Author Topic: Prepaying Mortgage Versus Investing More Pre-FIRE?  (Read 2374 times)

desert_phoenix

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Prepaying Mortgage Versus Investing More Pre-FIRE?
« on: April 25, 2019, 08:34:04 PM »
Is there a standard mustachian answer to this?  I find the call very tough to make.  I think it might make more sense to pay off the mortgage to have lower required expenses, but since I believe enough in equities to stay 100% stock outside of my emergency fund, I feel like I should be consistent and keep the mortgage and never pay extra.

Thoughts?

happy

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #1 on: April 25, 2019, 08:42:45 PM »
Basically 2 camps. If your mortgage is very low interest as is common in the States it usually makes more mathematical sense to invest making a higher amount of interest/dividends. For others, nothing beats being debt free, so they will prefer to pay this off.

If you look around you'll find some fiercely argued threads on this.

The numbers are different in Australia where I am but FWIW  I've generally invested 50% and put the other 50% off the mortgage.

RWD

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #2 on: April 25, 2019, 08:52:04 PM »
Depends on your interest rate and some other variables. The standard Mustachian answer is to follow the Investment Order.

Laura33

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #3 on: April 26, 2019, 08:53:33 AM »
FWIW, I am splitting the difference:  I am keeping my very low mortgage while I am still employed, because my money is much better invested in the market; but I have also timed the mortgage to be paid off by my planned FIRE date, so I have the security of lower mandatory spend once I no longer have a steady income stream from an outside source.

I know there are many who take the position that you should take your mortgage to the grave with you, because keeping that extra money invested in the market will give you better returns regardless of whether you are 35 or 75.  But achieving and maintaining FI requires two conflicting considerations:  maximizing your gains; and minimizing your downside risk.  IMO, when you are in your asset-building years, it is appropriate to put more emphasis on maximizing gains, because you have the safety net of a consistent paycheck to carry you through any market downturns.  OTOH, when you are FIREd, it is appropriate to shift your emphasis to limiting risk -- not entirely, because you still need your assets to grow, but since your safety net of current income has gone away, it is reasonable to also get rid of leverage so you don't have to worry about pulling enough out of your investments to cover those debt payments.

formerlydivorcedmom

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #4 on: April 26, 2019, 09:53:16 AM »
FWIW, I am splitting the difference:  I am keeping my very low mortgage while I am still employed, because my money is much better invested in the market; but I have also timed the mortgage to be paid off by my planned FIRE date, so I have the security of lower mandatory spend once I no longer have a steady income stream from an outside source.

We are doing the same.

I actually started paying extra on our mortgage as soon as we got it, with the idea that it would be paid off a few years early...the year one of the kids turns 18 and child support stops.  I figure it is unlikely we stop spending on that kid cold turkey, so when that income dries up, the mortgage bill will go away instead of the cost of a teenager's car insurance.

As we got closer, we've realized that year will likely also coincide with our retirement. 

So we pay some extra every month, and we invest the rest.

SwordGuy

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #5 on: April 26, 2019, 02:55:13 PM »
If you're planning on getting rid of your mortgage when you FIRE, it's more likely to turn out financially better if you invest until you are nearing retirement, then pay the mortgage off with a lump sum payment.    That gives you max growth with the only risk being the market is way down when you planned to retire (which might have kept you from retiring anyway).

CanuckExpat

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #6 on: April 27, 2019, 03:46:08 PM »
If you believe there is a financial, or psychological benefit to paying off your mortgage, then you can do it, but even if that is the case, do not make extra pre-payments to principal. Instead, put aside those savings to another vehicle, then make large lump sum payments to your mortgage, and recast the mortgage at the same time. That way you get a cash flow benefit, and less downside risk in the future (you have lower monthly payments if something goes south).
Simply making pre-payments won't help your cash flow situation, a recast will.

That is assuming you are diligent and disciplined enough to set aside funds in a seperate savings vehicle, and then make a lump sum mortgage payment. If you are not disciplined enough, you could make extra principal payments, and then re-cast as convenient and fees allow.

desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #7 on: April 27, 2019, 08:51:06 PM »
Thanks for your thoughts, everyone. 

My mortgage is at 3.75%  It is a VA loan, which means it cannot be recast as far as I know.

According to the investment order, I should not pre-pay, since my mortgage is not 3% higher than the current 10-year Treasury note yield.

I already max my 401k and Roth.  I have no non-mortgage debt. My mortgage is small enough that, under the recent tax changes, I am likely to only ever take the standard deduction.

My only reason for paying early was thinking about future cash flow.  Maybe this question is closer to having a proper answer once I decide on a FIRE date?  The last few years have been a focus on savings/investing and wanting to avoid looking too hard at the math before I had a real 'stache to work with, if that makes sense. Now I am a couple hundred thousand in, so maybe it is time.

Perhaps I need to do a case study in a few months if I still feel unsure about it, since the mortgage is new and I am getting a small pay raise in June that will change my percentages on how much I am investing, etc...

In my head, I was throwing around two scenarios:

A)  Take the extra amount I'd need to pay on principal for month to finish payoff in 20 years and put it all into a taxable brokerage account.  Hope past returns are somewhat mirrored in the future and I am more likely than not to be substantially ahead in 20 years overall.  Then I could do something like SwordGuy said and maybe pay off what is left at year 20 in a big chunk since I would be FIRE'd by then.

B)  Take that amount for the 20-year payoff and pay against the mortgage now.  But if/when the next big crash comes, turn off the tap on the mortgage and put that money towards the "stocks on sale" until my overall returns get over some certain amount.

I think I prefer A since B has a bit of a market timing whiff to it.

CanuckExpat

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #8 on: April 28, 2019, 11:16:39 AM »
Specifics matter. At 3.75% it is really hard for me to think you gain much by pre-paying. Except phsychology, and cash flow once it's paid off.

Compare to the equivalent fixed income investments.
For small amounts of money, you can beat that with rewards checking accounts (a bit of work)
You can get semi-risky fixed income investments already that beat that.
The composite rate on ibonds is getting close to 3%.
Somewhere over the next x years, interest rates will finally go up, possibly, and you would be able to beat that on an FDIC account or government backed bond.

maizefolk

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #9 on: April 28, 2019, 11:21:59 AM »
If your goal is cash flow, prepaying doesn't help until you've actually paid the whole thing off, so you can punt the decision.

Save and investment outside your mortgage now, and once you have enough accumulated to pay off the mortgage in one fell swoop you can decide whether you'd like to actually do so or not.

desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #10 on: April 28, 2019, 01:24:36 PM »
Indeed.

My work offers a 401(a) in addition to the 401k (TSP since I am a fed) that I max.  It allows me to pay in up to 10% of my base salary, after tax, per pay period that can be rolled out once a year where my contributions can be rolled into my Roth IRA and my gains can be rolled into my TSP, all penalty and tax free.

The cool thing is that I only have to pay $5 a pay period to qualify it forever.  So if your 10% benefit is $205, then paying $5 only for 10 pay periods means you can pay in $2000 at any future time.

Do you all think that it would make sense to drop down to $5 a pay period on this benefit (which I currently max) and instead put the difference into a taxable brokerage account?  My thinking is that I could buy back the 401a benefit in the future following other increases in pay, but could be growing my taxable brokerage account in the meantime that would have no restrictions on it so I could make the call to use that money on the mortgage if it made sense to pay it off as soon as I wanted to FIRE.

I guess I have trouble because I don't want to think too much about FIRE or I will turn into a 70% savings rate person and never go outside, haha.  But without choosing an age to aim to FIRE at, it seems hard to make a best call on continuing to max the 401a or switching to increase that current value into my taxable brokerage account.

Telecaster

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #11 on: April 28, 2019, 01:35:28 PM »
Do you all think that it would make sense to drop down to $5 a pay period on this benefit (which I currently max) and instead put the difference into a taxable brokerage account?  My thinking is that I could buy back the 401a benefit in the future following other increases in pay, but could be growing my taxable brokerage account in the meantime that would have no restrictions on it so I could make the call to use that money on the mortgage if it made sense to pay it off as soon as I wanted to FIRE.

No, it is almost always desirable to max your tax advantaged space before going to the regular brokerage.   That's a pretty cool benefit that most people don't get because their plans don't allow it.  And it allows you to jam potentially a ton of extra money into your Roth, which of course is then tax free forever.   And you can withdraw your contributions (but not gain) anytime tax and penalty free.

So you still have access to your contributions if you need it, but the tax savings is great. 

desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #12 on: April 28, 2019, 01:48:01 PM »
Do you all think that it would make sense to drop down to $5 a pay period on this benefit (which I currently max) and instead put the difference into a taxable brokerage account?  My thinking is that I could buy back the 401a benefit in the future following other increases in pay, but could be growing my taxable brokerage account in the meantime that would have no restrictions on it so I could make the call to use that money on the mortgage if it made sense to pay it off as soon as I wanted to FIRE.

No, it is almost always desirable to max your tax advantaged space before going to the regular brokerage.   That's a pretty cool benefit that most people don't get because their plans don't allow it.  And it allows you to jam potentially a ton of extra money into your Roth, which of course is then tax free forever.   And you can withdraw your contributions (but not gain) anytime tax and penalty free.

So you still have access to your contributions if you need it, but the tax savings is great.

Cool, thanks for your time.  I try to do my due diligence and read as much as I can, but sometimes you just want to ask the smart people here to make sure you have the right mindset.

And, yeah, the only real downside of this 401a is the roll-out of contributions can only happen once a year.  I just did one, so can't touch it until next spring.  But it was definitely nice to roll $13,000 into my Roth IRA with Vanguard (the plans we can put the 401a itself into are kind of meh and have a higher fee than VTSAX/VTIAX, so it felt nice on multiple levels).

I think I will just continue with having a fat emergency fund, paying the minimum on the mortgage, maxing TSP/401A/Roth, and putting any extra into taxable.

I sincerely appreciate all of you helping me out :)
« Last Edit: April 28, 2019, 01:53:51 PM by desert_phoenix »

Brother Esau

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #13 on: April 28, 2019, 06:57:56 PM »
I have about 13 years left on a mortgage at 3.25% and will therefore not pay anything extra to it until I pay it totally off around $20 - $30 grand. Will coincide with the time I retire so, make sense

FireAnt

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #14 on: April 29, 2019, 10:23:16 AM »
If you're planning on getting rid of your mortgage when you FIRE, it's more likely to turn out financially better if you invest until you are nearing retirement, then pay the mortgage off with a lump sum payment.    That gives you max growth with the only risk being the market is way down when you planned to retire (which might have kept you from retiring anyway).

I'm considering this myself, although I worry about the tax implications since this money would be diverted to a taxable account (all tax advantaged accounts are maxed at this time).  I'm guess it would be a huge chunk of money that would be taxed. Right now we're doing we're splitting the difference 50/50 with the plan that we would have our mortgage paid off by the time we FIRE/semi-FIRE.

maizefolk

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #15 on: April 29, 2019, 10:47:35 AM »
If you're planning on getting rid of your mortgage when you FIRE, it's more likely to turn out financially better if you invest until you are nearing retirement, then pay the mortgage off with a lump sum payment.    That gives you max growth with the only risk being the market is way down when you planned to retire (which might have kept you from retiring anyway).

I'm considering this myself, although I worry about the tax implications since this money would be diverted to a taxable account (all tax advantaged accounts are maxed at this time).  I'm guess it would be a huge chunk of money that would be taxed. Right now we're doing we're splitting the difference 50/50 with the plan that we would have our mortgage paid off by the time we FIRE/semi-FIRE.

Are you talking about the money you're investing rather than paying off the mortgage being taxed at the time of investment? If so, this would seem like a non-issue since you're paying income tax on those funds regardless of whether they go to your mortgage processor or vanguard/schwab/et al.

If alternatively you're worried about paying a lot of capital gains on the investments when you sell them to zero out the mortgage, that's certainly possible. However the only situation where they would arise is when the market has been performing well, so I think you'd still be much better off with extra investment returns + extra capital gains taxes vs neither, wouldn't you?

FireAnt

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #16 on: April 29, 2019, 11:58:33 AM »
If you're planning on getting rid of your mortgage when you FIRE, it's more likely to turn out financially better if you invest until you are nearing retirement, then pay the mortgage off with a lump sum payment.    That gives you max growth with the only risk being the market is way down when you planned to retire (which might have kept you from retiring anyway).

I'm considering this myself, although I worry about the tax implications since this money would be diverted to a taxable account (all tax advantaged accounts are maxed at this time).  I'm guess it would be a huge chunk of money that would be taxed. Right now we're doing we're splitting the difference 50/50 with the plan that we would have our mortgage paid off by the time we FIRE/semi-FIRE.

Are you talking about the money you're investing rather than paying off the mortgage being taxed at the time of investment? If so, this would seem like a non-issue since you're paying income tax on those funds regardless of whether they go to your mortgage processor or vanguard/schwab/et al.

If alternatively you're worried about paying a lot of capital gains on the investments when you sell them to zero out the mortgage, that's certainly possible. However the only situation where they would arise is when the market has been performing well, so I think you'd still be much better off with extra investment returns + extra capital gains taxes vs neither, wouldn't you?

I'm talking about the capital gains. Still a newbie in the investing world, so I think I need to do more research.

Telecaster

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #17 on: April 29, 2019, 12:16:21 PM »

I'm talking about the capital gains. Still a newbie in the investing world, so I think I need to do more research.

Having a capital gains bill is a good thing, right?  Because that means you made money on your investments.   And capital gains are lightly taxed (at least for now).   You might not pay very much. 

catccc

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #18 on: April 29, 2019, 01:04:27 PM »
I'm not a homeowner, but... I'd say put extra $ in a taxable investment account (just a regular vanguard brokerage account).  When you decide to RE, you can pay off the mortgage if you want so you don't need to draw down as much in RE.  How far are you from RE.  I think the further away you are from RE, the more sense this makes.

maizefolk

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #19 on: April 29, 2019, 01:57:13 PM »
FireAnt, no worries that's one of the things the forum is for.

My prediction is that however you run the numbers, it'll be hard to come up with a scenario where you have a big capital gains hit because you invested rather than paying off your mortgage, but aren't still substantially better off (even post tax) than if you'd been paying off the mortgage over time instead.

But don't take my word for it, plug in some numbers and see what happens.

desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #20 on: April 29, 2019, 04:03:31 PM »
I'm not a homeowner, but... I'd say put extra $ in a taxable investment account (just a regular vanguard brokerage account).  When you decide to RE, you can pay off the mortgage if you want so you don't need to draw down as much in RE.  How far are you from RE. I think the further away you are from RE, the more sense this makes.

I am actually not sure, haha. 

Charts like the below are from starting at $0 saved, from what I understand.  But I am unsure if there are similar formulas or easy-to-figure ways to know how far along the path I am.  Mostly because my savings rate has fluctuated quite a bit in the years since I started saving for FIRE and has not been a consistent percentage.


acepedro45

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #21 on: April 29, 2019, 04:17:14 PM »
Quote
Is there a standard mustachian answer to this?

There was, but they banned him for being too obnoxious.

https://forum.mrmoneymustache.com/off-topic/r-i-p-boarder42/


desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #22 on: May 09, 2019, 08:44:09 PM »
I feel 100% comfortable not pre-paying my mortgage now.  But now I am thinking more about buying points.  I am still in the float period prior to locking in my mortgage rate for my new mortgage (but it can't go any higher than 3.75%), so I don't have the finalized numbers.  But before interest rates ticked up on me, the chart I had was:
Interest Rate Points
   
 
Interest Rate    Points        Origination   P&I
      3.000%   2.500%     1.000%      $885   
    3.125%   2.000%     1.000%      $900   
    3.250%   0.750%     1.000%      $914   
    3.375%   0.000%     1.000%      $928   
    3.625%   0.000%     0.000%      $958   
    3.750%   -0.250%     0.000%      $973   
    3.875%   -0.750%     0.000%      $988   
    4.000%   -1.000%     0.000%      $1,003   
    4.125%   -1.250%     0.000%      $1,018   
    4.250%   -1.375%    0.000%      $1,033

The break-even point is a ways out on these, but since it would be paid for in 2019 dollars, but future savings each month would be in 2020, 2022, 2030, etc...dollars, I wonder if it may be more worth it.  Once my rate locks in tomorrow, I will have to ask for the update chart for all of the above to think on some more.

I feel like people usually root against buying points since it is rare to take a mortgage all the way to the end.  But even if I moved temporarily out of it, it would either be because work temporarily relocated me overseas, or because I was doing FIRE overseas for a while.  Which then makes me think buying points would be worth it because going from $958 to $885 could make the difference in closer years to whether I could rent it out at cost or not (I will 100% be here for 2.5 years at the shortest prior to a temporarily work location).  I suppose once it is like 10 years out, inflation would make it fairly easy to  cover my costs with a renter considering the area.  Although maybe I am just trying to convince myself it is worth it and it still isn't.  It would be ~$7350 in the above example to buy down to 3% interest.  It would be VTSAX now I'd have to sell, if that makes a difference.

Perhaps money in the market already is not worth taking out to buy points no matter what?

Telecaster

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #23 on: May 09, 2019, 09:09:02 PM »
I feel 100% comfortable not pre-paying my mortgage now.  But now I am thinking more about buying points.  I am still in the float period prior to locking in my mortgage rate for my new mortgage (but it can't go any higher than 3.75%), so I don't have the finalized numbers.    

Points are pre-paid interest.  Do you pre-pay any of your other bills?   

desert_phoenix

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #24 on: May 11, 2019, 09:37:59 AM »
I feel 100% comfortable not pre-paying my mortgage now.  But now I am thinking more about buying points.  I am still in the float period prior to locking in my mortgage rate for my new mortgage (but it can't go any higher than 3.75%), so I don't have the finalized numbers.    

Points are pre-paid interest.  Do you pre-pay any of your other bills?

That seems a bit apples to oranges, and if paying my other bills now lowered the amount I'd pay for 30 years when I'd then no longer pay for electric or whatever, then yes.  I would consider it.

Cubert

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Re: Prepaying Mortgage Versus Investing More Pre-FIRE?
« Reply #25 on: May 12, 2019, 06:09:23 AM »
We just paid ours off a few months ago. While I realize the margins indicate "don't pay it off", especially with low interest, it's sure nice to not have a cloud over your head with a mortgage.

I also like to think of an early pay off as a low yield, consistent return vehicle in reverse. I.E., you're guaranteed to get that 3 or 4% return on the mortgage interest by paying off your home early.

I dunno. Sometimes it's purely an emotional decision, but I kinda dig the freed-up cash flow month over month!