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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Zombie Burger on January 16, 2021, 09:54:57 AM

Am I at (or past) a breakeven point on my home mortgage, with regard to investments?
The principle + interest we pay is just over 9700 annually. To cover that using VTSMX funds (assuming 7% annual growth), we need to have about 140k invested. Well... our mortgage balance also happens to be 140k.
If I do nothing, I should still have that 140k in the bank 22 years from now when the mortgage is paid. If I pay off the mortgage now, and start investing that 9700 annually, it should add up to 475000 in 22 years.
Am I missing something here, or does it make sense to pay off the debt?

Yeah, you're missing the momentum that comes from ALREADY having $140k invested. You're making a lot more than $9700 per year plus 7% growth.
And you're missing taxes and penalties that have to be paid when you pull it out of the investment account.
The mortgage rate is much cheaper than what you're making in the market. That spread supercharges your investment growth. Don't do it.

I should have pointed out that I simplified this somewhat; the 140k is actually sitting in a money market account, essentially free of any tax obligations. The question is whether to use it to pay off the mortgage, or shove it into VTSMX.
Remember, the 140k isn’t going to grow because 100% of the gains will go toward paying the mortgage. The thing I was missing in my original calculation, is that while the 140k will be paying the mortgage, I still have $9700 to invest annually. That makes the total 22 year valuation 615k. So, in a predictable market, you’re right in that it’s better financially to not pay off the mortgage.
I suppose the follow up question would be: Is it smart to take 140k in cash and invest it in the market right now?

Since your mortgage payment (at least the P+I bit) doesn't increase with inflation, I'd suggest using 9% rather than 7% for investment returns. 7% is the long run rate of return after inflation, 9% is the long run rate of return before inflation.
How many years are left on your mortgage?

I should have pointed out that I simplified this somewhat; the 140k is actually sitting in a money market account, essentially free of any tax obligations. The question is whether to use it to pay off the mortgage, or shove it into VTSMX.
Remember, the 140k isn’t going to grow because 100% of the gains will go toward paying the mortgage. The thing I was missing in my original calculation, is that while the 140k will be paying the mortgage, I still have $9700 to invest annually. That makes the total 22 year valuation 615k. So, in a predictable market, you’re right in that it’s better financially to not pay off the mortgage.
I suppose the follow up question would be: Is it smart to take 140k in cash and invest it in the market right now?
No one can say for certain, since that would require knowledge of what the market will do in the future. The tools you have to rely on are your IPS and predetermined asset allocation. If you are going off of the gut feelings of "the market feels high" or "but what about [insert current world issue or possible future event]?", then it is a form of market timing. Which, you know, happens to people all the time, no shame, but is not the best way to make decisions on these kinds of things.
Also, bat signal to @rdw for list of failed market predictions.

I think paying off the mortgage (or paying it down faster) vs investing is a personal decision. Historically it's better to invest b/c your mortgage rate will be lower than your return on the market, but I know especially on this form the debt weighs heavily on many. We were aggressively paying down our 3.75% 30 year mortgage for about 7 years even though it was a very good rate, but we were also maxing our retirement accounts and adding some posttax investing as well, but we refinanced to a 2.25% 15 year last year and the math made it work that paying down actually hurt us so we had to shift to taking those extra payments we would have made to mortgage and invest them for maximum benefit.
Even though the choice was very clear to not pay down the mortgage anymore, it still took a change in mindset to do this and I'm finally at ease with it. If we decide to retire in the next 14 years then we'd probably look at knocking out the mortgage, but at that point it can be done w/our posttax investing that "should" be higher than what we would have prepaid at the time.
I also recommend getting the "Karl's mortgage calculator" app on your phone, as you can play around w/the numbers, see where your payments are going, if you prepay anything, what it'll do to your mortgage payoff time period, etc. You may decide to split the difference and pay down a bit while investing the rest.

A broader question is why you have (and would keep?) $140k in a money market account which loses out to inflation every year. Is there another purpose (e.g. downpayment or business acquisition?)
I would follow the investment order, which means first using that money to max out taxadvantaged accounts and then normal investment accounts (assuming no debt and Efund). The only time you’d want to pay off a ~3% debt would be when you’ve got all your other bases covered (i.e. maxedout retirement contributions + lots in investment income), a firehose of cash each month and you are just paying down liabilities. If that’s not you right now, I’d recommend not doing it.
Of course, paying down the mortgage is a better use of that money than just letting it sit in a money market account year after year.

You can't be assuming 7% growth if the money is sitting in a money market fund. Use 0% or 2% growth instead.

For me, it would depend on what else I had in terms of investments and what my long term goal is.
if all I had was 140k in cash and no other investments... I'd keep the mortgage and invest it all into index funds.
if I already had a few 100k in index funds or were relatively close to FI, I might consider paying off the mortgage early to reduce expenses in early retirement.

You seem to be mixing apples and oranges. In the case of 140k invested, you are saying 9700 comes from the investment. Then in the case of 140k paying off mortgage, where is the 9700 coming from to invest? If it is from your paycheck, why is that not accounted for in the first scenario. The numbers should be a lot closer in the comparison if you use the same variables.
Scenario 1:
140k invested, brings in 9700/annual that pays for mortgage
9700 from paycheck remains unspent, therefore can be invested
At the end of 22 years, you have 140k invested plus 22 yrs of 9700 from paycheck invested (475k number you came up with)
Scenario 2:
Payoff mortgage using 140k so there is no money it brings
9700 from paycheck remains unspent, therefore can be invested
140k is gone so only 22 yrs of 9700 invested which is the 475k you calculated
If there is no 9700 from paycheck in Scenario 1 then there is no 9700 from paycheck in Scenario 2.
(It is late at night so maybe i am misunderstanding your scenarios)
Edited to add: sure enough as soon as i posted, i saw your other response and it seems you realized you were missing the 9700/yr)

Am I at (or past) a breakeven point on my home mortgage, with regard to investments?
The principle + interest we pay is just over 9700 annually. To cover that using VTSMX funds (assuming 7% annual growth), we need to have about 140k invested. Well... our mortgage balance also happens to be 140k.
If I do nothing, I should still have that 140k in the bank 22 years from now when the mortgage is paid. If I pay off the mortgage now, and start investing that 9700 annually, it should add up to 475000 in 22 years.
Am I missing something here, or does it make sense to pay off the debt?
The whole point, I mean really, the whole point is you are weighing up a certain outcome with a lower payout vs an uncertain outcome that is expected to be higher, but involves uncertainty along the way.
Investment returns are far from gauranteed, and many people are less well psychologically equipped to pay off their mortgage through investing rather than paying down debt, even if the expected rate of return is better.
Extend the logic of your argument  if you are getting a better return by investing than paying off mortgage debt then why bother paying off your house at all, just refinance into perpetuity while you continue to build you wealth.

Investment returns are far from gauranteed, and many people are less well psychologically equipped to pay off their mortgage through investing rather than paying down debt, even if the expected rate of return is better.
Extend the logic of your argument  if you are getting a better return by investing than paying off mortgage debt then why bother paying off your house at all, just refinance into perpetuity while you continue to build you wealth.
It's a balance, IMO  between paying interest and gaining compounded gains. For me, I want to minimize interest, AND have a paid off house by age 65.
So I have a 15 year mortgage, at 2.625%, on which I do NOT prepay.
Refinancing would:
1) Increase interest paid.
2) Lengthen the term.
3) Increase my required spend in retirement.
So I'm OK with a shorter term, lower interest paid, and not prepaying the term.

Mathematically, there is never a tipping point where paying off debt at a lower rate than what you can (expect to) earn investing the money will make you richer. That is just maths.
In OP's case, he is deciding wether to liquidate all his accumulated investments so far to pay off the outstanding debt on the house and restart from scratch, or carry on paying mortgage and let his investments continue to grow.
Assuming 7% investment return:
In scenario A, if he stays invested, his 140k pot grows to 620k after 22 years even without any further contributions, and he makes the final mortgage payoff, so he is left with 620k and a paid off home.
In scenario B, if he liquidates his investments and pays off the mortgage, he restarts from zero but now invests 9.7k/yr cashflow he's freed up. 9.7k per per invested over 22 years gives you a final nestegg of 420k and a paid off home.
Scenario A wins
It doesn't matter what rate of return you use, so long as the growth in investing is greater than the interest rate you are paying on the debt (net of taxes, of course) then you come out ahead by investing, all other things being equal.
Behaviourally there can be case made for choosing to prioritize the mortgage, as people tend to be adverse to debt and prefer the certainty of debt repayment to the uncertainty of investing returns.

Towards the end of an amortization schedule you are mostly paying off principal  so there is need to hurry. In contrast, payments early in the amortization schedule are mostly interest so prepaying early makes sense. That said, we did pay off our mortgage about 10 months early as we literally had nothing else that we could think of doing with our money 😀

Towards the end of an amortization schedule you are mostly paying off principal  so there is need to hurry. In contrast, payments early in the amortization schedule are mostly interest so prepaying early makes sense. That said, we did pay off our mortgage about 10 months early as we literally had nothing else that we could think of doing with our money 😀
You're still paying the same percentage of interest no matter where you are in the amortization schedule.

Towards the end of an amortization schedule you are mostly paying off principal  so there is need to hurry. In contrast, payments early in the amortization schedule are mostly interest so prepaying early makes sense. That said, we did pay off our mortgage about 10 months early as we literally had nothing else that we could think of doing with our money 😀
This is a common logictrap people fall into. It's true that in the beginning extra payments towards principal will have a compound effect on the amount of total interest paid, but what's ignored is that this comes at the expense of even greater (and far more certain) investment gains.
For example: Assume a $320k note, 30y/3% yield. In the beginning, each $500 extra put towards principal will reduce the total interest paid by $725.36. It would *almost* eliminate the final payment (#360 = $123). However, since money is fungible, that same amount invested over 30 years would be $2,871 at 6%, or over $5k at anything above 8%.
Remember that the historical stock market average is >9% before inflation, and that in the last 120 years the SP500 has *never* had a 30 period where absolute returns were less than 5%. While there's a decent (e.g. ~35%) chance that the market will go down any given year and therefor it can make sense to pay down your note when there's not much time left, there risk is mitigated by longer time periods. The longer the time period, the less sense it makes to pay down a mortgage early.

Am I at (or past) a breakeven point on my home mortgage, with regard to investments?
The principle + interest we pay is just over 9700 annually. To cover that using VTSMX funds (assuming 7% annual growth), we need to have about 140k invested. Well... our mortgage balance also happens to be 140k.
If I do nothing, I should still have that 140k in the bank 22 years from now when the mortgage is paid. If I pay off the mortgage now, and start investing that 9700 annually, it should add up to 475000 in 22 years.
Am I missing something here, or does it make sense to pay off the debt?
As others have said, whatever is higher (interest or % return) is the mathematically best option. That does ignore the safety factor of a paid off home. But, other have posted here that there is a major safety factor with a chunk of money in the bank. (are you safer with a paid off home and nothing in the bank or owing $140K with $140K in the bank?) Over time the money in the bank "should" grow faster so you would have more money in the bank than you owe.
One thing that needs to be emphasized is that you are NOT coming out ahead by keeping the money in a MM account. Those returns are lower than your mortgage interest. Pick one, pay off your mortgage or invest the money in the market.

Am I at (or past) a breakeven point on my home mortgage, with regard to investments?
The principle + interest we pay is just over 9700 annually. To cover that using VTSMX funds (assuming 7% annual growth), we need to have about 140k invested. Well... our mortgage balance also happens to be 140k.
If I do nothing, I should still have that 140k in the bank 22 years from now when the mortgage is paid. If I pay off the mortgage now, and start investing that 9700 annually, it should add up to 475000 in 22 years.
Am I missing something here, or does it make sense to pay off the debt?
As others have said, whatever is higher (interest or % return) is the mathematically best option. That does ignore the safety factor of a paid off home. But, other have posted here that there is a major safety factor with a chunk of money in the bank. (are you safer with a paid off home and nothing in the bank or owing $140K with $140K in the bank?) Over time the money in the bank "should" grow faster so you would have more money in the bank than you owe.
One thing that needs to be emphasized is that you are NOT coming out ahead by keeping the money in a MM account. Those returns are lower than your mortgage interest. Pick one, pay off your mortgage or invest the money in the market.
Just a bit of nitpicking here, but the "safety factor" of a paid off home is often overstated. Simply put you will always owe taxes and insurance, and over multidecadal timeframes taxes tend to exceed your starting PI payments. If you don't pay said taxes, you will be penalized and face eviction, just as you would if you don't pay your mortgage. Ergo, a paid off mortgage does not eliminate the risk of eviction.
...and of course a pile of money in investments helps one pay the necessary bills on a home, be they mortgage payments, taxes, repairs, etc.

+1 to nereo  particularly in the world today where you can easily borrow at < 4% for 30 year timelines, it is actually a lower risk move to take out as much of a mortgage as the bank will give you at the super low rates and invest the proceeds.
Not that that justifies buying more house  at the end of the day the house you live in is primarily a consumption item. But how much house you buy is a separate decision from how you finance it once you've decided to buy a home.

These opposing threads cover the eternal Invest or Payoff Mortgage Debate:
Mortgage PayOff Club: https://forum.mrmoneymustache.com/throwdownthegauntlet/mortgagepayoffclub!!/ (https://forum.mrmoneymustache.com/throwdownthegauntlet/mortgagepayoffclub!!/)
Don't Payoff Your Mortgage Club: https://forum.mrmoneymustache.com/throwdownthegauntlet/dontpayoffyourmortgageclub/ (https://forum.mrmoneymustache.com/throwdownthegauntlet/dontpayoffyourmortgageclub/)
Last week, I faced the same decision as you and decided to pay it off. Mortgage was ~100K at 3.25% fixed with 13 years remaining. However, I'm within 5 years of FIRE and no mortgage makes it easier and less risky. It also allows me to pursue other career options which may not pay as well since Lean FI has been reached. If an opportunity comes up, my plan is to have a HELOC in place for 80% of the equity to access it. Either way, it's a nice first world problem to have.

These opposing threads cover the eternal Invest or Payoff Mortgage Debate:
Mortgage PayOff Club: https://forum.mrmoneymustache.com/throwdownthegauntlet/mortgagepayoffclub!!/ (https://forum.mrmoneymustache.com/throwdownthegauntlet/mortgagepayoffclub!!/)
Don't Payoff Your Mortgage Club: https://forum.mrmoneymustache.com/throwdownthegauntlet/dontpayoffyourmortgageclub/ (https://forum.mrmoneymustache.com/throwdownthegauntlet/dontpayoffyourmortgageclub/)
There are reasons one might do either. However, those are NOT opposing threads, as has been made clear over years of backandforth "lively discussion". The former is and should remain a celebratory thread for those wishing to pay off the mortgage  the latter is more about discussion of assumptions and risk/reward. Please respect the defacto "truce" and don't debate the reasons for not paying off a mortgage in the mortgage payoff thread.

Yes, it is theoretically true that even if you have made every single mortgage on a 30 year mortgage for the last 29 years and 11 months but miss the last one then the bank can reposess your entire house, leaving you homeless and all your previous payments as a sunk cost.
In practice this is never going to happen, but it does highlight that your home is not really truely yours unless you have it paid off AND can pay all the future due taxes on it.
Personally I have leveraged myself up to the eyeballs and gone interestonly on as much of the mortgage as I can. Our monthly payments are unbelieveably low, but of course we are not amortizing much capital. We invest the additional cashflow to build our wealth independently while holding a large outstanding mortgage balance. One day we may pay off the mortgage all in one go to own the house outright.
In a way this is much LESS risky than a full amortizing mortgage. Firstly the monthly mortgage payment is lower, so easier to cover if we ever do run into cashflow difficulties. And if the worst ever did happen and we were repossessed, with less of our wealth tied up in the house we would only stand to lose that amount and keep our other investments.

Yes, it is theoretically true that even if you have made every single mortgage on a 30 year mortgage for the last 29 years and 11 months but miss the last one then the bank can reposess your entire house, leaving you homeless and all your previous payments as a sunk cost.
I don’t know the laws in the UK but in the US the mortgage lender can only recoup the remaining balance on the mortgage and associated (often considerable) costs with eviction and selling. Which means you will get much of the equity back should the bank foreclose in the last year of your mortgage (though it will be no where near what you will get if you sold, as the bank has no vested interest in getting the maximum value  they want only to recoup costs hence why foreclosure sales can often be 30% below market.)
We are generally in agreement here, but there’sa lot of misinformation out there, including the belief that a paid off home is security from eviction if you lose your job (you need to pay taxes  this was aBIG deal in the Great Recession in California when there was a ton of evictions from people who had paid off homes but couldn’t pay their often substantial tax Bill)

Yes, it is theoretically true that even if you have made every single mortgage on a 30 year mortgage for the last 29 years and 11 months but miss the last one then the bank can reposess your entire house, leaving you homeless and all your previous payments as a sunk cost.
I don’t know the laws in the UK but in the US the mortgage lender can only recoup the remaining balance on the mortgage and associated (often considerable) costs with eviction and selling. Which means you will get much of the equity back should the bank foreclose in the last year of your mortgage (though it will be no where near what you will get if you sold, as the bank has no vested interest in getting the maximum value  they want only to recoup costs hence why foreclosure sales can often be 30% below market.)
We are generally in agreement here, but there’sa lot of misinformation out there, including the belief that a paid off home is security from eviction if you lose your job (you need to pay taxes  this was aBIG deal in the Great Recession in California when there was a ton of evictions from people who had paid off homes but couldn’t pay their often substantial tax Bill)
I did not fully research this, but yes, it seems similar thing here. A repossessed property is resold at a firesale auction in order to recoup the loan amount. Any amount that falls short you are still liable for, so you could end up with some ongoing mortgage debt and no home. It's also likely that the times when repo rates are the highest are also likely to be times when the market is already very depressed.. it is usually rocketing interest rates that push up mortgage costs and whack real estate prices.
Glad to say that I am very much NOT an expert in this area!