that must be met, a little different approach seems prudent.  If we are dealing with robots or computer models then yes, leverage the heck out of low rate debt as there is no human cost associated with losing it all.

Warren buffet seems like a pretty smart guy, and I don't know for sure, but I'll bet he doesn't carry a mortgage on his primary residence so he can leverage that capital in the market.  I could be wrong, he might do exactly that, but my hunch is that it's paid off.

Sounds like it worked out pretty well for him in the end.  Got to live a rockstar lifestyle and ended up in the same house he would have had if he had lived prudently.

well, no not really.  He lost his capital and source of income, hence he is renting part of his home to his son in order to pay the mortgage and living off social security.  I mean, I guess it's better than NOT having a renter and social security, but not by a lot.

SnackDog

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #85 on: August 19, 2014, 04:09:20 AM »
One should always be mindful of how one's capital is employed - tying it up in real estate is generally not the best use of it. To that end, getting a long-term (term depends on your accurate forecast of how long you will live in the house) interest-only mortgage or even selling the house should always be considerations, especially during retirement.  Careful planning is in order to minimize the fees associated with both financing and selling a property.

Everyone talks about 30 year mortgages, but those generally have the worst (highest) interest rates.  Lenders are delighted because they lock you into those high rates and then you sell, typically after 7 years.  Be smart.  Figure out how long you will actually own the house and get an appropriate length mortgage and optimum interest rate.

Ynari

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Re: Invest vs Payoff Debts: SWR Effects of Mortgage Payoff
« Reply #86 on: August 19, 2014, 08:42:39 AM »
I don't know if anyone has mentioned this, but here's the reason the FIRE date jumps up:

If you have a mortgage, you are probably including the interest+principal payment in your FIRE calculations.  You are calculating that for the rest of your life you will be paying $10k per year on mortgage.  This is, of course, an incorrect assumption.  (Though it's the easiest for most people to assume, and gives you a further safety cushion, so it's not a bad thing.)  Unless you have an interest-only mortgage, you will eventually pay it off and your expenses will go down.  This is why the FIRE date jumps down when you consider paying off your mortgage - you're correcting that safety-margin-error.  (Also: even with the mortgage, your FI date is that soon.  Stop calculating mortgage as a yearly expense and start calculating NPV if you want it to be accurate.)

So it would only be fair to compare 1. an interest-only mortgage 2. paying off house and/or 3. NPV of a time-sensitive mortgage. At that point, it all comes down to interest rates vs. your own preferences.