Author Topic: Paying off mortgage?  (Read 15546 times)

1larogers

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Paying off mortgage?
« on: December 09, 2016, 09:08:45 PM »
This must have been addressed, but I can't find a blog entry for it.

I don't understand the thinking behind paying off a primary residence if you can finance for 3% and leverage the money for other investments with a higher return? I think this is pretty standard, but it doesn't seem to be the norm on this wonderful, amazing site. Thank you for all the inspiration. 

JustTrying

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Re: Paying off mortgage?
« Reply #1 on: December 09, 2016, 09:42:41 PM »
Yes, most mustachians would agree that you should invest rather than pay off the mortgage if your interest rate is super low.

WackyTomato

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Re: Paying off mortgage?
« Reply #2 on: December 10, 2016, 03:29:26 AM »
I disagree.

You can do all the math you want, but at then end of the day, paying off debts is never a bad move in my opinion.

There is also considerable psychological satisfaction from actually owning your house 100%.  Personally, I absolutely hate paying interests.

Davids

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Re: Paying off mortgage?
« Reply #3 on: December 10, 2016, 06:05:05 AM »
I would not fault anyone who has a 3% mortgage and pays it off early. There is a psychological factor of being debt free that some people value highly.

chasesfish

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Re: Paying off mortgage?
« Reply #4 on: December 10, 2016, 06:38:04 AM »
The never settled debate....just don't spend all the money.   Option A of paying off your mortgage and Option B of investing are both good choices.  Option C of blowing the money instead of doing A & B is the poor choice.

It usually comes down to a marginally higher net worth if you leave your mortgage in place vs. the peace of mind and lower monthly obligation of paying off your mortgage in full.

ltt

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Re: Paying off mortgage?
« Reply #5 on: December 10, 2016, 08:20:18 AM »
We paid off our mortgage about 8 years ago when the financial crisis was starting.  Have never regretted it--ever.  It was a fairly large payment that hasn't been hanging over our head for the last 8 years, and it feels great---never writing a monthly mortgage check.  From a financial standpoint, I understand why people say don't pay it off, but from a personal standpoint, I thoroughly understand why people say pay it off.  In the end, it's up to the individual and what works best for them.

Linea_Norway

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Re: Paying off mortgage?
« Reply #6 on: December 10, 2016, 08:29:06 AM »
I regretted once that I had paid off the mortage. About a year later we bought a cabin and didn't have enough stash to pay for it. So we had to take up a 50% mortage for a year and a half. As the house was paid down, I could just adjust the amount of loan on the house. We had to pay a new sum for a new mortgage. It might have been cheaper tp not have removed the whole loan.
But for all other respects, it is very satisfying to not have debts.

BlueHouse

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Re: Paying off mortgage?
« Reply #7 on: December 10, 2016, 12:03:24 PM »
It's a personal decision based on one's tolerance for risk.  That's what it comes down to. 

You identify the risks and quantify them before you can determine your tolerance for each risk.  Financial risk is only one part of the equation to me. 

Retire-Canada

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Re: Paying off mortgage?
« Reply #8 on: December 10, 2016, 12:23:37 PM »
This must have been addressed, but I can't find a blog entry for it.

I don't understand the thinking behind paying off a primary residence if you can finance for 3% and leverage the money for other investments with a higher return? I think this is pretty standard, but it doesn't seem to be the norm on this wonderful, amazing site. Thank you for all the inspiration.

I'd rather have $400K extra in my portfolio and a $400K mortgage as long as rates are low like they are now.

Debts_of_Despair

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Re: Paying off mortgage?
« Reply #9 on: December 10, 2016, 12:24:52 PM »
I like waking up every morning knowing I don't own anyone a single penny.  At the same time, I also like taking all the money that was previously going to my mortgage and putting it in investment accounts.  Best of both worlds, IMO.

t5inside

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Re: Paying off mortgage?
« Reply #10 on: December 10, 2016, 12:27:39 PM »
Personally I keep going back and forth. At 2.5% on a 15 year, I don't think I can bring myself to pay any extra. Instead what I plan to do is invest, then in 5-7 years when my investment account is worth the remaining mortgage balance, re-evaluate and maybe pay it off early (otherwise just keep investing, I'm only 29 and 44 is still young enough to pay it off)

LAGuy

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Re: Paying off mortgage?
« Reply #11 on: December 10, 2016, 12:32:18 PM »
One of the best reasons for carrying a mortgage is for the interest write off while working, especially if you're in the 25% tax bracket or higher. The supposed new Trump tax plan will massively increase standard deductions. If that happens, the ability for most of the middle class to write off their mortgage interest will go away and paying off the mortgage starts to seem like a much better idea. Certainly, having your mortgage paid off once you're no longer working is an extremely good idea as it allows you to reduce the amount of money you need to take from your investments, thus reducing your tax bill (or another way of looking at it, allow you to have more spend in retirement at a lower tax bill).

Debts_of_Despair

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Re: Paying off mortgage?
« Reply #12 on: December 10, 2016, 01:16:27 PM »
Re: interest tax deduction, I never understood this logic.  Pay the bank $100 so you can save $25 on taxes.  No thanks.  I understand it effectively lowers your interest rate but I'd rather just keep the $100 to do as I please with it.

Linea_Norway

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Re: Paying off mortgage?
« Reply #13 on: December 10, 2016, 02:27:04 PM »
This must have been addressed, but I can't find a blog entry for it.

I don't understand the thinking behind paying off a primary residence if you can finance for 3% and leverage the money for other investments with a higher return? I think this is pretty standard, but it doesn't seem to be the norm on this wonderful, amazing site. Thank you for all the inspiration.

I'd rather have $400K extra in my portfolio and a $400K mortgage as long as rates are low like they are now.

Isn't the issue with stock that it in theory can go down to zero. The chance is not very big, but it could happen. In that case you would keep sitting with the mortgage. It is taking an extra chance to invest with borrowed money.

lostamonkey

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Re: Paying off mortgage?
« Reply #14 on: December 10, 2016, 02:46:06 PM »
This must have been addressed, but I can't find a blog entry for it.

I don't understand the thinking behind paying off a primary residence if you can finance for 3% and leverage the money for other investments with a higher return? I think this is pretty standard, but it doesn't seem to be the norm on this wonderful, amazing site. Thank you for all the inspiration.

I'd rather have $400K extra in my portfolio and a $400K mortgage as long as rates are low like they are now.

Isn't the issue with stock that it in theory can go down to zero. The chance is not very big, but it could happen. In that case you would keep sitting with the mortgage. It is taking an extra chance to invest with borrowed money.

Mustachians are investing in index funds. There is almost a zero chance of them becoming worthless unless there is an appocalyse or communist revolution. Even if Vanguard went under, you would be fine. If there is an appocalyse or communist revolution, your money is the last thing you will be worried about.

If you choose to pay off your low interest mortgage early instead of investing, you will likely have to work longer and reach FIRE later. If the phychological benefits of being debt free for you is worth it then have at it.

Syonyk

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Re: Paying off mortgage?
« Reply #15 on: December 10, 2016, 08:12:30 PM »
Why don't you bring up religion and politics while you're at it? :p

Oh... well, I see politics already showed up anyway.

It depends on what you expect to happen going forward, and what your personal risk tolerances are.  Looking back, investing the extra seems reasonable.  Looking forward, with the world past peak oil, global weirding affecting economies, the bit of financial shell games going on to keep "growth" going, and other related things, it's not certain that the next decades will maintain the same growth as the last decades - which would favor the guaranteed return of paying off a mortgage over the uncertainty.

And then there's my problem, which was that banks don't loan money to bums.  Two months between jobs for moving?  That's fine.  Three months, even with a signed employment contract?  Well, that's just no good, and you're a worthless bum, because you could just go to Vegas and blow all that money after getting the mortgage, couldn't you?  So I shuffled some stuff and wrote a check.  The lender was not entertained when he figured out he wasn't getting a commission this time...

waltworks

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Re: Paying off mortgage?
« Reply #16 on: December 10, 2016, 10:11:15 PM »
Throw out the "world goes to hell" shitshow scenario, because in that case, it doesn't matter whether you paid off your house or invested. If your index funds go to zero, it's because we are all dead.

If owing money drives you nuts and you are very risk averse, pay it off.

If optimizing your finances and making calculated risk type decisions is your thing, don't pay it off any faster than you have to.

-W

Syonyk

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Re: Paying off mortgage?
« Reply #17 on: December 10, 2016, 10:20:18 PM »
They don't have to go to zero. They just have to offer a lower return than a mortgage interest rate over the period of relevance.

WackyTomato

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Re: Paying off mortgage?
« Reply #18 on: December 11, 2016, 01:21:09 AM »
If you choose to pay off your low interest mortgage early instead of investing, you will likely have to work longer and reach FIRE later. If the phychological benefits of being debt free for you is worth it then have at it.

This is highly questionable and it also depends on whether you plan on changing homes a lot over the next decade or two.

Also, banks are always taking a crapload of interests on your mortgage over the first few years, likely to mitigate the risks that the consumer will switch mortgage to another bank.  Personally, I don't know why this is legal but here we are...

waltworks

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Re: Paying off mortgage?
« Reply #19 on: December 11, 2016, 10:09:39 AM »
This is highly questionable and it also depends on whether you plan on changing homes a lot over the next decade or two.

Also, banks are always taking a crapload of interests on your mortgage over the first few years, likely to mitigate the risks that the consumer will switch mortgage to another bank.  Personally, I don't know why this is legal but here we are...

If this is your understanding of how amortization works, please, please stop offering financial advice to anyone (here or elsewhere).

Wow.

-W

BlueHouse

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Re: Paying off mortgage?
« Reply #20 on: December 11, 2016, 10:26:33 AM »
This is highly questionable and it also depends on whether you plan on changing homes a lot over the next decade or two.

Also, banks are always taking a crapload of interests on your mortgage over the first few years, likely to mitigate the risks that the consumer will switch mortgage to another bank.  Personally, I don't know why this is legal but here we are...

If this is your understanding of how amortization works, please, please stop offering financial advice to anyone (here or elsewhere).


Wow.

-W

What waltworks means is that the interest RATE (fixed) is the same throughout the loan.  The reason you're paying so much more in the beginning of the loan than toward the end of the loan is because your principal balance is higher.  The math is Interest Rate * Principal Balance = Interest owed (annual).  Do the calculation at the beginning of the loan when you still owe 200,000 and again at the end of the loan when you still owe $50,000 and you'll see the difference.   
I hope that helps.

waltworks

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Re: Paying off mortgage?
« Reply #21 on: December 11, 2016, 10:28:54 AM »
They don't have to go to zero. They just have to offer a lower return than a mortgage interest rate over the period of relevance.

This only sort of true, because it ignores the liquidity (pretty important) and diversification (very important) advantages of an index fund. Your house can have problems not covered by insurance, your neighborhood can get horribly crappy, a natural disaster can make your whole area uninhabitable, etc. And if you need money (to jump on another investment, to pay a debt, etc) it's a lot easier to sell some stock than take out a HELOC (which might be impossible to get anyway if you're FIRE without regular employment).

-W

tomsang

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Re: Paying off mortgage?
« Reply #22 on: December 11, 2016, 10:54:20 AM »
Everything you could ever want to know about paying off your mortgage!!!

http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg66727/#msg66727

There are calculators in the pages that show you how much it pushes back your retirement date by paying it off early vs. investing the funds.  Lots of discussion on how you are safer having a mortgage and a larger portfolio.  As someone mentioned it comes down to psychology.  The math and logic support keeping the mortgage, so the key is to reset the idea of it being bad to pay interest and reset the idea that you are safer with a paid off or partially paid off mortgage.  Good luck!


HoundDog

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Re: Paying off mortgage?
« Reply #23 on: December 11, 2016, 11:14:29 AM »
I highly recommend this article:

https://www.kitces.com/blog/why-keeping-a-mortgage-and-a-portfolio-may-not-be-worth-the-risk/

A quote from the article:

Quote
... its not sufficient to just get a higher return from stocks than it costs to borrow on the mortgage. The borrowing cost of the mortgage or rather, the effective return that you get by repaying the mortgage and eliminating the associated interest cost is a guaranteed, risk-free return. Investing in stocks, on the other hand, is risky. No investor would prudently pick a highly risky return just because its barely higher than a risk-free alternative!

In other words, what people forget is that there's a concept of "risk-adjusted return." Yes, an index fund can typically beat a low-interest mortgage. But one carries a degree of risk and the other doesn't.

The whole idea of investing is that you get a reward for taking on risk. So it's not enough that your stock investments give you a better return that paying off your 3.5% mortgage early. The question is, how much better was the return -- and was it worth the added risk? Some would argue that the difference needs to be about 4% in this case. In other words, if you felt you could get a 7.5% return in an index fund, then yes, that was the right thing to do vs. paying off the mortgage. Any lower and it's a lot dicier.

My point isn't that you should do one thing or another, or that 4% is the right figure to use. I just wanted to note that the issue isn't as simple as some seem to think.


« Last Edit: December 11, 2016, 11:17:30 AM by HoundDog »

tomsang

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Re: Paying off mortgage?
« Reply #24 on: December 11, 2016, 11:32:39 AM »
I highly recommend this article:

https://www.kitces.com/blog/why-keeping-a-mortgage-and-a-portfolio-may-not-be-worth-the-risk/

A quote from the article:

Quote
... its not sufficient to just get a higher return from stocks than it costs to borrow on the mortgage. The borrowing cost of the mortgage or rather, the effective return that you get by repaying the mortgage and eliminating the associated interest cost is a guaranteed, risk-free return. Investing in stocks, on the other hand, is risky. No investor would prudently pick a highly risky return just because its barely higher than a risk-free alternative!

In other words, what people forget is that there's a concept of "risk-adjusted return." Yes, an index fund can typically beat a low-interest mortgage. But one carries a degree of risk and the other doesn't.

The whole idea of investing is that you get a reward for taking on risk. So it's not enough that your stock investments give you a better return that paying off your 3.5% mortgage early. The question is, how much better was the return -- and was it worth the added risk? Some would argue that the difference needs to be about 4% in this case. In other words, if you felt you could get a 7.5% return in an index fund, then yes, that was the right thing to do vs. paying off the mortgage. Any lower and it's a lot dicier.

My point isn't that you should do one thing or another, or that 4% is the right figure to use. I just wanted to note that the issue isn't as simple as some seem to think.

If your investments are not going to outperform 3% or less after tax benefits over a 30 year period of time, then do not plan on retiring with a Safe Withdrawal Rate over 1%.  The US stock market has never had a 30 year stretch of returns less than 7%.  The reason the 4% SWR works is to adjust for inflation and for the ups and downs of the stock market.  If you are prepaying a 3% or less after tax benefits, you are locking in a loss compared to the 4% rule.  For the 4% rule to work you need to average approximately 7% over 30 years.  If you are locking in less that 3% you by definition are pushing out your retirement date.  Check out the other blog as it is pretty detailed. 

Prepaying a mortgage also locks up your capital in an illiquid asset.  If the shit hits the fan 3 years into paying off a mortgage early, you can not call up the bank and say that I have prepaid three years of payments.  They will say, make your monthly payment or we will start foreclosure proceedings.  Read the link and you will see the math, the added risk you are taking by locking up your investment capital into a mortgage, etc.

Linea_Norway

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Re: Paying off mortgage?
« Reply #25 on: December 11, 2016, 11:33:49 AM »
I have always had some rules:
- don't borrow money for something else than buying property or financing an education
- don't invest with money that you can't afford to loose in a worst case scenario

I personally are not extremely comfortable having a lot of money in stock. I use index funds and that feels a bit safer than other stock funds. But there is allways a risk that the marked might collapse and I wouldn't want to keep sitting with a high mortgage. But it is indeed one's personal choice for risk taking.

waltworks

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Re: Paying off mortgage?
« Reply #26 on: December 11, 2016, 11:41:32 AM »
I think the concept of "risk" is being misused here. The "risk" of running out of money is HIGHER with the paid off house.

Additionally, paying off a debt backed by a single asset in one location is probably not risk-free by any reasonable standard.

I sometimes wonder if the "I'm too conservative to own stocks" folks are just not great with math, because in the scenario we're talking about here, the conservative route is really the opposite. You can just *dislike debt* for whatever reason (which is totally legitimate) but you are taking on *more* risk by paying off a mortgage (at least the low interest ones most of us now presumably have in the US).

-W

tomsang

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Re: Paying off mortgage?
« Reply #27 on: December 11, 2016, 11:50:13 AM »
http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg66727/#msg66727

All of this has been covered in the posts above.  An area of confusion for those living outside of the country is that The US offers/Offered 30 year fixed rate mortgages for less than 4% and in many cases 3%, plus on top of that they allow you to deduct your mortgage interest from your taxes.  These loan interest rates can not increase or change unless you sell the house.  This was a gift from the government to spark investment in the US and financial security after the great recession.  It was a once in a life time gift to mortgage holders.  If you are prepaying your mortgage at these rates you are giving back this huge gift to homeowners.  The math and how much it pushes back your financial retirement date can be calculated, the same way that you can calculate your safety through Cfiresim and other calculators. 

Retire-Canada

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Re: Paying off mortgage?
« Reply #28 on: December 11, 2016, 12:19:59 PM »
Isn't the issue with stock that it in theory can go down to zero. The chance is not very big, but it could happen. In that case you would keep sitting with the mortgage. It is taking an extra chance to invest with borrowed money.

If the global stock market went to zero having a mortgage would be the least of my worries. It would be zombie & cannibal time. The only things that would have value would be chainsaws, gasoline, shotgun shells and MREs.

I willing to take my chances that my investment portfolio doesn't go to zero.

I think there is a greater chance my home value will go to zero than that ^^^ happening.
« Last Edit: December 11, 2016, 05:14:13 PM by Retire-Canada »

SeaEhm

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Re: Paying off mortgage?
« Reply #29 on: December 11, 2016, 12:47:06 PM »
Do what makes you happier and lets you sleep better at night.

Not every purchase and item of ownership is in the truest form of simplicity. 

HoundDog

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Re: Paying off mortgage?
« Reply #30 on: December 11, 2016, 12:53:09 PM »
http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg66727/#msg66727

All of this has been covered in the posts above.  An area of confusion for those living outside of the country is that The US offers/Offered 30 year fixed rate mortgages for less than 4% and in many cases 3%, plus on top of that they allow you to deduct your mortgage interest from your taxes.  These loan interest rates can not increase or change unless you sell the house.  This was a gift from the government to spark investment in the US and financial security after the great recession.  It was a once in a life time gift to mortgage holders.  If you are prepaying your mortgage at these rates you are giving back this huge gift to homeowners.  The math and how much it pushes back your financial retirement date can be calculated, the same way that you can calculate your safety through Cfiresim and other calculators.

It's irrelevant whether or not it's a "once in a lifetime gift," by somebody's definition. Either you are getting appropriately compensated for your risk in the stock market, or you're not. And if not, I'd pre-pay the mortgage.

The relevant factors are: your mortgage rate, your expected stock market returns, and your risk tolerance (and, by extension, appropriate "risk premium").

As I said, I don't pretend to have answers for anyone. I just want to point out that it's not as simple as, "I could do better with stocks!"

tomsang

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Re: Paying off mortgage?
« Reply #31 on: December 11, 2016, 01:08:58 PM »
http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg66727/#msg66727

All of this has been covered in the posts above.  An area of confusion for those living outside of the country is that The US offers/Offered 30 year fixed rate mortgages for less than 4% and in many cases 3%, plus on top of that they allow you to deduct your mortgage interest from your taxes.  These loan interest rates can not increase or change unless you sell the house.  This was a gift from the government to spark investment in the US and financial security after the great recession.  It was a once in a life time gift to mortgage holders.  If you are prepaying your mortgage at these rates you are giving back this huge gift to homeowners.  The math and how much it pushes back your financial retirement date can be calculated, the same way that you can calculate your safety through Cfiresim and other calculators.

It's irrelevant whether or not it's a "once in a lifetime gift," by somebody's definition. Either you are getting appropriately compensated for your risk in the stock market, or you're not. And if not, I'd pre-pay the mortgage. The relevant factors are: your mortgage rate, your expected stock market returns, and your risk tolerance (and, by extension, appropriate "risk premium").

As I said, I don't pretend to have answers for anyone. I just want to point out that it's not as simple as, "I could do better with stocks!"

The point is if you can't beat 3% or less after tax incentives with the stock market over 30+ years, then you can not retire early with anything over a 1% Safe Withdrawal Rate.  It does not mathematically make sense.  Your life expectancy will be what drives your retirement ability, not your portfolio returns.  So those who are paying off their mortgage, should not be focused on Early Retirement as you can't get there without the stock market performing at least as good as the worst 30 year stretch, which happens to be over 7%.  This is the same logic on why you can't retire early if all of your investments are in cash.  If you are betting on the stock market to reflect an return of less than 3% pre inflation return over the next 30 years, then you are by definition expecting there to be deflation.  If you believe that deflation is in the future, then you should not own a house or other assets as they will decrease in value over the future and hurt your chances of retiring. 

If you feel otherwise, please show me the math.  Every calculator, every 4% study, and every piece of financial advice is based on people using equity to generate returns to support a retirement.  You can't pick and choose based on feelings and then say that the calculators say you are safe with a 3% or 2% Safe Withdrawal Rate.  If you put the information into any of the calculators it will show you that if you can't get a 3% fixed return pre inflation, you can't retire with a Safe Withdrawal Rate of 1% or more.   

HoundDog

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Re: Paying off mortgage?
« Reply #32 on: December 11, 2016, 01:21:03 PM »
So no one on this board has both paid off a mortgage early and retired early?

waltworks

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Re: Paying off mortgage?
« Reply #33 on: December 11, 2016, 01:22:32 PM »
So no one on this board has both paid off a mortgage early and retired early?

Of course people have. But it's not the optimal strategy mathematically. At current/recent interest rates in the US, it's arguably a *terrible* idea.

-W

tomsang

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Re: Paying off mortgage?
« Reply #34 on: December 11, 2016, 01:24:14 PM »
So no one on this board has both paid off a mortgage early and retired early?

They did it even though the math shows that they would have been significantly better off keeping the mortgage.  If they were doing it mathematically and saying that they can't expect to get a return better than 3%, then they could not justify retiring early.  It does not mathematically make sense.  You can calculate how much it is pushing back or hurting your quest to retirement with the spreadsheets in the link provided. 

HoundDog

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Re: Paying off mortgage?
« Reply #35 on: December 11, 2016, 01:32:41 PM »
So no one on this board has both paid off a mortgage early and retired early?
If they were doing it mathematically and saying that they can't expect to get a return better than 3%, then they could not justify retiring early.

It sounds like you may not have read the article I originally linked to. The point is that "a return better than 3%" is not good enough.

It's not fair to compare a risk-free return to a potential (risk-laden) stock return. Past stock performance is no guarantee of future returns. You need to be sure you're compensating yourself appropriately for the risk you're taking. If you have a 3% effective mortgage rate, I'd suggest hanging onto that mortgage and investing in stocks (or whatever other investment you like) if you think you can get a return of 7% to 8%.

Otherwise, I'd pay off the mortgage early.

It really depends on your personal situation. No two situations are the same!

doneby35

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Re: Paying off mortgage?
« Reply #36 on: December 11, 2016, 01:51:12 PM »
If one was able to pay off the mortgage in 5 years instead of 15, with additional principal payments, and the market just so happens to be down during that period, then I would think that would make one feel more comfortable with the fact that it is a guaranteed 3% return. I don't see how risking it all with stocks when the market is down could make anyone more comfortable than not having a monthly $1000 for a mortgage payment for example.
« Last Edit: December 11, 2016, 02:06:10 PM by doneby35 »

waltworks

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Re: Paying off mortgage?
« Reply #37 on: December 11, 2016, 01:52:52 PM »
Let's define "risk" here, shall we?

You have a limited lifetime, and if you want to spend that time working as little as possible (sort of the background situation here), then you are "spending" your years accumulating assets until you have enough to not work anymore.

When you spend more time working (which, statistically, you will if you are paying off your mortgage early, or want a 2% SWR and keep saving up to get there, or blow your money on hookers and yachts), you are *guaranteeing* that you will lose some of your non-renewable supply of life.

In that context, I see the decision to pay off very low interest debt as the DEFINITION OF RISKY. You are, in essence, *betting against yourself*.

Again, if you just hate being in debt for any reason, there is a quality of life issue that makes the math meaningless - the goal is to be happy, not just to optimize your financials. If your goal is to stop working as early as possible and not run out of money in retirement, though, paying off your mortgage is probably a terrible decision.

-W

waltworks

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Re: Paying off mortgage?
« Reply #38 on: December 11, 2016, 01:55:39 PM »
If one was able to pay off the mortgage in 5 years instead of 15, with additional principal payments, and the happens just so happens to be down during that period, then I would think that would make one feel more comfortable with the fact that it is a guaranteed 3% return. I don't see how risking it all with stocks when the market is down could make anyone more comfortable than not having a monthly $1000 for a mortgage payment for example.

You are fundamentally misunderstanding the mathematics of FIRE here, as well as liquidity and diversification and how they matter.

That said, for folks who don't like math and are scared of stocks (unfortunately many people), it's probably better to pay off the house as a form of enforced savings.

-W

Telecaster

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Re: Paying off mortgage?
« Reply #39 on: December 11, 2016, 02:08:27 PM »
I highly recommend this article:

https://www.kitces.com/blog/why-keeping-a-mortgage-and-a-portfolio-may-not-be-worth-the-risk/

A quote from the article:

Quote
... its not sufficient to just get a higher return from stocks than it costs to borrow on the mortgage. The borrowing cost of the mortgage or rather, the effective return that you get by repaying the mortgage and eliminating the associated interest cost is a guaranteed, risk-free return. Investing in stocks, on the other hand, is risky. No investor would prudently pick a highly risky return just because its barely higher than a risk-free alternative!

In other words, what people forget is that there's a concept of "risk-adjusted return." Yes, an index fund can typically beat a low-interest mortgage. But one carries a degree of risk and the other doesn't.

The whole idea of investing is that you get a reward for taking on risk. So it's not enough that your stock investments give you a better return that paying off your 3.5% mortgage early. The question is, how much better was the return -- and was it worth the added risk? Some would argue that the difference needs to be about 4% in this case. In other words, if you felt you could get a 7.5% return in an index fund, then yes, that was the right thing to do vs. paying off the mortgage. Any lower and it's a lot dicier.

My point isn't that you should do one thing or another, or that 4% is the right figure to use. I just wanted to note that the issue isn't as simple as some seem to think.

Kitces is a super smart guy and I love his stuff, but he makes a persistent mistake namely he confuses volatility and risk.   Which is what they teach you in business school and lot of people make that same mistake.   However, volatility is NOT risk.   

Essentially what he is saying in that article is that you should demand a risk premium for investing in the stock market.  Since the risk free return rate is 2% (government bonds), and paying down the 4% mortgage gives you 2% over that rate.   Stocks, he says, should command a 5% bump over the risk free rate, or 7%  return.    Since we might not get 7% over the next few years, perhaps stocks aren't worth it.

But that's wrong.   Risk is the chance of the permanent loss of capital.   A typical home mortgage is 30-years.  So that's the time period of interest.  Over a 30-year period the risk of permanently losing money in the broad stock market is essentially zero.   Right?     So we don't need a risk premium.   All we need is to be reasonably confident that over that period, stocks will return greater than the mortgage interest rate.   The odds of that are really good.   


Syonyk

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Re: Paying off mortgage?
« Reply #40 on: December 11, 2016, 03:03:51 PM »
So those who are paying off their mortgage, should not be focused on Early Retirement as you can't get there without the stock market performing at least as good as the worst 30 year stretch, which happens to be over 7%.  This is the same logic on why you can't retire early if all of your investments are in cash.  If you are betting on the stock market to reflect an return of less than 3% pre inflation return over the next 30 years, then you are by definition expecting there to be deflation.  If you believe that deflation is in the future, then you should not own a house or other assets as they will decrease in value over the future and hurt your chances of retiring.

It depends on one's path towards retirement.  I think the markets are likely to be iffy at best during my remaining life, so I've been focusing on productive property investments that keep my cost of living as low as possible once I semi-retire or fully retire or whatever it is I'm planning to call it.

So, solar, gardens, greenhouses, water storage, etc - and, in the case of solar, I'm oversizing it somewhat with money now, so I can either bank kWh going forward, still be ~0 power bill as the panels degrade, power an electric car, or some combination of all of those - so by effective prepaying my power bill for (ideally) the next 50+ years, I reduce my uncertainty going forward.  I'm also planning to go with string inverters over micro inverters, so I can hook up a battery bank if I see the need for that in the future (being able to run fully or partially off grid).  And have copper run so I can interconnect my various systems if needed (my office is currently totally off grid, and I'd like to be able to power basics in the house from there if needed - which does mean I need to snag a two phase inverter for out there at some point).

Same is true for the gardens and greenhouses.  I'm working towards being able to, if required, meet most of my needs immediately on the property, with a surplus to trade/sell/take care of family/etc.  I'd like to be able to live comfortably on under $10k/yr, if I need to.  I'd prefer to have more coming in and spend more, but I'm aiming for the ability to run extremely inexpensively as an option.

I disagree that the markets are the only path towards early retirement, and am working towards proving that theory.

Nations and currencies go through their arcs and decay, and I'd rather still be flexible if something happens to the dollar (which I consider to be a reasonable enough chance during my expected remaining 60 years or so to be worth considering).  This is part of why I keep a non-trivial chunk of value in not-dollars as well (including bitcoin, because why not?).

I agree that looking backwards, tossing everything into the stock markets makes sense, but past returns are no guarantee of future performance and all that, and I see some impressive storms on the horizon that make me question the next 5 decades of market performance.

Maybe I'm wrong and I'd have been better off in the markets.  Oh well.  I do have money in the markets, and if that performs nicely, awesome bonus.  I'd rather be heavily diversified in paths to not needing a full time job (technically, I'm already there as I work part time), but if one of the variety of things I think are possible in my lifetime comes to pass, I'd rather have put some effort into hedging against that, such that it leaves me in a better place after that event.

As far as deflation and not owning assets goes, a paid off house is an entirely reasonable thing to, you know, live in.  I don't expect it to appreciate over time, as I'm not in a crowded coastal city.  I expect it to decrease in value over time as it gets older, but I intend to keep living in it for the rest of my life.

Also, the mortgage question is irrelevant to me as I wasn't able to get one anyway...

waltworks

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Re: Paying off mortgage?
« Reply #41 on: December 11, 2016, 03:07:00 PM »
If you're looking at this from a prepper frame of mind, it's totally irrelevant whether you pay off the mortgage or invest, though, right?

Why even post that? If you're that fearful, it makes sense to do everything you're doing. But it also makes sense to *pay the minimum on any low interest debt* since there's a chance you will actually never have to finish paying it, right? In the context of the OP's question, your post doesn't make much sense, except that you feel the world will be in a worse place in the future than it is now (which, as I just said, probably means pay the minimum on the mortgage, though you might "invest" in solar/greenhouse/etc in your case).

-W

Syonyk

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Re: Paying off mortgage?
« Reply #42 on: December 11, 2016, 03:17:14 PM »
If you're looking at this from a prepper frame of mind, it's totally irrelevant whether you pay off the mortgage or invest, though, right?

Not entirely.  If one assumes a catastrophic overnight event, sure.  I agree.  If one assumes things proceed as normal as nations go down the backside of their arc through history, banks are still going to be pretty upset if one doesn't pay one's mortgage for a long while.

Quote
If you're that fearful, it makes sense to do everything you're doing. But it also makes sense to *pay the minimum on any low interest debt* since there's a chance you will actually never have to finish paying it, right?

I entirely agree - in the context of unsecured debt.  I've got a bunch of money sitting on 0% CCs, and I'm not going to pay that off before it's due.  In the context of secured debt (car, house, etc), I disagree.  Plenty of things can happen that interfere with one's ability to pay that debt, and the lender is highly likely to come looking for the property securing the loan - which, in the case of a house, is rather easy to find.

HoundDog

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Re: Paying off mortgage?
« Reply #43 on: December 11, 2016, 03:22:02 PM »
If you're looking at this from a prepper frame of mind, it's totally irrelevant whether you pay off the mortgage or invest, though, right?
Most "preppers" that I've ever heard of would want zero mortgage debt. They'd want as little to do with the financial system as possible, and wouldn't enjoy the idea that their house could be taken away if their income were disrupted. Most don't like the idea of property taxes and insurance, either, but not much they can do about that.

waltworks

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Re: Paying off mortgage?
« Reply #44 on: December 11, 2016, 03:42:06 PM »
Yeah, if we're on the backside of history/about to enter a new dark age... no ER for anyone. So there is no point discussing stocks vs. mortgages. You will keep working at some level (perhaps as a subsistence farmer) until you die in that scenario, because even if your house is paid off - there is no wider scale economy in place to support passive income.

Again, irrelevant to the OP's question.

Let me be clear: there is nothing wrong with preparing for bad stuff. But if you spend all your time thinking that way, there is really no point in worrying about "retirement" in the sense that it is used on this forum (living off of passive income/doing what is most fulfilling for you whether it is "work" or not) because that sort of "retirement" won't exist in your dystopian future. 

-W

Syonyk

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Re: Paying off mortgage?
« Reply #45 on: December 11, 2016, 03:44:48 PM »
Yeah, if we're on the backside of history/about to enter a new dark age... no ER for anyone. So there is no point discussing stocks vs. mortgages. You will keep working at some level (perhaps as a subsistence farmer) until you die in that scenario, because even if your house is paid off - there is no wider scale economy in place to support passive income.

I disagree, based on the fact that the arc of nations seldom involves a cliff.  It involves slow, uneven decline - during which time there are plenty of jobs, but market returns are unlikely to be positive for long periods of time.

Quote
Let me be clear: there is nothing wrong with preparing for bad stuff. But if you spend all your time thinking that way, there is really no point in worrying about "retirement" in the sense that it is used on this forum (living off of passive income/doing what is most fulfilling for you whether it is "work" or not) because that sort of "retirement" won't exist in your dystopian future.

That depends on if one's idea of a good time involves gardening/aquaponics or not! :)

waltworks

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Re: Paying off mortgage?
« Reply #46 on: December 11, 2016, 03:51:23 PM »
Well, that's great. If you enjoy farming, you are all set regardless. It's *still* probably in your best interest to pay off the debt as slowly as possible (if you're really a prepper, hyper/high inflation should be pretty high on your list of worries).

I prefer to be optimistic about the future and embrace some uncertainty/volatility. The human race has come a long way and I see no reason that can't continue indefinitely.

-W

Cathy

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Re: Paying off mortgage?
« Reply #47 on: December 11, 2016, 04:25:24 PM »
It's clear what the correct answer is when it comes to the perennial debate about prepaying fixed-rate non-callable government-favoured low-interest tax-deductible long-term possibly-non-recourse debt secured by an instrument on which creators are generally slow to foreclose.

The more interesting question to me is why so many Americans and Canadians get the analysis so very wrong. As an initial matter, math is hard, and is not taught very comprehensively in pre-university education, so that is probably part of the issue. However, that doesn't explain the entire problem because some very intelligent people who are normally very good at math -- such as Kitces and a certain long-term forum poster here -- still manage or managed to come to the wrong conclusion. I am starting to think that a contributing factor to the misunderstanding is the interaction of two prevailing societal norms, specifically:
  • The popular news media tells us that the mark of success and adulthood in a capitalistic society is ownership of a home. The state reinforces this narrative through an array of tax and other incentives.
  • In many people's minds, they don't "own their home" unless and until they hold legal title free of any charge.

The logical conclusion is that one should purchase a home and then pay off any mortgage loans as fast as possible.

Neither of the two underlying propositions makes much sense, but from my observations in everyday life, and from reading many forum threads on this topic, these seem to be widely held beliefs, which to a certain extent are even forwarded by the educational system.

I am not sure what the solution is to helping people understand this issue better. In typical forum discussions, patient explanation never seems to work, because even if somebody recognises that their original arguments are wrong, they then fall back on "but it gives me pleasure to prepay my loan" and how we can challenge that?
« Last Edit: December 11, 2016, 04:38:43 PM by Cathy »

HoundDog

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Re: Paying off mortgage?
« Reply #48 on: December 11, 2016, 06:04:33 PM »
they then fall back on "but it gives me pleasure to prepay my loan" and how we can challenge that?
Why would it be necessary or desirable to challenge that?

Also, saying that Kitces "managed to come to the wrong conclusion" does not mean that Kitces came to the wrong conclusion.

Cathy

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Re: Paying off mortgage?
« Reply #49 on: December 11, 2016, 06:30:51 PM »
they then fall back on "but it gives me pleasure to prepay my loan" and how we can challenge that?
Why would it be necessary or desirable to challenge that?

Personally, I consider it "desirable" because I'm interested in helping people retire as early as possible. It's not "necessary" for me to provide this help of course, just like it's unnecessary to donate to charity or engage in other good work, but these are all altruistic pursuits. In fact, it's actually probably in my financial interest for people to make bad financial decisions insofar as it prolongs their working careers, keeps them dependent on an employer, and generally drives them to continue doing work that enriches me, as somebody who owns (in part) the means of production. As it turns out, though, I'm motivated by more than just base self-interest. If we stuck to only "necessary" activities, we wouldn't be posting to this forum at all. There's more to life than what's necessary.

That said, thank you for your question. I think it's important to periodically take a step back and ask why we are doing something, even something like posting to a forum. Critical analysis should be directed inward as well, and regularly questioning our own motives is valuable.
« Last Edit: December 11, 2016, 06:40:35 PM by Cathy »