Author Topic: Pay Off House Before Early Retirement?  (Read 21666 times)

jpo

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Pay Off House Before Early Retirement?
« on: May 08, 2012, 02:00:56 PM »
Mustachians, I am 24 and will be buying a house soon (with ~20% down), but am curious about whether to pay off the house before seriously saving for early retirement or pay over the normal 30 year term.

I have run some numbers, assuming:
  • constant expenses
  • constant income
  • 4% passive income from nest egg
  • 6% return from the market
  • Tax rate on passive income is 15%

I am looking to buy a house that is about 2.5x my current salary. That should enable me to make roughly double mortgage payments and pay the house off in 10 years if I should so choose.

  • If I pay the mortgage off in 10 years, I will be able to retire at 41 with a passive income of ~16k.
  • If I pay the mortgage off in 30 years, I will be able to retire at 46 with a passive income of ~31k.

If I pay the mortgage off in 10 years and work until 46 anyway, I would have a passive income of ~29k... but my expenses would be much lower (~15k), whereas if I do not do extra payments I would still be on a "tight" budget  (expenses == income at ~30k) until I am 57 and the mortgage is paid.


So, my question is, would the average Mustachian pay off the house first to lower his total expenses, or save up a big nest egg that covers the mortgage too? Or completely redo his calculations with different assumptions?

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #1 on: May 08, 2012, 02:33:02 PM »
Depends on your risk tolerance and comfort level.

Some people are anti-debt, others don't mind carrying good debt.

Mathematically you should retire with more money if you take the longest mortgage you can and invest any extra money that you would pay towards principal.

Some people sleep better at night having a paid off house.  Some sleep better having lots of liquid investments (and the ability to pay off the house at any time, if they wished).

It all depends on you.
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Norman Johnson

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Re: Pay Off House Before Early Retirement?
« Reply #2 on: May 08, 2012, 08:16:07 PM »
Personally, I don't like debt. We paid off our house this year (we are 31) and I have not regretted it once. I own the place I live and no one can take it away from us, even if we both are out of work. As an added bonus, I am able to extend my maternity leave because we can live off my husband's income for the summer. Having the freedom to work reduced hours if we choose to is worth any small gains we might have made in the markets. (Mortgage was floating at 4% and there is no tax deduction in Canada.)

Mathematically, you can crunch the numbers, but life has a way of throwing curve balls like a spouse/kids/sick relatives/awesome far away job opportunities/etc that can change housing needs. Go with what works for you now, and been be flexible in the future.

And really, the fact that you are doing calculations before you buy tells me you will probably make a pretty good decision, whatever you choose.

gooki

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Re: Pay Off House Before Early Retirement?
« Reply #3 on: May 08, 2012, 09:02:17 PM »
And really, the fact that you are doing calculations before you buy tells me you will probably make a pretty good decision, whatever you choose.

Agreed.

Can you find a guaranteed investment plan that will return a higher rate than the mortgage rate? If so it's a no brainer to go for the longer term.

However the reality is you generally can't find guaranteed investments like that (otherwise the bank would be putting their money into them instead of lending to you).

For me it comes down to:
- Your tolerance for risk.
- Your ability to diversify your investments.
- Your self control on spending - will you save all the extra money you have per month (with the longer term loan), or would you spend it?

I'd also run the number with repayment in 5 years and see how you come out (interest rates would be approx 1% lower than 30 year term). Sacrificing a few luxuries in the early years of your mortgage (while the balance is highest) and putting all your extra cash into repayment can get you on a great path.

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #4 on: May 08, 2012, 10:00:33 PM »
I own the place I live and no one can take it away from us, even if we both are out of work.

That's simply not true.  If you don't pay your taxes, the government takes it.

Or they can take it with eminent domain.  Or someone sues you and takes it.  Or whatever.  Plenty of ways to lose it, but especially that first one.. Even if you're mortgage free, you still owe payments on the house, you can never own property in this day and age.

In fact, the more equity you have, the more you risk losing.  The bigger mortgage you have (keeping that investment liquid elsewhere) the less at risk you are.
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Dicey

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Re: Pay Off House Before Early Retirement?
« Reply #5 on: May 08, 2012, 11:00:27 PM »
I second "arebelspy". His remarks are spot on. You can lower your monthly outgo, but your house will always cost you. I remember after my parents paid off their house, my dad started complaining about the high cost of utilities. I kept reminding him that it was a good "problem" to have.

More importantly, giant kudos to you for putting yourself in such an awesome position. Just the fact that you are thinking along these lines at your age dramatically increases your chances of FI, ERE and all that other badass stuff.

Norman Johnson

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Re: Pay Off House Before Early Retirement?
« Reply #6 on: May 09, 2012, 06:51:08 AM »
Yes, I suppose I should have been more specific... I can't lose it to the bank due to not paying my mortgage. I'm comfortable with having my cash tied up in my house and the risk associated with that, moreso then investing on the stock market. Like I said before, I don't like debt.

fiveoh

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Re: Pay Off House Before Early Retirement?
« Reply #7 on: May 09, 2012, 07:48:34 AM »
Couple of things... did you factor inflation in to your future expenses/income needed?  In 20+ years 15k will not be what it is today.

I struggled with this same question recently.  I finally decided to do both.  Instead of dumping all the money in to one or the other I pay some down on the mortgage and put some extra into investments.  You can play with ammortization calculators and figure out how much extra you need to pay off in xx amount of years.  I.e. pay it off in 18 instead of 10 or 30.  That leaves you with extra income from investments(slightly more risk) and paying the house off sooner(less risky, guaranteed return).

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #8 on: May 09, 2012, 08:04:36 AM »
I own the place I live and no one can take it away from us, even if we both are out of work.

That's simply not true.  If you don't pay your taxes, the government takes it.


Not in Texas my friend.  We have the homestead act and they cannot take your home for unpaid taxes.  However, I'm sure they could make you life very uncomfortable.

Are you sure?  Homestead acts generally don't include protection from forced sale for unpaid taxes.  It will lower your property tax bill and protect your primary home from creditors in a lawsuit, but you still have to pay property taxes usually.

Do you have a link maybe?
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James

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Re: Pay Off House Before Early Retirement?
« Reply #9 on: May 09, 2012, 08:10:57 AM »
If you can separate it out into purely a money flow and liquidity question, then you will probably end up on the invest and keep the mortgage side.  If you can't separate it out, and it just feels better to pay off the house and you keep feeling pulled that way, then you will probably end up finding a reason to go that route and pay off the mortgage.  It's complicated enough to justify either alternative, but from a strict financial view I think the data is clear that investing instead of paying of the house is usually superior.  That doesn't make one answer right or wrong though, it just changes the question to be more of a personal one.

jpo

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Re: Pay Off House Before Early Retirement?
« Reply #10 on: May 09, 2012, 09:00:24 AM »
And really, the fact that you are doing calculations before you buy tells me you will probably make a pretty good decision, whatever you choose.
Agreed.
Thanks!

Can you find a guaranteed investment plan that will return a higher rate than the mortgage rate? If so it's a no brainer to go for the longer term.

However the reality is you generally can't find guaranteed investments like that (otherwise the bank would be putting their money into them instead of lending to you).

For me it comes down to:
- Your tolerance for risk.
- Your ability to diversify your investments.
- Your self control on spending - will you save all the extra money you have per month (with the longer term loan), or would you spend it?

I'd also run the number with repayment in 5 years and see how you come out (interest rates would be approx 1% lower than 30 year term). Sacrificing a few luxuries in the early years of your mortgage (while the balance is highest) and putting all your extra cash into repayment can get you on a great path.
Repayment in 5 years (2.5x mortgage payments) would mean I wouldn't be contributing to my Roth IRA, which for me is not an option (have always maxed it out).

I doubt I can find a better guaranteed return than the mortgage, although the stock market historically performs better, etc. etc.

I am fairly confident I would actually save the extra money if I took the longer term loan. I'm a big fan of automatic transfers, so I treat automated savings as if I don't even have the money available in my regular checking.

Couple of things... did you factor inflation in to your future expenses/income needed?  In 20+ years 15k will not be what it is today.

I struggled with this same question recently.  I finally decided to do both.  Instead of dumping all the money in to one or the other I pay some down on the mortgage and put some extra into investments.  You can play with ammortization calculators and figure out how much extra you need to pay off in xx amount of years.  I.e. pay it off in 18 instead of 10 or 30.  That leaves you with extra income from investments(slightly more risk) and paying the house off sooner(less risky, guaranteed return).
In a word, no. I am assuming the returns are after inflation.

I'm sure I could balance my payments/contributions so that I can pay off the house and retire in the same year... that would be a cool scenario!

If you can separate it out into purely a money flow and liquidity question, then you will probably end up on the invest and keep the mortgage side.  If you can't separate it out, and it just feels better to pay off the house and you keep feeling pulled that way, then you will probably end up finding a reason to go that route and pay off the mortgage.  It's complicated enough to justify either alternative, but from a strict financial view I think the data is clear that investing instead of paying of the house is usually superior.  That doesn't make one answer right or wrong though, it just changes the question to be more of a personal one.
I agree that investing, assuming a higher rate of return than the mortgage interest rate, is probably mathematically better. However, I do find myself leaning towards paying off the house because the "returns" are guaranteed.

gooki

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Re: Pay Off House Before Early Retirement?
« Reply #11 on: May 09, 2012, 07:08:03 PM »
Repayment in 5 years (2.5x mortgage payments) would mean I wouldn't be contributing to my Roth IRA, which for me is not an option (have always maxed it out).

Are you currently planning to buy on your singular income? If/when you become a multiple income household you may find that 5 year repayment plan doable without effecting your Roth IRA.

My main point is don't be afraid to take a shorter term mortgage especially if it means lower interest rates.

jpo

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Re: Pay Off House Before Early Retirement?
« Reply #12 on: May 09, 2012, 09:33:56 PM »
Repayment in 5 years (2.5x mortgage payments) would mean I wouldn't be contributing to my Roth IRA, which for me is not an option (have always maxed it out).

Are you currently planning to buy on your singular income? If/when you become a multiple income household you may find that 5 year repayment plan doable without effecting your Roth IRA.

My main point is don't be afraid to take a shorter term mortgage especially if it means lower interest rates.
My girlfriend currently lives with me and only makes a negligible salary, so I am not counting on her financial support in purchasing the house. She pays for her own expenses but does not contribute to the rent/utilities. As an aside... if we do get married down the line I'm wondering about a prenup. I wouldn't want to buy a house with 100% of my money and end up losing it.

I like the flexibility the 30 year will provide over a 15 year. If I pay it down quickly the interest rate matters less. I am too risk averse for an ARM.

gooki

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Re: Pay Off House Before Early Retirement?
« Reply #13 on: May 09, 2012, 09:43:31 PM »
Ahhhhhh, but the interest rate matters most in those first few years, as that is when the balance of the loan is sufficiently higher than your income.

Can you ever see yourself in a situation where it would take more than 15 years to pay down the mortgage? If the answer is no, then there's not point paying more for 30 years of flexibility.

PS I know a ARM would seem risky to some, but I like to highlight one extreme to make the middle ground 15 years become the sensible solution.

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #14 on: May 10, 2012, 08:17:52 AM »
Can you ever see yourself in a situation where it would take more than 15 years to pay down the mortgage? If the answer is no, then there's not point paying more for 30 years of flexibility.

Isn't the whole point of flexibility because one can't see the future?  For the same reason some want an emergency fund.  If you lose your job, have medical issues, suddenly need to support an ailing family member, whatever.. being able to switch to 

And even if you aren't in a situation where it would take longer than 15 years, 30 could still be a better option for flexibility.  Example: you get 15 year.  You aggressively pay down early so it's on track to pay down in 10.  Year 8, you lose your job.  Wish you could lower your payments now?  Good luck refinancing with no job income.  All that equity is trapped, and you have a higher payment.  Whoops.  With 30 year mortgage you drop down the payment to the minimum.. year or two later have a job and resume aggressive repayment and pay it off in 12 years.  Even though it doesn't fit the idea of "Can you ever see yourself in a situation where it would take more than 15 years to pay down the mortgage" - because it only too 12 years - it's still a situation you'd want a 30-year.

Blanket statements are tough to make.  I wouldn't just assume that because one may not be able to envision taking longer than 15 years to pay off their mortgage that they absolutely positively should go for a short repayment period.  (Nor should they absolutely go for a longer.)

PS I know a ARM would seem risky to some, but I like to highlight one extreme to make the middle ground 15 years become the sensible solution.

Or you could go murder the poster you disagree with.

PS I know murdering someone seems bad to some, but I highlight it as an option so one sees using hyperbole and poor suggestions to make a different bad suggestion less "extreme" is ridiculous.

;)

http://en.wikipedia.org/wiki/Argument_to_moderation
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Re: Pay Off House Before Early Retirement?
« Reply #15 on: May 10, 2012, 08:41:46 AM »
I like the flexibility the 30 year will provide over a 15 year. If I pay it down quickly the interest rate matters less. I am too risk averse for an ARM.

I'm pretty close to a future version of you.  I bought a house when I was 25 (in 2002), with 20% down, that cost about 2.5x of my salary.  I got a 30 yr mortgage (at 5.75%), even though I intended to make my monthly payments with extra principal that would get it paid off in 15 years.  I didn't go with a lower-cost 15 yr because I wanted the flexibility to reduce my payment if necessary.  In reality, I was able to pay at that 15 yr rate for 9 years, and then, despite maxing out my 401(k)/IRA all those years, going through a Great Recession, and losing my job for a bit in there, I realized I had enough cash on hand to pay off the remainder of the balance, and I did so.  If I had to do it over again, I probably wouldn't go with a 10-year mortgage, but I'd be more comfortable taking a 15 yr.

Probably the main difference between me and you is that because of the relatively high rate I had (though in 2002 it was plenty good!) the "guaranteed return" from paying my mortgage off early was an easier argument to make than the one you'll face with the crazy-low "guaranteed return" you'd get from paying off a mortgage that you got today.  At today's rates, maybe I'd still take a 30yr, just to have the flexibility to *not* pay it off, though I'm happy I didn't really have to factor that in in my case!  As others have said, just the fact that you're thinking about this suggests that you won't really make a "bad" decision no matter which way you go.  And "which way you go" is pretty changeable, especially over 30 years.  I couldn't even stick with my "15 year plan" for more than 9 years before ending it.

I'm sure I could balance my payments/contributions so that I can pay off the house and retire in the same year... that would be a cool scenario!

This was also my plan.  My 15-year payoff would have been done when I was 41, and that seemed like it would also coincide with the time when I would have "enough" in my 'stash.  So I used that mortgage-payoff date to establish a fairly firm retirement date, because I wouldn't want to stop working *before* I was done with mortgage payments.  But now that I've suddenly paid off the mortgage, the reasons to wait until I'm 41 to retire have become a lot less clear, and I'm going to have to find some other way to make the "when?" decision.  Auuughh!  [/first-world-Mustachian problems]

velocistar237

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Re: Pay Off House Before Early Retirement?
« Reply #16 on: May 10, 2012, 09:54:18 AM »
I've mentioned before a really awful post over on The Simple Dollar where the author argues for paying down low-interest debt for the purpose of having "cash flow." It got me thinking: if you invest the difference, at what point can you pay your mortgage from the savings, in a way that depletes the principal upon your last payment?

With a mortgage rate of [inflation+]1% and an investment return of [inflation+]4%, it would take 7 years and 5 months for the saved difference between a 10 year and 30 year payment to pay for the rest of the mortgage. With 15 and 30, it's 11 years, 9 months. A 0.5% lower interest rate on the shorter loan lengthens the savings period by only about 2 months in the 10/30 case and 6 months in the 15/30 case. If you want to pay off your house aggressively in 5 years, instead take out a 30 year loan and invest the difference, and it only takes 3 1/2 years.

Obviously, you wouldn't isolate your mortgage from the rest of your finances, but it's a useful perspective, I think. Also, inflation+4% is a pretty safe rate of return, and should things go south, we Mustachians have margins upon margins of safety.

James

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Re: Pay Off House Before Early Retirement?
« Reply #17 on: May 10, 2012, 10:04:29 AM »
Also, inflation+4% is a pretty safe rate of return, and should things go south, we Mustachians have margins upon margins of safety.

You are talking about very short stretches of the market, I disagree that inflation+4% is "pretty safe".  Sure, over longer stretches the market return gets pretty safe, but you are talking time periods of less than 10 years.  That doesn't mean it's a bad idea to go with a longer mortgage and invest the savings, just that it carries much more risk than you suggest.

Dicey

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Re: Pay Off House Before Early Retirement?
« Reply #18 on: May 10, 2012, 10:52:03 AM »
"That doesn't mean it's a bad idea to go with a longer mortgage and invest the savings, just that it carries much more risk than you suggest."


On the contrary, being obligated for a lower amount of money each month gives one far greater flexibility. Mustachians are not the sort of folks who get the payment as low as possible and squander the rest.
« Last Edit: May 10, 2012, 10:15:29 PM by Diane C »

velocistar237

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Re: Pay Off House Before Early Retirement?
« Reply #19 on: May 10, 2012, 10:54:56 AM »
You are talking about very short stretches of the market, I disagree that inflation+4% is "pretty safe".  Sure, over longer stretches the market return gets pretty safe, but you are talking time periods of less than 10 years.  That doesn't mean it's a bad idea to go with a longer mortgage and invest the savings, just that it carries much more risk than you suggest.

The stretches are 15 to 20 years (30 minus 15 and 10, respectively), which are pretty long, and a diversified, rebalanced portfolio would help keep it stable. Trying out FIREcalc with a 50/50 portfolio over 22 years, there's a 90% chance of success. On average, you would finish with $30K extra.

(Note: I messed up this analysis; see below.)
« Last Edit: May 20, 2012, 11:59:58 AM by velocistar237 »

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #20 on: May 10, 2012, 11:10:04 AM »

The stretches are 15 to 20 years (30 minus 15 and 10, respectively), which are pretty long, and a diversified, rebalanced portfolio would help keep it stable. Trying out FIREcalc with a 50/50 portfolio over 22 years, there's a 90% chance of success. On average, you would finish with $30K extra.

Posts like this are why I love the MMM forum.  Yay for making financial decisions based on math and logic, rather than emotion and sentiment!
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velocistar237

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Re: Pay Off House Before Early Retirement?
« Reply #21 on: May 10, 2012, 11:17:01 AM »
On average, you would finish with $30K extra.

I forgot to say, this is for a $100K loan, and I think the $30K would be inflation adjusted, so about $15K in today's dollars.

jpo

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Re: Pay Off House Before Early Retirement?
« Reply #22 on: May 11, 2012, 11:07:25 AM »
I like the flexibility the 30 year will provide over a 15 year. If I pay it down quickly the interest rate matters less. I am too risk averse for an ARM.

I'm pretty close to a future version of you.  I bought a house when I was 25 (in 2002), with 20% down, that cost about 2.5x of my salary.  I got a 30 yr mortgage (at 5.75%), even though I intended to make my monthly payments with extra principal that would get it paid off in 15 years.  I didn't go with a lower-cost 15 yr because I wanted the flexibility to reduce my payment if necessary.  In reality, I was able to pay at that 15 yr rate for 9 years, and then, despite maxing out my 401(k)/IRA all those years, going through a Great Recession, and losing my job for a bit in there, I realized I had enough cash on hand to pay off the remainder of the balance, and I did so.  If I had to do it over again, I probably wouldn't go with a 10-year mortgage, but I'd be more comfortable taking a 15 yr.

Probably the main difference between me and you is that because of the relatively high rate I had (though in 2002 it was plenty good!) the "guaranteed return" from paying my mortgage off early was an easier argument to make than the one you'll face with the crazy-low "guaranteed return" you'd get from paying off a mortgage that you got today.  At today's rates, maybe I'd still take a 30yr, just to have the flexibility to *not* pay it off, though I'm happy I didn't really have to factor that in in my case!  As others have said, just the fact that you're thinking about this suggests that you won't really make a "bad" decision no matter which way you go.  And "which way you go" is pretty changeable, especially over 30 years.  I couldn't even stick with my "15 year plan" for more than 9 years before ending it.

I'm sure I could balance my payments/contributions so that I can pay off the house and retire in the same year... that would be a cool scenario!

This was also my plan.  My 15-year payoff would have been done when I was 41, and that seemed like it would also coincide with the time when I would have "enough" in my 'stash.  So I used that mortgage-payoff date to establish a fairly firm retirement date, because I wouldn't want to stop working *before* I was done with mortgage payments.  But now that I've suddenly paid off the mortgage, the reasons to wait until I'm 41 to retire have become a lot less clear, and I'm going to have to find some other way to make the "when?" decision.  Auuughh!  [/first-world-Mustachian problems]
Would you do the same thing if you were back in my shoes? It sounds like it's working out for you, close to retiring around 35/40. Anything in particular you'd change about the strategy?

I've mentioned before a really awful post over on The Simple Dollar where the author argues for paying down low-interest debt for the purpose of having "cash flow." It got me thinking: if you invest the difference, at what point can you pay your mortgage from the savings, in a way that depletes the principal upon your last payment?

With a mortgage rate of [inflation+]1% and an investment return of [inflation+]4%, it would take 7 years and 5 months for the saved difference between a 10 year and 30 year payment to pay for the rest of the mortgage. With 15 and 30, it's 11 years, 9 months. A 0.5% lower interest rate on the shorter loan lengthens the savings period by only about 2 months in the 10/30 case and 6 months in the 15/30 case. If you want to pay off your house aggressively in 5 years, instead take out a 30 year loan and invest the difference, and it only takes 3 1/2 years.

Obviously, you wouldn't isolate your mortgage from the rest of your finances, but it's a useful perspective, I think. Also, inflation+4% is a pretty safe rate of return, and should things go south, we Mustachians have margins upon margins of safety.
Might just be missing something, but how exactly are you calculating this?

velocistar237

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Re: Pay Off House Before Early Retirement?
« Reply #23 on: May 11, 2012, 06:50:05 PM »
Might just be missing something, but how exactly are you calculating this?

You can calculate the monthly payment amount for a 1% loan in OpenOffice Calc using the payment function.
10 year payment =PMT(1%/12;10*12;100000)= -$876.04
30 year payment =PMT(1%/12;30*12;100000)= -$321.64

The amount in your account from investing the difference for 7 years, 5 months at 4% can be found using the future value function.
=FV(4%/12;(7+5/12)*12;-876.04+321.64) = $57,331.21

The monthly investment payout (interest plus some principal) that would deplete the investment on the last 30-year loan payment, starting at 7 years, 5 months is given by
=PMT(4%/12;(30-(7+5/12))/12;57331.21) = $321.63

Notice that this is the same as the 30 year payment, minus a penny. So, if you pay your mortgage off with monthly payments of $876.04, it will take you ten years, but if instead you put $321.64 into your mortgage and invest $554.40, you can stop at 7 years, 5 months, and then pay the rest of your mortgage from the investment account one month at a time for the next 22 years, 7 months.

You could solve for the 7 years, 5 months, but I did it by trial-and-error.

If you want to be more conservative, use [inflation+]3% for the rate of return. It still ends up shaving 2 years off of your 10-year schedule, and the FIREcalc success rate goes up to 96%.

It's an interesting exercise that shows that paying off low interest debt doesn't make sense from a financial perspective, and it frames the question in terms of time rather than money.

(Note: I messed up the FIREcalc part of this analysis; see below.)
« Last Edit: May 20, 2012, 12:00:37 PM by velocistar237 »

WageSlave

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Re: Pay Off House Before Early Retirement?
« Reply #24 on: May 18, 2012, 11:25:38 AM »
Another consideration, although from the "market timing" mindset.  Consider that being a bondholder carries an interest rate risk: if interest rates go up, the underlying value of your bond goes down (generally speaking).  Having a mortgage is the opposite of being a bond holder: rising interest rates work in your favor.

Given the current interest rates, it's a reasonable bet that they will go up; probably more of a matter of when, rather than if.  But keep in mind, my use of the word "bet" was absolutely deliberate.  :)

The point is illustrated by this hypothetical (but completely unlikely) scenario: you have the cash to buy your house outright.  Despite this, you put zero down and take out a 30-year loan at 4%.  The next day, interest rates rise substantially, and now the rate on the 30-year US Treasury is 4.25% (and they are selling at par).  What luck!  Now you take the money you would have spent on the house, buy the government debt, and net 0.25%.  The house is effectively free now.

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Re: Pay Off House Before Early Retirement?
« Reply #25 on: May 18, 2012, 05:28:20 PM »
I am in the pay it off crowd.  Paid mine off in 6 years and have little current investments as i'm in the accumulation stage but my mortgage with escrow (taxes) was 700 ish a month and now is $113 dollars a month, that is taxes and insurance together.  So yes the government can take it away but it would be extremely unlikely.  As a nurse I have seen a lot of bad happen to good people of all ages.  I would want my wife to be able to pay any remaining bills if something would happen to me.  Yes I do have life insurance but you don't always die when you get sick.  I plan on not "betting" the farm so to speak.  My mortgage rate was 6.75% so the math was more in my favor.  I really don't know what I would of done if I would of gotten the current 3% ish rates that are out there now.  I can tell you it does feel nice knowing my family will always have a house over their head.  Paying off the house allowed us to take more risks like currently being a one income family and allowing my wife to go the college full time cash flowed.  You also state that you could pay it off in 10 years but you may be able to do it faster once you start as its rather addicting as its guaranteed savings.  Either way congratulations on starting so early and yeah put down the 20% my realtor talked me out of it at first as "no one puts down money anymore."  I paid PMI for two years and still regret it. 

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Re: Pay Off House Before Early Retirement?
« Reply #26 on: May 19, 2012, 11:05:29 AM »
If you feel certain you can handle the payments, you are usually better off with a long-term mortgage and investing the difference than paying off the house early. Velo's very interesting calculation assumes that the interest rate always stays 1% over the inflation rate.  If you get a fixed rate mortgage, you are likely to have an interest rate lower than the inflation rate in a few years.  Meanwhile, assuming you invest in stocks, the stocks should, over the long term, beat the inflation rate.

Remember, mortgage rates are now at or near their historic lows.  The people who bought houses at 5% rates in the 60's and early 70's spent thirty years crowing over their unfortunate neighbors who were paying mortgage rates in excess of 10%.

I say this assuming you are young enough that you are comfortable investing in stocks, and that you are buying a small enough house that the payments are not a stretch.  I am also assuming that you will stay in the house for 30 years.  This may not be the case, since 1st-time homebuyers often make mistakes because they don't understand their true needs and preferences.  Given how much thought you are putting into this, that may not be the case for you.

Having said all that, I paid off my house at age 50 after 7 years in the house, and it felt really good!

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Re: Pay Off House Before Early Retirement?
« Reply #27 on: May 19, 2012, 11:35:28 AM »
You are talking about very short stretches of the market, I disagree that inflation+4% is "pretty safe".  Sure, over longer stretches the market return gets pretty safe, but you are talking time periods of less than 10 years.  That doesn't mean it's a bad idea to go with a longer mortgage and invest the savings, just that it carries much more risk than you suggest.

The stretches are 15 to 20 years (30 minus 15 and 10, respectively), which are pretty long, and a diversified, rebalanced portfolio would help keep it stable. Trying out FIREcalc with a 50/50 portfolio over 22 years, there's a 90% chance of success. On average, you would finish with $30K extra.


You said: "If you want to pay off your house aggressively in 5 years, instead take out a 30 year loan and invest the difference, and it only takes 3 1/2 years."


That is a 3 1/2 year time stretch in the market that you are counting on increased rate of return to pay of the 30 year loan early (goal being 5 years minimum).  If the market does poorly over the 3 1/2 years, which isn't terribly unlikely for such a short stretch, then you obviously aren't going going to pay it off by then.  Even 5 years, the time you hoped to pay it off, isn't a long stretch in the market.  So if I had a goal of retiring in 5 years and wanted my house paid off to do so, then I might aggressively pay off my mortgage instead of investing the money in order to be sure it was gone at that point.  Yes, I would be giving up a high potential for greater gains in the market in order to gain the benefit of being sure it would be paid off at a certain date. 


I would personally probably choose the market investments instead of paying off the house, but that's not to say there isn't a fair rational for paying it off instead.


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Re: Pay Off House Before Early Retirement?
« Reply #28 on: May 19, 2012, 07:31:10 PM »
There's nothing wrong with wanting to pay off a mortgage early, but it provides little advantage until it's completely paid off.  I would conservatively-moderately invest the money you are planning to pay toward your mortgage until you can send in the whole amount.  The flexibility you get from having that money available is too important.  It's very hard to see what hardships you might encounter in the future.  Once you put money in the house it can be very difficult to get it back out, especially if you are experiencing hard times.  It shouldn't be difficult to find a steady 6-7% return that would still be net positive after taxes over your mortgage payment.  Then once you have the money saved up, you can make the choice of paying the entire mortgage or not.  In the meantime, making additional payments means that you don't have the money and still have a mortgage. This is not a wise choice (IMO).
« Last Edit: May 19, 2012, 07:36:04 PM by Mirwen »

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Re: Pay Off House Before Early Retirement?
« Reply #29 on: May 20, 2012, 03:22:03 AM »
To a large extent this is what my wife and I did on top of some aggressive debt repayment (increased monthly payments by $1000 a month from day 1).

Once the value of our shares matched the remaining balance of our mortgage, we cashed up and became debt free. I've no regrets. One year on the value of the shares hasn't moved. And not paying 5.75% on 80,000 for a whole year feels damn good.

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Re: Pay Off House Before Early Retirement?
« Reply #30 on: May 20, 2012, 06:35:16 AM »
You said: "If you want to pay off your house aggressively in 5 years, instead take out a 30 year loan and invest the difference, and it only takes 3 1/2 years."

That is a 3 1/2 year time stretch in the market that you are counting on increased rate of return to pay of the 30 year loan early (goal being 5 years minimum).  If the market does poorly over the 3 1/2 years, which isn't terribly unlikely for such a short stretch, then you obviously aren't going going to pay it off by then.

It only takes 3.5 years to save up enough to pay off the house over 30 years. You're investing over the entire 30 years. In the 5-year/30-year case, the first 3.5 years is just the accumulation phase, where you invest the difference between your 5-year payment and the 30-year payment. Investing continues for the next 26.5 years until the loan is paid off.

It looks like FIREcalc can model this, though not on the month scale. For the 10/30 case, you end up with a 95% success rate after saving for just 7 years, and for 5/30, if you save for 4 years instead of 3.5 years, you end up with a 100% success rate with an average gain of $80K. If you go the full 5 years, the historical minimum you would end up with was $50K extra. One thing that my analysis didn't account for was the correlation between returns during the accumulation phase and after, as in, if you lose money early on, you're historically likely to gain it back.

(Note: I messed up the FIREcalc part of this analysis; see below.)
« Last Edit: May 20, 2012, 12:01:25 PM by velocistar237 »

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Re: Pay Off House Before Early Retirement?
« Reply #31 on: May 20, 2012, 09:44:30 AM »
Love the FireCalc site. Thanks for that!

On financial terms - depending on assumptions - a low rate, long term fixed rate loan is a great thing to be able to have. Borrow at 4% pre-tax and inflation for 30 years? Wow. Most people in the world can't do that. The US is exceptional, and probably a result of Government intervention keeping rates controlled.

Investing that money will almost certainly return more than that. On this basis, we should all have 80% (avoid PMI), 30-yr fixed rate mortgages, with the rest in the market/portfolio. It's the math, as Arebelspy points out.  Especially if you can gain those long term returns tax-protected.

BUT, it isn't that simple, or easy. It relies on some big assumptions:
- you can always service the debt
- you will continue to save at a high rate
- you won't buy a bigger house than you need
- you will always invest wisely, even in a market melt-down
- relatively stable future tax regime


I'd say it's one of the many advantages of advanced Mustachianism and 'Stash accumulation. But it does implicitly assume Mustashian discipline will be attained!

Tthe current rates are truly exceptional, probably less than 1% real interest rate, or even negative after tax especially. "Fill your boots', as they say.  If you fit the criteria, borrow low, fixed and long!

Just do not consider the house you live in as an investment.





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Re: Pay Off House Before Early Retirement?
« Reply #32 on: May 20, 2012, 11:57:30 AM »
I have to backpedal a bit; I mixed up my inflation+rate with my rate, meaning I was plugging in money borrowed at 1%.

With a 4% mortgage and a 7% return, you still get the same behavior in the constant-rate analysis. The FIREcalc results aren't as solid, though, for the case where you stop saving early and start paying your mortgage from your savings. If you save for 8 years in the 10/30 case, you have a 50% chance of success. So the time perspective might not be so useful.

If you do a 30 year mortgage instead of a 10 and invest the difference, you still come out with a 100% success rate and about $50K ahead, so that's not in doubt. Doing 30 instead of 5 gives you a success rate of 98% and about $70K ahead.

2handband

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Re: Pay Off House Before Early Retirement?
« Reply #33 on: May 20, 2012, 06:47:46 PM »
My take:

Most Americans are two paychecks from having their asses chucked out on the streets. This is insane. Do not, repeat, do not, put yourself in a position in which your livelihood is dependent upon your income. I live in a shitty trailer park in a house that I own. Lot rent is $250, which is more than I would like but at the same time I can't imagine not being able to scrape it together. Absolute worst case, I think I could come up with $250 every month. There's a tremendous amount of security in that. You buy that house and you put yourself in a position in which if you lose your job you're going to have a big problem. I'd think long and hard.

Think of it like this. You buy that house you can maybe retire at 40. You look for a cheaper option and maybe you can retire next year. God, i wish I'd started thinking in these terms when I was your age. it would've been easy then, as a single man. Now I'm 38 years old with a sick wife and a four-year-old daughter trying to think my way out from under the fucking lot rent.

grantmeaname

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Re: Pay Off House Before Early Retirement?
« Reply #34 on: May 20, 2012, 07:17:30 PM »
Your lifestyle is not the only one possible for anyone and not the absolute best and most virtuous. It works for you, and that's fine, but that doesn't mean that everyone needs to make your choices.
I'm not screaming at you to join "wage slavery", so quit yelling at me to join the happy life of trailer ownership. It's great that it works for you, but half the point of these forums is that the posters make their own choices based on their own values.

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Re: Pay Off House Before Early Retirement?
« Reply #35 on: May 20, 2012, 07:24:49 PM »
Your lifestyle is not the only one possible for anyone and not the absolute best and most virtuous. It works for you, and that's fine, but that doesn't mean that everyone needs to make your choices.
I'm not screaming at you to join "wage slavery", so quit yelling at me to join the happy life of trailer ownership. It's great that it works for you, but half the point of these forums is that the posters make their own choices based on their own values.

Whoa, take it easy there. Who's yelling at anyone to do anything? I'm just throwing ideas on the table. The OP is 24 and staring down 16 awful years of working full-time, so I'm suggesting that he might want to consider other options. That's all. If he decides he likes working a job and wants to continue doing it this way, good for him.

2handband

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Re: Pay Off House Before Early Retirement?
« Reply #36 on: May 20, 2012, 07:39:29 PM »
As an addendum to my last post, a... what did you call it? Oh yes: "a happy life of trailer ownership" isn't the point. In fact I'd ditch the trailer in a heartbeat if it wasn't my cheapest option at the moment. The point is a low-stress, easygoing life, which I'm sort of assuming is the point of all this. If we liked working, we wouldn't be posting here.

arebelspy

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Re: Pay Off House Before Early Retirement?
« Reply #37 on: May 20, 2012, 07:42:38 PM »
The point is a low-stress, easygoing life, which I'm sort of assuming is the point of all this. If we liked working, we wouldn't be posting here.

I love my job. If I was FI right now, I'd keep doing it.

Doesn't mean I don't want FI as soon as possible (and likely RE after that, simply because I figure by that point I may be ready for new challenges. Who knows though).

I agree with the low stress, easygoing part, but that has more to FI with a person's attitude than situation.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

2handband

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Re: Pay Off House Before Early Retirement?
« Reply #38 on: May 20, 2012, 07:47:32 PM »
The point is a low-stress, easygoing life, which I'm sort of assuming is the point of all this. If we liked working, we wouldn't be posting here.

I love my job. If I was FI right now, I'd keep doing it.

Doesn't mean I don't want FI as soon as possible (and likely RE after that, simply because I figure by that point I may be ready for new challenges. Who knows though).

I agree with the low stress, easygoing part, but that has more to FI with a person's attitude than situation.

To be honest, I think that puts you in the vast minority. I don't personally know anybody, anybody at all, who wouldn't quit their jobs instantly given a winning lottery ticket. Strangely enough, I'm one of those who would keep working. But then, I play guitar for a living... who doesn't like playing guitar? I WOULD, on the other hand, give up my high-paying gig playing in an 80s-oriented pop-rock cover band and start a much lower paying one playing original metal if I didn't need money. I would stop doing the jazz gigs as well.

elysianfields

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Re: Pay Off House Before Early Retirement?
« Reply #39 on: May 21, 2012, 03:04:48 AM »
I agree with Ric Edelman's advice, and he says it much more eloquently than I could, here:  http://www.ricedelman.com/cs/education/article?articleId=232

We just refinanced our rental, 30 years at 3.5%, which after tax deductions is 2.42375%.  There are plenty of solid blue-chip stocks paying more than that in dividends.  I see no reasonable argument for paying off our mortgage anytime soon, YMMV.

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Re: Pay Off House Before Early Retirement?
« Reply #40 on: May 21, 2012, 04:09:41 PM »
I agree with Ric Edelman's advice, and he says it much more eloquently than I could, here:  http://www.ricedelman.com/cs/education/article?articleId=232

We just refinanced our rental, 30 years at 3.5%, which after tax deductions is 2.42375%.  There are plenty of solid blue-chip stocks paying more than that in dividends.  I see no reasonable argument for paying off our mortgage anytime soon, YMMV.

wow. Nice deal.

Fully agree. And if it allows a higher level of tax-protected saving in the 'stash, even better.

Plus, it might allow you to have 2 (or more) rental units when otherwise you'd have all your eggs in one basket, another benefit.

skyrefuge

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Re: Pay Off House Before Early Retirement?
« Reply #41 on: May 21, 2012, 07:48:56 PM »
and start a much lower paying one playing original metal if I didn't need money.

ha, I think this is at least fourth reference to metal I've seen on this forum (including my avatar).  It's making me wonder if metal fans are over-represented amongst mustiachians like computer engineers are!

KittyWrestler

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Re: Pay Off House Before Early Retirement?
« Reply #42 on: May 22, 2012, 11:42:45 AM »
Don't forget about the tax benefits of the 401K or IRA contributions. You deducted a ton if you make a lot of money. And if you don't take advantage of that and instead paying down your mortgage, meaning, less interest to deduct, you pay a lot more tax.

We are higher earning couple so paying off house and not contributing to our retirement doesn't make sense from tax perspective, so we max out on our retirement funds and throw whatever we can at our mortgage. At the end of day, tax benefits get us further ahead.

jpo

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Re: Pay Off House Before Early Retirement?
« Reply #43 on: May 22, 2012, 12:39:51 PM »
I have to backpedal a bit; I mixed up my inflation+rate with my rate, meaning I was plugging in money borrowed at 1%.

With a 4% mortgage and a 7% return, you still get the same behavior in the constant-rate analysis. The FIREcalc results aren't as solid, though, for the case where you stop saving early and start paying your mortgage from your savings. If you save for 8 years in the 10/30 case, you have a 50% chance of success. So the time perspective might not be so useful.

If you do a 30 year mortgage instead of a 10 and invest the difference, you still come out with a 100% success rate and about $50K ahead, so that's not in doubt. Doing 30 instead of 5 gives you a success rate of 98% and about $70K ahead.
Plugging in my expected numbers of 4% mortgage rate and 6% market return, for 100% FIREcalc results I'd need to invest the difference for ~18.5 years.

The key to doing this really is to make sure you're investing the complete difference each month, no exceptions.

Also interesting to note is that when the 18 years are up and I could stop saving the difference is when I would also hit FI...

Don't forget about the tax benefits of the 401K or IRA contributions. You deducted a ton if you make a lot of money. And if you don't take advantage of that and instead paying down your mortgage, meaning, less interest to deduct, you pay a lot more tax.
The annual expected mortgage interest is hardly more than the standard deduction anyway.

and start a much lower paying one playing original metal if I didn't need money.

ha, I think this is at least fourth reference to metal I've seen on this forum (including my avatar).  It's making me wonder if metal fans are over-represented amongst mustiachians like computer engineers are!
I am representing both :-)
« Last Edit: May 22, 2012, 12:47:46 PM by jpo »

KittyWrestler

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Re: Pay Off House Before Early Retirement?
« Reply #44 on: May 22, 2012, 12:53:31 PM »

Don't forget about the tax benefits of the 401K or IRA contributions. You deducted a ton if you make a lot of money. And if you don't take advantage of that and instead paying down your mortgage, meaning, less interest to deduct, you pay a lot more tax.
The annual expected mortgage interest is hardly more than the standard deduction anyway.



Not if you put in max into 401K for both people. For us, $17000 each and $34000 both with 33% tax savings is huge. Our income is in the top bracket so it makes a huge difference if we save for the retirement instead of paying down mortgage.
Without putting as much as possible into retirement, we would have to pay a lot more in tax

jpo

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Re: Pay Off House Before Early Retirement?
« Reply #45 on: May 22, 2012, 01:10:43 PM »
Don't forget about the tax benefits of the 401K or IRA contributions. You deducted a ton if you make a lot of money. And if you don't take advantage of that and instead paying down your mortgage, meaning, less interest to deduct, you pay a lot more tax.
The annual expected mortgage interest is hardly more than the standard deduction anyway.

Not if you put in max into 401K for both people. For us, $17000 each and $34000 both with 33% tax savings is huge. Our income is in the top bracket so it makes a huge difference if we save for the retirement instead of paying down mortgage.
Without putting as much as possible into retirement, we would have to pay a lot more in tax
Whoops, I totally misread what you posted. Thought you were referring to itemizing mortgage interest.

Yes, this makes sense to save on taxes. I am currently maxing the Roth every year but am not contributing to the 401k (no match right now) and am saving 20% down so I can stop throwing away money on rent... although I suppose I am also throwing money away on taxes!

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Re: Pay Off House Before Early Retirement?
« Reply #46 on: May 22, 2012, 01:20:06 PM »

Don't forget about the tax benefits of the 401K or IRA contributions. You deducted a ton if you make a lot of money. And if you don't take advantage of that and instead paying down your mortgage, meaning, less interest to deduct, you pay a lot more tax.
The annual expected mortgage interest is hardly more than the standard deduction anyway.



Not if you put in max into 401K for both people. For us, $17000 each and $34000 both with 33% tax savings is huge. Our income is in the top bracket so it makes a huge difference if we save for the retirement instead of paying down mortgage.
Without putting as much as possible into retirement, we would have to pay a lot more in tax

Still, be careful of overdosing on 401ks. Typically you'd want to fund it only up to the employer match, because the withdrawal conditions are harsh (?links?). With your excess I'd rather invest in Roths (if you can) and other tax optimised ways not as bound up as 401s.


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Re: Pay Off House Before Early Retirement?
« Reply #47 on: May 22, 2012, 06:04:19 PM »
Still, be careful of overdosing on 401ks. Typically you'd want to fund it only up to the employer match, because the withdrawal conditions are harsh (?links?). With your excess I'd rather invest in Roths (if you can) and other tax optimised ways not as bound up as 401s.

I always cringe when I hear this advice.  I strongly disagree, because there are only a very narrow set of conditions in which it is possible to overdose on a 401k. 

One of those conditions, and the easiest one to meet, is if you are a person who expects their total taxable income to be much higher in retirement than it is while working.  The only way I can see to make that happen is to inherit a bunch of money, or work a very long career.  I don't think anybody on an ERE forum fits either of those conditions.

A 401k defers taxes until after you retire.  If you are saving a big chunk of your current income so that you can retire, then your current tax rate is higher than your retirement tax rate will be.  In this situation, the Roth makes no sense.  Why opt to pay a higher tax rate?

The second point about the harsh withdrawal conditions is also a red herring.  Rule 72(t) makes it easy to get some out, and the 5 year Roth IRA rollover pipeline makes it simple to get all of the rest out, without penalty, and the only caveat is that you need to have five years of expenses saved up outside of your 401k.  Roth Roth IRA principal contributions would count, as would any taxable accounts.

If you're very near retirement and don't have 5 years of accessible savings in your Roth and taxable investment accounts, then you can overdose on the 401k.  I don't think anyone else can.

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Re: Pay Off House Before Early Retirement?
« Reply #48 on: May 22, 2012, 06:19:28 PM »
Thanks Sol!

Perhaps it's because I'm close to RE that I thought that way about 401ks in general.

WageSlave

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Re: Pay Off House Before Early Retirement?
« Reply #49 on: June 04, 2012, 04:11:48 PM »
Let me throw another example out there, with a slightly different spin.  The OP asked about paying down his mortgage quickly.  My question is a little different: let's say you have the money to buy a house outright; should you?

From my math, even if your rate of return on investments is the same as the interest on your mortgage, investing still comes out ahead due to the magic of compound interest.

Let's say you're looking at a $100k loan or spending that outright.  Assume a 30-year loan on $100k at 4.00%:
  • Monthly payment: $477
  • Annual outlay: $5729 (monthly payment X 12)
  • Total interest paid: $71,870 (over 30 years)
  • Total outlay for purchase: $171,870
A conservative annual withdrawal rate of 3% of $5729 (your annual mortgage outlay from above) requires a portfolio of about $191k.  (5729/0.03=190,966.67)

According to what I've read, over any 30-year period, the US total stock market has at worst returned about 7%.  Let's be ultra conservative, and assume a 5% return on that $100k that didn't go into the house.  After 30-years, with compound interest, that $100k is worth over $432k (100(1+0.05)^30=432,194).

In fact, after 20 years, that $100k (assuming 5% returns) is worth over $265k---at this point, the annual returns exceed what is needed to cover the mortgage payment.

I excluded inflation from the above, because I'm assuming it works equally for you with regard to the mortgage payment as is does against you with your investments.

As far as I can tell, besides the emotional perk of not having any debt, the downside to a loan is reduced cash flow.  You trade cash flow now for greater future wealth.

Thoughts?  Does my analysis miss anything?