Pay off Mortgage or Invest?

[cbr shadow]

I am wondering if I should be putting extra money towards my mortgage to get it paid off, or should I be investing the money?  Here are the stats..

$209,000 mortgage loan, recently refinanced for 3.75%

I'm 28 yrs old and make ~$50,000 before deductions
My wife is 29 yrs old and makes ~$100,000 before deductions

Student loads are paid off, cars are paid off and reliable, lifestyle is finally under control so we can save a good amount..  We're both putting into our 401k's to get our full company matches.  I'm considering opening a Roth IRA or contributing more into my 401k.  Both of our 401k's are through Vanguard, and I've been reading a lot lately about VTSAX (index) funds though them.  What's the best next move?
1) Max out both of our 401k's (or try to)..
2) Keep 401k to get full company match, plus open a Roth HRA
3) Invest extra money in index funds (VTSAX) through Vanguard
4) Other...

Thanks,
Ryan

[RoseRelish]

I'd refinance again. Rates are somewhere between 3% and 3.25% for 30-year terms.

And probably max out at least one of your 401k accounts and putting the rest in a ROTH/taxable account. I'm a big fan of mixing up future taxable income streams to spread the risk of tax law changes.

Other than that, keep saving and earning.

[arebelspy]

Invest.

[Catt]

Make sure you have an adequate emergency fund before doing anything.

At these low interest rates I wouldn't pay more against the mortgage until you max out your tax advantaged retirement accounts. 

You could probably do a no cost refinance for 30 year around 3.5% if you want to start that process again.

Only after that would I consider whether or not to pay more towards the mortgage or invest in a taxable account.  I don't think you can go wrong either way at this point.

[rvanmanen]

What if your house is completely paid off and have no other debt and are set with emergency funds?  With rates what they are currently, I am considering a HELOC and investing it.  I have seen a few other posts elsewhere that tend to say this is not a good idea, but isnt it essentially the same as to what the OP would be doing if he chooses to invest?

We are both 41, and have about 125k already in the market and can get about that much on a HELOC for 2.75%

[Jamesqf]

A quarter or half percent reduction in interest rate just doesn't (IMHO, anyway) justify the hassle & cost of refinancing.  Just looking at current rates, I'd have to pay 1.25 points to get a 15 year fixed rate of 3%.

[Catt]

What if your house is completely paid off and have no other debt and are set with emergency funds?  With rates what they are currently, I am considering a HELOC and investing it.  I have seen a few other posts elsewhere that tend to say this is not a good idea, but isnt it essentially the same as to what the OP would be doing if he chooses to invest?

We are both 41, and have about 125k already in the market and can get about that much on a HELOC for 2.75%

Tough to find any investment that will pay more than 2.75% after taxes without taking on significant risk.  You are better off keeping up a high savings rate and investing it.

A quarter or half percent reduction in interest rate just doesn't (IMHO, anyway) justify the hassle & cost of refinancing.  Just looking at current rates, I'd have to pay 1.25 points to get a 15 year fixed rate of 3%.

It can be a pain for sure but you can get a no cost 15 year fixed refinance for about 3% right now and possibly better if you really dig for it.

[Lars]

Student loads are paid off, cars are paid off and reliable, lifestyle is finally under control so we can save a good amount..  We're both putting into our 401k's to get our full company matches.  I'm considering opening a Roth IRA or contributing more into my 401k.  Both of our 401k's are through Vanguard, and I've been reading a lot lately about VTSAX (index) funds though them.  What's the best next move?
1) Max out both of our 401k's (or try to)..
2) Keep 401k to get full company match, plus open a Roth HRA
3) Invest extra money in index funds (VTSAX) through Vanguard
4) Other...

I recommend
1) Max both out 401k's. With a marginal fed tax rate of 25%, your retirement tax rate is sure to be much lower.
2) Fully fund both Roth IRAs since you probably don't qualify for traditional IRA.
3) Pay enough extra on mortgage to pay it off just before you plan to stop working. I prefer to match the terms of my debts to the length of my employment to limit risk.
4) Invest the extra in index funds.

I'd imagine you can manage all four with almost no problem.

[sibamor]

$209k mortgage at 3.75%
I assumed payment of:

$/mo     total interest              duration
1000      130k                          29.0 yrs
1050      118.4k                       26.9 yrs
1100      108.5k                       23.9 yrs
1150      100.2k                       22.3 yrs
1200      93k                            21.8 yrs
1250      87k                            19.5 yrs
1300      81.5k                         18.4 yrs
1350      77.1k                         17.3 yrs


As you can see by the trend developing for every $50/mo you can afford to kick towards your mortgage equates to diminishing returns of interest not paid paid. With each $50 your return is  basically 10k/8k/7k/6k/5k/4k of interest not paid.  Try to find the balance that satisfies you.

(Given that your household income is 150k and no debt I'm guessing you kick a lot more towards your loan.)

To begin taking that equivalent money and starting investment portfolio what to you expect your rate of return to be on the increments of $600/yr ($50/mo)?

Invest
2k/yr assume 4% every year ROI will return 70k after 20yrs.
2k/yr assume 5% every year ROI will return 77k after 20yrs
2k/yr assume 8% every year ROI will return 114k after 20 year


Doing some approximating if you put $150/mo towards mortgage you will save 30k in interest payments over 20 yrs and 9 yrs on mortgage. If you put that same $150/mo (2k/year) with a conservative 5% ROI you will get 77k in 20 yrs.

Obviously it makes sense to work on the investment portfolio.  But I would recommend something different.  Beyond the first year start up funds for your portfolio, I would take the excess funds you have available to tackle the mortgage/investment and split it either 2:1, 1:1, 1:2. That way both the portfolio builds and the mortgage drops.

[Done by Forty]

Both.  With $150k pre-tax, you don't have to choose. 

View an extra mortgage payment as a bond/savings account with at guaranteed 3.75% return.  You wouldn't want all your money going there, but your mix of assets might include a certain amount going to that kind of 'investment'.

[smalllife]

Mathematically it makes sense to invest.  However, it depends on what your long terms goals are.  Personally I would rather have a paid off house and have to work part time than be forced to work full time longer while I carry the mortgage.  But that's just me and I fully recognize that I am trading capital gains for peace of mind.

[arebelspy]

Personally I would rather have a paid off house and have to work part time than be forced to work full time longer while I carry the mortgage. 

I don't understand your example.

Can you please explain, because it doesn't make sense to me.

I'd see it as: pay off house (at low interest rate), have to work longer to build up stache
Versus
Build up stache (at high interest rate), use excess to pay off house if desired, FIRE earlier.

[WaxOnWaxOff]

Personally I would rather have a paid off house and have to work part time than be forced to work full time longer while I carry the mortgage. 

I don't understand your example.

Can you please explain, because it doesn't make sense to me.

I'd see it as: pay off house (at low interest rate), have to work longer to build up stache
Versus
Build up stache (at high interest rate), use excess to pay off house if desired, FIRE earlier.

Question: at what point would it make sense to pull the trigger and pay off the house from the 'stache? I'm dealing with this dilemma right now.

[arebelspy]

Personally I never would.

But if you want the paid off house for emotional, rather than financial reasons, the mathematical answer is: as late as possible.

If you are earning above your loan amount, wait until you're ready to FIRE before paying it off.

So if you need 700k and a 300k paid off home, rather than paying off the home early and then trying to save 700k, you will be able to FIRE earlier if you save up 1MM, then pay off the home and have the 700k that you need left.

Again, assuming your returns are more than your 3-ish% mortgage (minus tax deduction, if applicable).

[smalllife]

Stache needs while carrying mortgage: $600,000 (personally, this would mean entire financial independence)
Stache needs without mortgage, assuming low paying part-time work is required (and acceptable) = $175,000.

Part time work would allow me to continue to build stache at a reasonable pace while working at truly enjoyable occupations.  Paid off house ensures extremely low living expenses while the stache is my FU money to let me move from job to job as I feel fit.  No I would not be completely FI, but I don't think that scraping together of $5000 annually to supplement my investment income would be hard at all.  I would need a greater cushion with the mortgage than without.

I suppose the bottom line is that I don't necessarily trust the stock market nor do I want to be dependent on it's returns.  Morally I have issues with investing in companies I despise, or even consumerism in general.  As I get more comfortable with investments I will move my funds accordingly, but I am not at that point yet.  I would much rather have a paid off  house and have to work a minimal amount (perhaps for barter or trade) than rely on the market for my well-being. 

As for paying off the house from the stache, that is certainly something I am considering but I am not in a position to make that decision yet (paying off a family loan).  I have a low 30k income, so $600,000 seems almost insurmountable in anything resembling a reasonable time line.  $175,000 is achievable.  5 years down the line that may change.

[RoseRelish]

@arebelspy: I completely agree with you about never paying the mortgage early or even always having a mortgage, I can explain one reason why people may want to pay it off.

Say I have a $200k mortgage at 4%. My payment is $955/month or $11,458/year. I would need a 5.7% return on my investment to generate enough money to make the monthly mortgage payments. (11,458/200,000). The return needed to generate enough income to make the $11,458 annual mortgage payment goes up over time as the principal is paid down. (When the principal balance is $100k, I would need a 11.458% return). Look, I realize this lumps principal and interest into one number, but it does illustrate the returns needed if you wanted your stache to throw off enough money to pay the bills.

[It Figures]

Personally I never would.

But if you want the paid off house for emotional, rather than financial reasons, the mathematical answer is: as late as possible.

If you are earning above your loan amount, wait until you're ready to FIRE before paying it off.

So if you need 700k and a 300k paid off home, rather than paying off the home early and then trying to save 700k, you will be able to FIRE earlier if you save up 1MM, then pay off the home and have the 700k that you need left.

Again, assuming your returns are more than your 3-ish% mortgage (minus tax deduction, if applicable).

I have struggled with this choice for a long time, but this is what ended up happening.  My husband and I were both self-employed and taking money from the business as required without any financial plan whatsoever.  We were young and stupid and making and spending a lot of money.  At some point, I realized we totally needed a punch in the face (before i even read MMM) and I tried to start saving.  My husband honestly had no concept of saving whatsoever.  No retirement, nothing.  He kept saying we had no money to put into savings.  I was a bit desperate and wasn't sure where to start, so I called the bank that was holding our mortgage and told them to increase our monthly payments.  Over the course of three years I kept on increasing the amount until finally this July when the term was up, we have only about $45,000 left on the mortgage.  I felt great in one way because it was a forced way to save money.   I was also putting money away into a TFSA which is at about $20,000.  However, my husband is still self-employed with only about $50,000 in a retirement fund and he is 42.  We refinanced the mortgage so that we are now only paying 1/3 of what we were paying before and we will have it paid off in 5 years.  My husband has finally realized that he can save and the extra amount we were putting toward the mortgage is finally going into his retirement savings.  If I could go back in time and give my 26 year old self some advice, I would say to save, save, save, forget about what other people are buying, because the freedom from financial independence far outweighs a backyard swimming pool, fancy new kitchen, or shiny SUV.  So basically, in answer to the OP I would also recommend investing.  Match your employer amount for your 401k, max out your Roth IRA and put as much as you can into your stash.  You are young and you have plenty of time to pay off the house.

[KulshanGirl]

I'm struggling with this same question.  My first goal isn't financial independence though, it's being able to switch to part time work ASAP so I can be home after school for my daughter when she is school age.  She is 2 now and in full-time care.  The way I can see to do this is to get rid of the mortgage payments to decrease my monthly expenses.  I'm not very concerned about what I could get with the long term gains from investing, because what it can't get me, as far as I can see, is time with my child.  Paying off my mortgage quickly CAN do that. 

And I also don't want to rely on the market, especially for that.  I'd rather take the safe route to my goal.  So there's MY case. :)

[arebelspy]

I'm struggling with this same question.  My first goal isn't financial independence though, it's being able to switch to part time work ASAP so I can be home after school for my daughter when she is school age.  She is 2 now and in full-time care.  The way I can see to do this is to get rid of the mortgage payments to decrease my monthly expenses.  I'm not very concerned about what I could get with the long term gains from investing, because what it can't get me, as far as I can see, is time with my child.  Paying off my mortgage quickly CAN do that. 

That's fine, but mathematically it's worse than investing, then selling the investment to pay off the mortgage.  You get rid of the mortgage SOONER doing that than paying down the mortgage (again, assuming you earn above your mortgage interest rate), and decrease your monthly expenses sooner.

Paying down the mortgage doesn't decrease your expenses until it's paid off, unless you refi to a smaller payment amount.  So invest, then pay it off at once.

Investing and then paying off the mortgage will actually get you the time with your daughter sooner than paying off the mortgage accelerated along the way.

And I also don't want to rely on the market, especially for that.  I'd rather take the safe route to my goal. 

That's the one correct statement there that I will agree with.  If that's the route you want to go, definitely do so.  But understand that at that point it's an emotional decision, rather than a mathematical one.

People are trying to "justify" the decision.  It's not necessary.  If you want to do it, go for it.   

But don't try to convince yourself that it is better mathematically, because it isn't.  Just accept that you're doing it a slower way and giving up returns for security, and that's okay.  Just like the debt snowball (which I'd never do) is good for some people - for psychological reasons, not mathematical ones.

[KulshanGirl]

^Yep.  I do know it's an emotional decision.  I'll take the sure 3.75% over the unknown in this instance.  In this path, I KNOW for sure that I will be able to go part time when she is in first or second grade.  Mortgage gone = part time job lifestyle.  Whatever the market might do between now and then, I'd rather keep an eye on that sure prize than gamble for better and end up not being able to be there for her.  It might be emotional and not the path that others might take, but I'm way more concerned with TIME with her than the money.  I see the stock market as a stick-it-out-over-the-long-haul vehicle with ups and downs, and my goal is short-term, precise, and super important to me.  :)  I simply have no interest in gambling, at all. 

I do have some emergency fund money that I will probably put into a Vanguard account, and I can contribute a little each month to it.  :)  If the market goes wild and climbs to the sky, I can use that to make it happen even faster.

[smalllife]

Is it still better even with the tax hit?  For a 5 - 10 year payoff schedule I don't see how capital gains can cover that plus taxes.

[Done by Forty]

For those advocating putting all available funds towards investment, is there a methodology you use for calculating risk with that plan?

For example, over a 5 year plan, we can assume 7% or 9% investment gains, and that's clearly better than paying off a 3.75% mortgage.  But...it's unlikely, but possible, that one's investments lose money over that time (just as it's possible to gain much more than 7 or 9% on average).  Is there any way to factor investment risk, or, not being able to predict what will happen in the future, is the best methodology simply to assume average returns?

[Lars]

I'm struggling with this same question.  My first goal isn't financial independence though, it's being able to switch to part time work ASAP so I can be home after school for my daughter when she is school age.  She is 2 now and in full-time care.  The way I can see to do this is to get rid of the mortgage payments to decrease my monthly expenses.  I'm not very concerned about what I could get with the long term gains from investing, because what it can't get me, as far as I can see, is time with my child.  Paying off my mortgage quickly CAN do that. 

That's fine, but mathematically it's worse than investing, then selling the investment to pay off the mortgage.  You get rid of the mortgage SOONER doing that than paying down the mortgage (again, assuming you earn above your mortgage interest rate), and decrease your monthly expenses sooner.

You will probably get rid of the mortgage sooner but it is certainly not guaranteed. I've heard this mentioned enough times I though I'd run the numbers through FIREcalc and see what the odds might look like. With a 15 year span to retirement, 3.75% interest rate on a 30 year mortgage, $200,000 loan, investing instead of paying off the loan early with extra payments (and refinancing to a 3% 15 year mortgage) comes out ahead 60% of the time with an average benefit of $11,000. Best case you come out 120,000 ahead and worst case you come out $80,000 behind.

[EDIT]
Damn, I messed up on the inflation component of the calculation. A revised calculation suggests the 15 year span to retirement, 3.75% interest rate on a 30 year mortgage, $200,000 loan, investing instead of paying off the loan early with extra payments (and refinancing to a 3% 15 year mortgage) comes out ahead 80% of the time with an average benefit of $47,000 in future dollars (maybe $30,000 adjusted for inflation).  Worst case is a loss of $20,000 and the best case is a gain of $130,000.

[arebelspy]

Absolutely.  It is guaranteed, given the parameters I specified in the parenthetical comment.  ;)

Since we can't know if investing will beat paying down the low rate, we have to do our best guesswork.

It certainly is interesting to see those numbers, so thanks for running that and sharing Lars.

Even FIRECalc is only backwards looking, not forwards.

I'm going with MMM's relentless optimism though, and saying that investing is the way to go.  And, as your numbers have shown, that certainly has been in the past 50% more of the time than not (i.e. worked 60% of the time to not 40%, for a 50% boost).  I have no reason to think it won't be true of the future.

[KulshanGirl]

Okay, my scenario is a bit more compact than that:  $106K mortgage, 20 year, 3.75%.  If I were to invest for those 20 years, sure thing I'd come out waaaaay ahead. I have no doubt.  But I want to stop working full time within five years, so that is my timeframe.  I don't think I'd trust any five year window in the stock market, I think it's too short.  For what I want to do, anyway. 

[jrhampt]

We've been doing a little of both, but focusing mainly on investing.  Just re-financed to a 15yr fixed at 2.875%.  We are maxing out our 401ks but ineligible for Roth or deductible IRA, so the plan is to keep investing in taxable and putting a small amount extra toward principal each month.  We used to just round up to the nearest $100, but with each subsequent re-fi,  our required payments kept getting lower and we kept paying the original payment amounts on the loan, until we were eventually putting $300 extra on the principal each month.  Now that our interest rate is so low, we may back that down and invest it instead.  I'm sure that once the balance gets low enough, we'll either downsize into a smaller, less expensive home or just decide to pay it off early so that we can stop needing full-time employment.

[Lars]

Please see the revised numbers in previous post after fixed an error with inflation. The odds are a much higher 80% for a delayed paydown with a benefit of 30k.

Arebelspy:
Good point on the optimism and odds - I think you've persuaded me away from my current position - paydown the mortgage just quickly enough that its paid just as you plan to stop working - to invest the difference. Especially if the reasonably expected downsides are modest, I agree it makes sense to invest if the odds are in your favor. Basically, I invest I probably reach FI a number of months sooner but I might have to work a year or two extra if things go poorly.

KulshanGirl:
If I understand your posts correctly, you prefer the certainly of being able to stop work in 5 years to the probability of being able to retire in 4 1/2 years (and almost certainly between 3 and 7 years). By chance, is your mortgage expense large enough that paying expenses while working part time would be difficult - did I read your comment right? Personally, I find investing acceptable because my wife and I plan to work part-time for a while even after FI and expect to be able to pay the mortgage part-time with that income so the downsides of investing are palatable.

[KulshanGirl]

If this were just about the money, or retiring, I'd be right on board with y'all.  I know that what you're saying is true.  Yep, I surely am trading some of my potential/probable interest earnings for TIME guaranteed  ...  time that is more valuable to me because my child is a child in it.  The stock market will likely outperform me, but the risk that it won't is not something that this particular goal can bear.  I'm cool with that potential loss.  And I AM going to open a Vanguard account with some of my savings as well. 

[KulshanGirl]

^Also, it's not about stopping work or retiring, I quite like to work.  I want to achieve a cost of living that can be suppported by part time work instead of the 9-5, so I can be home with the child after school.  I'm totally glad to keep working to pay for that lowered cost of living as opposed to investment income paying for it.   FI is awesome to think about but it's not an immediate goal of mine.

To the original poster, sorry for the threadjack.  :)