Author Topic: Should I pay off my mortgage early?  (Read 22713 times)

sol

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Should I pay off my mortgage early?
« on: December 10, 2014, 11:52:56 AM »
Background:  Our family of five spends about $50k/year, roughly half of which goes to our mortgage. 

I understand the traditional arbitrage argument that a mortgage is low-interest debt that allows you to invest more money at better rates of return than you're paying for the loan.  Mortgage rates are currently low, market returns are currently high. Mathematically that would totally make sense to me, if it was the only consideration. 

But the modern environment of the early retiree is more complex than it used to be, and there are other incentives to artificially decrease your annual expenses by prepaying your mortgage.  For example...

1.  Health Insurance.  For people who can show income less than 250% of the Federal Poverty Level, the ACA offers premium subsidies (on any plan) and cost sharing (on Silver plans only) that are together potentially worth several thousand dollars per year.

2.  FAFSA applications for your kids.  Federal need-based financial aid (mostly low interest loans) is available to families that can show low enough income, and your total assets are ignored if your family income is below $50k per year.  We have three kids to put through college, and a large nest egg that colleges would love to raid.

3. The Earned Income Tax Credit.  Federal tax law subsidizes low-income families with a refundable tax credit if they can show earned income like from a side gig, but you are disqualified if you have too much investment income like dividends from your taxable investment account.  Paying off our mortgage with our taxable account would both reduce our expenses (and thus the income we would show) and it would reduce our taxable investment income, making us EIC eligible.

4.  General tax rates.  With lower ongoing expenses, you are sheltered from paying income tax.  Our family could do Roth conversions of about $40k/year before paying any tax, so even lowering our expenses from $50k to $30k would let us do excess conversions tax free, instead of "just-enough" conversions that would be partially taxed.

The value of the financial aid for college is hard to quantify ahead of time, though probably not zero, but I think the other three points alone are worth roughly $10,000 per year to my family of five if we prepay our mortgage.  That would be like 40% of our residual expenses.

Doing so would basically deplete our taxable investment account, plus probably require selling a rental house.  With a mortgage rate of about 3.25% and a hoped-for market return of 7%, we'd be losing a 3.75% edge on the balance of the loan, or $7500 per year.  If our portfolio does 9% per year we'd be about even. 

So one way of looking at this is that if our portfolio does 9% or better after taxes, I'm better off carrying the mortgage despite all the freebies you get for being low-income.  Over the remaining 10 year span of our 15 year mortgage, that could totally happen.  Or the market could crash and I'd look like an idiot.

The more I think about it, the more I lean towards paying it off.  The freebies make it much closer to a "guaranteed" 9% return on investment instead of a "maybe" 9% return from our portfolio if we carry the mortgage and leave the money invested.

thd7t

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Re: Should I pay off my mortgage early?
« Reply #1 on: December 10, 2014, 12:12:44 PM »
Background:  Our family of five spends about $50k/year, roughly half of which goes to our mortgage. 

I understand the traditional arbitrage argument that a mortgage is low-interest debt that allows you to invest more money at better rates of return than you're paying for the loan.  Mortgage rates are currently low, market returns are currently high. Mathematically that would totally make sense to me, if it was the only consideration. 

But the modern environment of the early retiree is more complex than it used to be, and there are other incentives to artificially decrease your annual expenses by prepaying your mortgage.  For example...

1.  Health Insurance.  For people who can show income less than 250% of the Federal Poverty Level, the ACA offers premium subsidies (on any plan) and cost sharing (on Silver plans only) that are together potentially worth several thousand dollars per year. 

This is a big one.  If you expect to get this benefit for your whole family for a number of years, it could pay back a lot.

2.  FAFSA applications for your kids.  Federal need-based financial aid (mostly low interest loans) is available to families that can show low enough income, and your total assets are ignored if your family income is below $50k per year.  We have three kids to put through college, and a large nest egg that colleges would love to raid.

Colleges don't raid retirement accounts, so if your money went into a Roth (for instance), it would not show up on FAFSA, but principal could be used as needed.  Then again, FAFSA also doesn't look at home equity.  Still, retirement accounts are more liquid, so I'd lean that way on this point.  In addition, I'm not sure of your kids' timeline for college.  You might get this option again, later, given a high savings rate.

3. The Earned Income Tax Credit.  Federal tax law subsidizes low-income families with a refundable tax credit if they can show earned income like from a side gig, but you are disqualified if you have too much investment income like dividends from your taxable investment account.  Paying off our mortgage with our taxable account would both reduce our expenses (and thus the income we would show) and it would reduce our taxable investment income, making us EIC eligible.

Seems like by the point you've got a family of five on around $30k/yr, your federal income tax will be pretty near zero.  EIC probably won't be too much to you.  Then again, you make the excellent point right below in 4.

4.  General tax rates.  With lower ongoing expenses, you are sheltered from paying income tax.  Our family could do Roth conversions of about $40k/year before paying any tax, so even lowering our expenses from $50k to $30k would let us do excess conversions tax free, instead of "just-enough" conversions that would be partially taxed.

You'd probably lower your taxes by around $3k/year.  Nice return in addition to your 3.25%, depending on the balance of your mortgage!

The value of the financial aid for college is hard to quantify ahead of time, though probably not zero, but I think the other three points alone are worth roughly $10,000 per year to my family of five if we prepay our mortgage.  That would be like 40% of our residual expenses.

Doing so would basically deplete our taxable investment account, plus probably require selling a rental house.  With a mortgage rate of about 3.25% and a hoped-for market return of 7%, we'd be losing a 3.75% edge on the balance of the loan, or $7500 per year.  If our portfolio does 9% per year we'd be about even. 

So one way of looking at this is that if our portfolio does 9% or better after taxes, I'm better off carrying the mortgage despite all the freebies you get for being low-income.  Over the remaining 10 year span of our 15 year mortgage, that could totally happen.  Or the market could crash and I'd look like an idiot.

The more I think about it, the more I lean towards paying it off.  The freebies make it much closer to a "guaranteed" 9% return on investment instead of a "maybe" 9% return from our portfolio if we carry the mortgage and leave the money invested.

I know people will say not to do it, but I think that it's worth the consideration!
« Last Edit: December 10, 2014, 12:19:02 PM by thd7t »

boarder42

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Re: Should I pay off my mortgage early?
« Reply #2 on: December 10, 2014, 12:18:54 PM »
i'm of the mindset you dont pay it off early while still building wealth but a paid off house after you start tapping the wealth in retirement makes a lot of sense. 

Farmgirl

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Re: Should I pay off my mortgage early?
« Reply #3 on: December 10, 2014, 12:24:57 PM »
We decided to expedite paying off our farm for several reasons.  The emotional one about being without a mortgage was one consideration.

But the most important one to us was that our mortgage payment was $1600 a month.  If we didn't have that anchor, we could both retire and be quite fine.  Also, a property like ours could potentially be a "hard sell"...you have to find the right buyer.  It could take a long time, and we didn't want to be compelled to take the first offer just to get out.

Everyone's reasons are different, but that was our thinking. 

thd7t

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Re: Should I pay off my mortgage early?
« Reply #4 on: December 10, 2014, 01:14:19 PM »
We decided to expedite paying off our farm for several reasons.  The emotional one about being without a mortgage was one consideration.

But the most important one to us was that our mortgage payment was $1600 a month.  If we didn't have that anchor, we could both retire and be quite fine.  Also, a property like ours could potentially be a "hard sell"...you have to find the right buyer.  It could take a long time, and we didn't want to be compelled to take the first offer just to get out.

Everyone's reasons are different, but that was our thinking.
I totally forgot to mention cashflow.  That can really add to your opportunities, down the line.

sol

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Re: Should I pay off my mortgage early?
« Reply #5 on: December 10, 2014, 01:51:08 PM »
Assuming you decide to pay off the house, when would you do that?  Now? Two years before the kiddies go to college?

The timing is important.  We should have a one or two year window between retiring and the "base year" for the FAFSA, during which we should be able to sell a rental and pay off our primary mortgage.

The FAFSA doesn't look at retirement accounts but it does see rental houses as assets, hence the desire to sell and put that equity into paying off our primary mortgage.  Of course, if we can get our income under the 50k limit, assets should be excluded anyway.

The EIC is refundable, so they actually send you a larger check with with a bigger family.  It's potentially worth $6k per year to my family even if we have zero tax liability.

The cash flow issue is complicated.  Our spending would drop, but so would our nest egg to support that spending.  And much of our spending could still come from Roth contributions from past years.  Really the only income we would be showing would be whatever we earned from side gig plus whatever we roll into the Roth pipeline.

MustachianAccountant

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Re: Should I pay off my mortgage early?
« Reply #6 on: December 10, 2014, 02:15:14 PM »

3. The Earned Income Tax Credit.  Federal tax law subsidizes low-income families with a refundable tax credit if they can show earned income like from a side gig, but you are disqualified if you have too much investment income like dividends from your taxable investment account.  Paying off our mortgage with our taxable account would both reduce our expenses (and thus the income we would show) and it would reduce our taxable investment income, making us EIC eligible.

Seems like by the point you've got a family of five on around $30k/yr, your federal income tax will be pretty near zero.  EIC probably won't be too much to you.  Then again, you make the excellent point right below in 4.

The EITC is "refundable" meaning you can reduce your taxes to $0, and still get money back from the government. So income tax being near zero isn't a consideration.
However, more than $3,500 in investment income does disqualify you, and the upper limit for a family of 5 is about $50k in income.
With $50k in spending, I have to assume that you have more than $50k in income.
On the other hand, I know you probably ran the numbers and are well aware of those limits and that you won't hit them.
Between the EITC, reduced tax burden (no dividends), and showing no liquidity to the FAFSA folks, this could be a good decision.
« Last Edit: December 10, 2014, 02:33:38 PM by MustachianAccountant »

Catbert

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Re: Should I pay off my mortgage early?
« Reply #7 on: December 10, 2014, 02:25:24 PM »
Be sure to include the capital gains tax and depreciation recapture that liquidating a brokerage account and selling a rental would have.   That might argue for doing the payoff over a couple of tax years.

FarmerPete

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Re: Should I pay off my mortgage early?
« Reply #8 on: December 10, 2014, 02:35:10 PM »
So, you don't mention the other big option.  If you have enough in your taxable accounts + the rental sale to pay off your mortgage, then is there some way to keep the money in your account and still claim the EIC, ACA, FAFSA, etc benefits?  If dividends will disqualify you for things, shift to investments that don't give off dividends.  Keeping the money in a taxed account and paying off the mortgage slowly should net you the same benefits.  It would mean less would need to be withdrawn from your 401k too.

MustachianAccountant

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Re: Should I pay off my mortgage early?
« Reply #9 on: December 10, 2014, 02:51:26 PM »
So, you don't mention the other big option.  If you have enough in your taxable accounts + the rental sale to pay off your mortgage, then is there some way to keep the money in your account and still claim the EIC, ACA, FAFSA, etc benefits?  If dividends will disqualify you for things, shift to investments that don't give off dividends.  Keeping the money in a taxed account and paying off the mortgage slowly should net you the same benefits.  It would mean less would need to be withdrawn from your 401k too.

The big one is FAFSA which looks at the parents' liquid investments. So if he's got $100k or more sitting in an investment account, the kids will qualify for less (or no) financial aid because FAFSA wants you to spend your own money first. On the other hand, FAFSA doesn't consider home equity in the equation, so if you can dump that $100k into your mortgage, you're "hiding" it from the financial aid calculation. With three kids, that's a big consideration.

(It's also why we have our kids' 529 money in my mother in law's name. But that's neither here nor there...)

Franklin

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Re: Should I pay off my mortgage early?
« Reply #10 on: December 10, 2014, 03:03:12 PM »
Quote
The more I think about it, the more I lean towards paying it off.  The freebies make it much closer to a "guaranteed" 9% return on investment instead of a "maybe" 9% return from our portfolio if we carry the mortgage and leave the money invested.

Sounds like you made your decision and I concur.  Two thoughts:
1. I'm currently going through my first FAFSA and extremely happy that my wealth is "hidden" in retirement and my house. 
2. I'm a much better investor now that my house is paid off.


Gone Fishing

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Re: Should I pay off my mortgage early?
« Reply #11 on: December 10, 2014, 03:05:25 PM »
Sol, you may really be on to something here!   I may have to rethink the mortgage myself. 

A lot of good points already. 

I would add:

Make sure you have enough left in taxable or accessable Roth contributions for an emergency.  I am assuming you already have enough in ROTH contributions for the first 5 years of your ladder?

If you qualify at your current income, replacing the mortgage with a HELOC may give you more flexibility for some of your manuvers.

Project out your taxes for the next 10 years (the current remaining on your motgage) or more, use 1/2 your current mortgage balance to calculate interest savings(average outstanding over that period).  As your children age, your tax status will change, make sure the tax benefits will run long enough to make it worth it. 


sol

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Re: Should I pay off my mortgage early?
« Reply #12 on: December 10, 2014, 03:51:57 PM »
So, you don't mention the other big option.  If you have enough in your taxable accounts + the rental sale to pay off your mortgage, then is there some way to keep the money in your account and still claim the EIC, ACA, FAFSA, etc benefits?  If dividends will disqualify you for things, shift to investments that don't give off dividends.  Keeping the money in a taxed account and paying off the mortgage slowly should net you the same benefits.  It would mean less would need to be withdrawn from your 401k too.

The other alternative here, I think, is to go the exact opposite route from my original post, and refinance our mortgage from a 15 to a 40 year in order to lower the annual outlay.

We'd still be screwed on the FAFSA, but we might get total expenses/income low enough to qualify for some ACA subsidies and the EITC, only because our family is so big.
« Last Edit: December 10, 2014, 03:54:40 PM by sol »

sol

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Re: Should I pay off my mortgage early?
« Reply #13 on: December 10, 2014, 06:27:42 PM »
2. I'm a much better investor now that my house is paid off.

Why is that?  This statement confuses me.

I am assuming you already have enough in ROTH contributions for the first 5 years of your ladder?

That all depends on what our rental properties sell for.  We plan to cover our first five years of expenses AND clear our mortgage with some combination of selling the rentals, emptying our taxable account, and raiding our existing Roth contributions.  The plan is to burn through as much liquidity as possible before FAFSA time, so that all of our assets are in sheltered accounts when it comes time to be judged on poorness.

And if something goes horribly wrong, our expenses would be so low with no mortgage to cover that even a part time job at the library or local christmas tree lot would go a long ways towards covering us.  Failing that, we can always just tap our 401k early and pay the damn 10% penalty on the few grand per year we'd need.  Lots of options.

Quote
If you qualify at your current income, replacing the mortgage with a HELOC may give you more flexibility

Yes, but that discussion is a whole separate post.

Quote
Project out your taxes for the next 10 years (the current remaining on your motgage) or more, use 1/2 your current mortgage balance to calculate interest savings(average outstanding over that period).  As your children age, your tax status will change, make sure the tax benefits will run long enough to make it worth it.

My current monthly projections spreadsheet is already a bit beyond that point, including real monthly amortization of our mortgage, our expected child support and solar panel reimbursement payments, and the chain of Roth conversions we intend to make. 

The problem is that last year before the five year pipeline kicks in.  In the year we retire we'll have some earned income from working part of the year, probably too much to qualify for significant tax benefits, but not so much that we'll pay LTCG on the first rental house sale.  At that point, there's not a lot of room to do low-tax Roth conversions, so that by the time five years have lapsed and our other accounts are looking depleted that first year of Roth conversions isn't quite enough to cover us.   It's the classic "too much in your 401k account" problem.

But the solution to that problem is to just eat the taxes in the first year of retirement, not eat them today by reducing our 401k contributions.

I do find it funny that this system is set up to charge you more if you didn't save quite enough, and charge you way less if you saved too much (and worked too long).  Just another set of golden handcuffs, I suppose.

Cheddar Stacker

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Re: Should I pay off my mortgage early?
« Reply #14 on: December 10, 2014, 07:07:08 PM »
Always trying to find an edge sol, I like that about you. Interesting concept that looks smart on the surface. I don't see any flaws but I haven't really thought it thru yet.

Let me play devil's advocate since you like ethical discussions, and you work in govt, and you have big thoughts, etc.

If it ends up being a breakeven analysis where there is no clear winner, consider how much more good you are doing for the economy by keeping the mortgage. The bank is making a profit, you have funds invested and hopefully being put to use by industry, you are paying into the tax pool rather than depleting it via EIC, and you are paying tuition rather than the govt covering it for you.

Something I haven't put a lot of thought into previously. Thanks for making me think about this.

sol

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Re: Should I pay off my mortgage early?
« Reply #15 on: December 10, 2014, 09:17:13 PM »
Always trying to find an edge sol, I like that about you.

I'm only planning on retiring once.  Don't really want to fuck it up.

EscapeVelocity2020

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Re: Should I pay off my mortgage early?
« Reply #16 on: December 10, 2014, 10:00:03 PM »
Sol, it certainly gets the wheels turning.  Personally, I have taken a 'blended' approach.  In other words, I opted for a 15 yr mortgage which comes with a lower rate and will be paid off (even if I go to term) before the kids start college.  I still plan to RE before the first starts college - and I won't be a stay at home parent!  I hope that ACA and college costs are more stable and predictable by then.

If you really think you can optimize, how do you get all of the numbers to make a 'perfect' assessment?  First off, you have to probably take a hit on taxes now in order to raise the funds, being in a higher bracket than if you were retired, and there's an opportunity cost of the lost interest deduction, but that is just math.  There's also missed investment gains (getting into the unknowable territory), and predicting what college costs will be (ugh, total black hole).  And what if something substantial changes?  All it takes is one reputable college giving a diploma for inexpensive online courses or Affordable Care to be effectively dismantled for this irreversible mortgage prepayment to turn out to be a loser.  The thing that sucks is, once you tie up capital in your home, it is more expensive to get it back out than a primary mortgage (and might get even more expensive if rates go up, which they are bound to eventually).

I file this under 'you really only know in hindsight' - maybe your timing is right and you sell investments at a high, have no mortgage, and can put all of your effort into saving to hit that 3-4% SWR.  On the flip side, my friend paid off his house in 2009 by selling investments and regretted it because mortgage rates kept falling (gotta love freeing up cash flow by refinancing) and the stock market has been on a tear...  Sometimes there is no right or wrong answer, just educated guessing about risk and reward, which is why this stuff is all so interesting. 

sol

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Re: Should I pay off my mortgage early?
« Reply #17 on: December 10, 2014, 11:44:32 PM »
If you really think you can optimize, how do you get all of the numbers to make a 'perfect' assessment?

Oh I have no illusions that my numbers are perfect.  But you don't need the right numbers to make the right decisions.  Ranges will do.

I can compare the cost of leaving the money invested vs the cost of prepaying the mortgage.  Both numbers are going to be wrong, but if the expected range of one is clearly superior to the other, then I'd rather make the choice that stacks the odds in my favor.

Quote
There's also missed investment gains (getting into the unknowable territory), and predicting what college costs will be (ugh, total black hole).

The investment gains aren't troublesome, all investments have an expected value regardless of the size of the error bars.  And college costs aren't really any harder, because we each get to decide what we want to contribute to our children's college educations.  I'm not obligated to pay 100%, or even 10%.  If I shoot for 75% and lose a bet, they only get 50%.  That's a risk I can transfer rather than eat, if necessary.

Quote
 
And what if something substantial changes?

Then I'm stuck with the decisions I've already made, but that's not necessarily a bad thing.  If I opt to prepay and "lock-in" those 9% returns, and then the market averages 12%, I haven't really lost anything.  I've still made 9%, and as long as that's enough to meet my goals then we're set.  The whole point of an adjusted risk basis is to quit playing the game if you've already won.  Past a certain point, there's little utility in that extra 3%.

But in broad outline, I take your point well.  Trying to estimate my monthly cashflow in 2023 feels pretty ridiculous.  Not bothering to estimate it feels even worse.


Franklin

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Re: Should I pay off my mortgage early?
« Reply #18 on: December 11, 2014, 07:29:52 AM »
Quote
Quote from: Franklin on December 10, 2014, 03:03:12 PM
2. I'm a much better investor now that my house is paid off.

Why is that?  This statement confuses me.

I like to think that the emotional side of investing can be tempered by eliminating the emotional burdens we place on ourselves, such as the need for shelter and education.  When those are put to rest it is much easier to use sound investment principles, rather than emotion.

benjenn

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Re: Should I pay off my mortgage early?
« Reply #19 on: December 11, 2014, 07:36:49 AM »
We're choosing to pay off our mortgage simply for the pleasure of being 100% debt free.  Yes, we could likely make more if we were to invest that money instead but then we'd continue to have a $1,400 monthly payment hanging over our heads for the next several years.  By paying off our mortgage, we eliminate that completely and can still retire by the end of 2015.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #20 on: December 11, 2014, 12:15:55 PM »
Sol, I undertook a similar analysis before deciding to keep my mortgage outstanding (though not nearly as rigorous an analysis as you appear to be doing, and I was focused primarily on ACA subsidies).  Ultimately I reached the opposite conclusion from the one you are leaning towards, because I came to the reverse conclusion about which set of returns are closer to being "guaranteed," for two reasons:  (i) the government entitlements like the ones you described are not set in stone and could easily change in a way that defeats the purpose of your careful planning, and (ii) much more significantly, I am not confident in my ability to juggle the many balls in the air required to realize those returns without screwing it up.  This type of optimization requires you to thread a labyrinthine series of needles (e.g., keep your income low enough to qualify for ACA subsidies, but not too low to disqualify you; get a side gig earning you income that qualifies you for EITC credit, not too much to disqualify you, and not one that offers a health insurance option that disqualifies you for ACA subsidies; and so on and so forth) in a way that is difficult at best and impossible at worst.

In addition, keeping the mortgage outstanding operates as a better inflation hedge.  Under your circumstances, paying it off will also provide a built-in inflation hedge (because most of the government entitlements are indexed to inflation or at least increased periodically to account for inflation in some fashion)--but, for the reasons described above, you can't count on getting these with 100% certainty, while the inflation hedge provided by an outstanding mortgage balance is essentially a sure thing.

However, the time horizon on my mortgage is much closer to 30 years than yours, so in your shoes I may have reached a different decision.  But I am curious to hear your thoughts on the considerations Cheddar raised above, and the related ethical question of whether it makes sense to go through so much trouble to make yourself look poor (when in fact you are quite rich) if it is close to a breakeven analysis anyway.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #21 on: December 11, 2014, 01:39:18 PM »
Also, when performing your analysis, give the same hard scrutiny to the potential disincentives of artificially decreasing your annual expenses in the modern environment of the early retiree.  Some of the obvious ones have been mentioned and, I'm sure, are already on your radar.  But think long and hard about all the less-obvious ways you can potentially be disadvantaged by manufacturing a tax return that makes you look like a pauper.

Here's one:  I currently earn a substantial amount of (tax-free) cash and a ridiculously-more-substantial amount of free travel benefits by playing the credit card churning game.  Once I stop working, I can only assume my ongoing ability to continue to qualify for new credit cards will be directly related to the (unsheltered) amount of my income and assets.

I'm sure there are others.

DoubleDown

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Re: Should I pay off my mortgage early?
« Reply #22 on: December 11, 2014, 06:51:37 PM »
I'm a little confused on the timeline because, on the surface, I'm wondering if you might have the opposite problem -- that is, too little income to qualify for ACA subsidies, EITC, etc.???

How many years until you retire, and how old will you and your kids be? When will you be filling out the FAFSA (and kids going to college) relative to the Roth pipeline going? And then will kids be done with college prior to you tapping traditional retirement accounts?

In a simplified cenario of realizing $50,000/year income from Roth conversions and with a family of 5, I'd expect you would end up with a parental contribution of $0 (or damn close) from the FAFSA. Is that not the case? I'm also guessing you'd qualify for giant ACA subsidies at that level.

But EITC is not available in that scenario because there's no earned income, correct?

If I've accurately summarized things, then I'd say you're golden and no further finagling is needed. You can keep your taxable investments liquid for now, then assess when your children are ready to apply for college whether you need to eliminate taxable accounts (such as by paying towards the mortgage). But you have quite a few years before you need to decide that!

I've lucked out a bit in the sense that my retirement timeline has my taxable accounts being mostly depleted right when my kids are old enough to start college (I'll be 54 then). Then I'll start withdrawing (tax free) from the Roth pipeline, and 5 years later can tap TSP/IRAs. I'd guess you won't have to do too many cartwheels structuring your timeline so you can get rid of taxable accounts when it makes sense.

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Re: Should I pay off my mortgage early?
« Reply #23 on: December 11, 2014, 07:23:05 PM »
Sell your rental and pay 'er off.

I sold our rental property last year and netted $200K from the sale. I put most of it down on my mortgage (~$170K) and don't regret it.

I reduced my monthly interest from $550/month to $140/month and knocked 10 years off the loan. I owe $58K yet and between my savings and brokerage have $80K .

I still get tempted to pay it off fully to free up $1640/month cash flow...but haven't pulled the trigger yet. Maybe tomorrow.

sol

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Re: Should I pay off my mortgage early?
« Reply #24 on: December 13, 2014, 02:19:05 PM »
I reached the opposite conclusion from the one you are leaning towards, because I came to the reverse conclusion about which set of returns are closer to being "guaranteed,"

I can see your point.  I guess I'm more confident in my own ability to juggle all the details than I am confident the markets will play along.  I have control over my spending and tax returns and health insurance decisions.  I can't do much if the market slides right after I stop working.

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In addition, keeping the mortgage outstanding operates as a better inflation hedge.

I think that's more true for the rental properties than it is for our primary residence.  I don't include home equity in our primary residence as part of my net worth because I can't spend it.  It doesn't contribute to my 4% SWR.  Yes, my home is an inflation hedge, but it's one that I never intend to realize.

The rental properties, on the other hand, appreciation there is money in my pocket.  Selling them off would remove that hedge, which probably means part of the returns would get allocated to something like TIPS.  Though honestly, I think the stock market is the best inflation hedge available.  Stagflation notwithstanding, recession and inflation are supposed to be mutually opposed.  The Phillips Curve is a thing for a reason, after all.


sol

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Re: Should I pay off my mortgage early?
« Reply #25 on: December 13, 2014, 02:34:15 PM »
If it ends up being a breakeven analysis where there is no clear winner, consider how much more good you are doing for the economy by keeping the mortgage. The bank is making a profit, you have funds invested and hopefully being put to use by industry, you are paying into the tax pool rather than depleting it via EIC, and you are paying tuition rather than the govt covering it for you.

After pondering for a while, I think I've decided this argument doesn't hold water.

If the cost/benefit analysis is about even, then whether or not I prepay my mortgage can't possibly make any difference to the economy.  In both cases I have worked for the exact same amount of time.  I have made the exact same amount of money in exchange for the same amount of productivity.  I own the same assets in the same proportions, outside of my mortgage balance which is a small fraction of my net worth anyway.  If there's a moral decision to be made here to support our economy, it's to avoid early retirement at all costs, and I've already discarded that idea.

The bank isn't losing a profit if I prepay, because they're just going to turn around and make new loans to other people.  If anything, holding my loan is PREVENTING someone else from getting a mortgage.  From that perspective, I'm doing the economy a favor by getting off their books.

My invested funds would decrease, that's true, because I would be cashing out some investments to clear my outstanding debt.  But isn't that what investing is all about?  Am I morally obligated to never draw down my portfolio?  I've lent my funds to those companies temporarily because I thought they could make me a profit.  When I take that profit (or loss) they will turn to other investors, or make due with less capital.  There's no law or moral obligation that says all private citizens have to be in debt up to their eyeballs in order to give corporations cheap capital.

And the tax credits argument would seem like the most convincing, for people who believe in paying taxes (and I do).  I would be reallocating my net worth in such a way to lower my tax burden, legally.  I still support most of the things my government does with my tax dollars, and so I have paid my taxes diligently my entire life.  I'm still struggling with the notion that I should feel morally obligated to pay more taxes than the law allows.

In that sense, paying off my mortgage is just like putting money into my 401k; it lowers my tax burden.  Or itemizing my deductions instead of claiming the standard deduction.  I've always paid my taxes, but never more than I thought Uncle Sam asked of me.  If he has decided not to tax people who pay off their mortgages like I'm proposing, who am I to argue?  Does anyone here feel some sort of patriotic duty to pay extra taxes?

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #26 on: December 13, 2014, 03:24:27 PM »
Quote
In addition, keeping the mortgage outstanding operates as a better inflation hedge.

I think that's more true for the rental properties than it is for our primary residence.  I don't include home equity in our primary residence as part of my net worth because I can't spend it.  It doesn't contribute to my 4% SWR.  Yes, my home is an inflation hedge, but it's one that I never intend to realize.

The rental properties, on the other hand, appreciation there is money in my pocket.  Selling them off would remove that hedge, which probably means part of the returns would get allocated to something like TIPS.  Though honestly, I think the stock market is the best inflation hedge available.  Stagflation notwithstanding, recession and inflation are supposed to be mutually opposed.  The Phillips Curve is a thing for a reason, after all.

I didn't follow this.  Keeping your mortgage outstanding would decrease your home equity, not increase it, but either way the amount of your home equity is irrelevant to how much your home's appreciation benefits you--assuming you did choose to consider home equity as part of your net worth, if you home appreciates by $X then your net worth also increases by $X, whether you have a mortgage or not.

What I meant when I said that carrying a mortgage is a good inflation hedge is the fact that it is long-term, fixed-rate debt--during periods of high inflation, you will be repaying those borrowed dollars with increasingly less-valuable dollars.  And because of the artificially low interest rates on U.S. mortgages that result from the unique dynamics of the quasi-government-subsidized American mortgage market, it is hard to find a better tool for protection against inflation than a 30-year mortgage.

milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #27 on: December 13, 2014, 04:33:22 PM »
Sol,

I think you've answered your own question.  Thank you for sharing your insightful calculus.

Any investment strategy that requires a 9% return will have significant risk that you are being paid for.

So a risk free 9% is always worth seizing.

The only other issue is that your analysis banks on the continuation of the current structure of Obama care, Financial aid requirements, the tax code, etc. (though compared to other assumptions, this is the most rational assumption to make.

As to your musings on the morality of avoiding taxes, I share your concern for this hypocrisy as a progressive who tries to minimize my tax burden.

In the end I've concluded that it is the job of the rational individual to advance his own economic interests (in terms of avoiding taxes, receiving benefits), and if is the job of the citizen to vote for the fairest system possible.

In the end your analysis just shows how labarynthine  the tax code and safety net are. And how this complexity needlessly complicates personal monetary decisions.

In my utopia there would be a progressive (though lower nominal rate ) tax code with no deductions  and every dollar earned would be treated the same, regardless of its source (earned income vs capital gains, vs dividends would all be taxed at the taxpayers marginal rate. )

But I don't see that happening anytime soon.

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Re: Should I pay off my mortgage early?
« Reply #28 on: December 15, 2014, 09:35:35 AM »
If it ends up being a breakeven analysis where there is no clear winner, consider how much more good you are doing for the economy by keeping the mortgage. The bank is making a profit, you have funds invested and hopefully being put to use by industry, you are paying into the tax pool rather than depleting it via EIC, and you are paying tuition rather than the govt covering it for you.

After pondering for a while, I think I've decided this argument doesn't hold water.

If the cost/benefit analysis is about even, then whether or not I prepay my mortgage can't possibly make any difference to the economy.  In both cases I have worked for the exact same amount of time.  I have made the exact same amount of money in exchange for the same amount of productivity.  I own the same assets in the same proportions, outside of my mortgage balance which is a small fraction of my net worth anyway.  If there's a moral decision to be made here to support our economy, it's to avoid early retirement at all costs, and I've already discarded that idea.

The bank isn't losing a profit if I prepay, because they're just going to turn around and make new loans to other people.  If anything, holding my loan is PREVENTING someone else from getting a mortgage.  From that perspective, I'm doing the economy a favor by getting off their books.

My invested funds would decrease, that's true, because I would be cashing out some investments to clear my outstanding debt.  But isn't that what investing is all about?  Am I morally obligated to never draw down my portfolio?  I've lent my funds to those companies temporarily because I thought they could make me a profit.  When I take that profit (or loss) they will turn to other investors, or make due with less capital.  There's no law or moral obligation that says all private citizens have to be in debt up to their eyeballs in order to give corporations cheap capital.

And the tax credits argument would seem like the most convincing, for people who believe in paying taxes (and I do).  I would be reallocating my net worth in such a way to lower my tax burden, legally.  I still support most of the things my government does with my tax dollars, and so I have paid my taxes diligently my entire life.  I'm still struggling with the notion that I should feel morally obligated to pay more taxes than the law allows.

In that sense, paying off my mortgage is just like putting money into my 401k; it lowers my tax burden.  Or itemizing my deductions instead of claiming the standard deduction.  I've always paid my taxes, but never more than I thought Uncle Sam asked of me.  If he has decided not to tax people who pay off their mortgages like I'm proposing, who am I to argue?  Does anyone here feel some sort of patriotic duty to pay extra taxes?

I'm not passing any moral judgment here as I may end up doing something similar. The rules are there, you are considering every possible way you can exploit them. Nothing wrong with that IMO. But I believe your dismissal of my thoughts above is a bit short sighted/one sided.

The bank won't necessarily lose profit by you repaying the loan because they can loan the funds elsewhere, and you might be doing some other borrower a favor, maybe. That other borrower still has to qualify for a loan, and if they qualify the bank will just borrow more to lend them regardless of your outstanding debt. In other words, your repayment of your mortgage doesn't automatically mean someone else will be able to borrow that money.

No you aren't morally obligated to keep your money invested, and that's not what I said at all. You are entitled to harvest the profits from your investments if you elect to do so. But in doing so you are lowering the overall "invested" capital available to public companies. Yes it's a pittance to them, but it's still true.

Taxes - I'm all for reducing them. I always planned to pay as little as possible post FIRE, and I still do. I never planned to shoot for the EITC, or ACA subsidies, and I doubt my income will be low enough to qualify as I intend to have a large amount of T.IRA to R.IRA conversion to accomplish in ~25 years. If you plan to that's fine, no judgment, and I'm sure you've paid in plenty over your lifetime. I don't feel I need to pay anything extra in taxes, and I'm not trying to force anyone else to.

Tuition - I'm not an expert here, so maybe someone else can chime in. If you are getting a lot of FAFSA money, wouldn't that deplete the available funds for others? Maybe so, maybe not, I don't know. But for me I would feel a bit weird having college tuition subsidized while I had $1-2M in the bank, particularly if that depletes the available resources for people who truly need the assistance.

The overall point I was trying to make: If 10-8=2, and 0+2=2, and the 10-8 scenario has a positive affect on the economy, why not stick with 10-8? I would argue the 10-8 scenario will almost always have a more positive affect on the economy. I tried to make that point, and your counter argument seemed to be that you weren't obligated to do so. I agree with that, you're not obligated at all, but do you really think it wouldn't be a net benefit/supportive of economic activity?

milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #29 on: December 15, 2014, 02:03:07 PM »
Cheddar,

A tax dollar saved and a benefit dollar spent have the exact same effect on the deficit, and on the economy as a whole.

To my eyes they are morally equivalent and functionally equivalent.

In other words a multimillionaire paying an effective tax rate of zero is just as destructive as a multimillionaire claiming subsidies under Obamacare (assuming the tax dollars saved or equivalent to the benefit dollars spent.)

The best way to stimulate the economy in a Keynesian sense is to redistribute it from the wealthy who save their money, to the poor who spend it.

I don't think you've made a convincing case that one approach (tax saving vs benefit taking) is more beneficial or harmful than another.





falcondisruptor

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Re: Should I pay off my mortgage early?
« Reply #30 on: December 15, 2014, 02:11:12 PM »
We've done the math and we're still paying our mortgage down ahead of schedule.  We're Canadians, so we don't have the reasons you listed, but we came up with a whole much of our own.  We're a single income family, so for us, keeping our expenses low is important to us.

Cheddar Stacker

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Re: Should I pay off my mortgage early?
« Reply #31 on: December 15, 2014, 02:17:59 PM »
Cheddar,

A tax dollar saved and a benefit dollar spent have the exact same effect on the deficit, and on the economy as a whole.

To my eyes they are morally equivalent and functionally equivalent.

In other words a multimillionaire paying an effective tax rate of zero is just as destructive as a multimillionaire claiming subsidies under Obamacare (assuming the tax dollars saved or equivalent to the benefit dollars spent.)

The best way to stimulate the economy in a Keynesian sense is to redistribute it from the wealthy who save their money, to the poor who spend it.

I don't think you've made a convincing case that one approach (tax saving vs benefit taking) is more beneficial or harmful than another.

Yeah, I see your point. $1 is $1, whether you are taking it or not paying it in.

I like your utopian tax system. I've proposed something similar here as well.

Well, I have nothing left in the tank to convince anyone, not that it was my goal to do so, I was just trying to spark thought/conversation about it. To each their own. I believe given the circumstances sol laid out, I would be inclined to let it ride and not pay off the mortgage. I just feel it fosters more economic activity, but I'm not an economist, and I'm terrible at "arguing" my case, so I'll just leave it there.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #32 on: December 15, 2014, 02:25:08 PM »
Miles, the comparison wasn't between paying less taxes and receiving more benefits.  Under one alternative, sol would be both paying more taxes and receiving less benefits, while under the other alternative he would be paying less taxes and receiving more benefits.

In any event, I hope this ethical discussion doesn't start to swallow the thread -- there are some unanswered questions above (including DoubleDown's questions about the details of the scenario and my question about hedging against inflation) that I would like to see answered or discussed.

Don't forget that we're trying to retire early here!

Franklin

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Re: Should I pay off my mortgage early?
« Reply #33 on: December 15, 2014, 03:01:39 PM »
Quote
In my utopia there would be a progressive (though lower nominal rate ) tax code with no deductions  and every dollar earned would be treated the same, regardless of its source (earned income vs capital gains, vs dividends would all be taxed at the taxpayers marginal rate. )

Miles, interesting concept but what are you trying to accomplish?  simplicity, equality, higher revenue, etc.

Sorry for sidetracking Sol, I'm hoping he is so convincing that we all just nod.

sol

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Re: Should I pay off my mortgage early?
« Reply #34 on: December 15, 2014, 07:46:18 PM »
I'm wondering if you might have the opposite problem -- that is, too little income to qualify for ACA subsidies, EITC, etc.???

ACA subsidies are available to anyone making less than 400% of the FPL, which is like $100k for a family like mine.  We won't show that much income even at our peak annual Roth conversion rate.  If we make less than about $58k/year , we would qualify for totally free health insurance through Washington's expanded medicaid plan, Apple Health.

The only requirement to qualify for the EITC is to have some earned income.  Any amount works, but it maxes out if you make like $12k/year.  We may or may not go down that road in retirement.

Quote
How many years until you retire, and how old will you and your kids be? When will you be filling out the FAFSA (and kids going to college) relative to the Roth pipeline going? And then will kids be done with college prior to you tapping traditional retirement accounts?

This is what my spreadsheet is for, to plan out the monthly costs and expenses through all of these transitions.  The plan is of course subject to change, but the plan at this moment is to retire in March of 2018 when our oldest kid is 14.  That gives us about a year and a half to sell rental properties and potentially pay off our mortgage before the base year for his FAFSA application (Jan-Dec of 2020).  Our first Roth conversion would be available in January of 2023, so we potentially need to fund expenses (and $200k of mortgage payoff) between 03/18 and 01/23 with our taxable account, existing Roth principal, and RE sale proceeds.   We'd live off the Roth pipeline conversions until we get full access to 401k funds in 2032.  Assuming our youngest holds to a traditional schedule, she would finish college in the spring of 2035 two months after the first pension kicks in at age 62.  We'd continue living partly off our portfolio through at least 2042, when both of us will have access to unreduced social security payments and pensions.

The pension and SS payments are particularly hard to figure, because together they would fund about 90% of our living expenses (only because our expenses are so much lower than our working income), unless they get cut or modified at some point over the next 25 years.  I've assumed they will all start at later ages than absolutely necessary, to give us some buffer.  If something goes awry, we can always draw them early and take the penalty.  If they do get reduced, we'll still have significant residual 401k funds to make up the difference.

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In a simplified cenario of realizing $50,000/year income from Roth conversions and with a family of 5, I'd expect you would end up with a parental contribution of $0 (or damn close) from the FAFSA. Is that not the case?

My first pass through the FAFSA was pretty discouraging.  At $45k of income (to stay under the $50k asset exclusion limit) your EFC is still like $14k/year.  I'll look into it in more detail, but it looks like $24k/year is the cutoff to have a zero EFC.

Quote
I'm also guessing you'd qualify for giant ACA subsidies at that level.

I'm still trying to figure this out.  The Apple Health website says a family of five will qualify for free insurance if they make less than $58k/year (see link above) but other sources say you don't qualify unless you make less than 138% of the FPL, and that's only like $38.5k.  I think the discrepancy is because the higher limit applies to insurance for children only, but not adults.  So we'd be buying subsidized insurance through our state exchange at a cost of about $4k/year combined premiums+deductibles.

Quote
But EITC is not available in that scenario because there's no earned income, correct?

Yes, unless we choose to work a little.  I have a couple of side gigs that can bring in a few thousand dollars per year for doing things I enjoy, so the EITC will always be an option if I want to work, or decide that I need the money.

« Last Edit: December 15, 2014, 08:04:41 PM by sol »

milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #35 on: December 15, 2014, 07:51:45 PM »
Two things: fairness and efficiency.

I'm a firm believer in progressive taxation, because Wealthy (like me) can better afford to pay taxes than poor,  and having poor people keep more of their own money in their pocket is good for the overall economy.

In addition the marginal utility of happiness tells us that Taxes hurt the poor more than the rich. (Because above a certain level increasing your wealth brings less and less additional happiness. )

In terms of fairness, it is axiomatic that hedge fund billionaires should not pay a lower marginal tax rate than garbage collectors.

In our current system we end up with a very regressive (or bell curve shaped) tax system, because those at the top have the most influence on the writing of the tax code.

And aside from The fairness issue, all of these tax laws create needless motion (like the opening of HSA's, backdoor Roth maneuvers,bizarre stock based reimbursement plans, tax loss harvesting, etc.) all of which serve to give people perverse incentives to do lots of things which don't in fact increase the efficiency or the productivity of society.

(Note: I am not criticizing people for doing these things. They are 100% rational under our current tax incentives. And I actually love doing these maneuvers, myself . But the analysis that Sol shared in his post is an example of a very smart individual expending a lot of mental energy on a fundamentally unimportant issue from a societal standpoint.

But mostly it's just the fairness issue. I am pro fairness!

teen persuasion

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Re: Should I pay off my mortgage early?
« Reply #36 on: December 15, 2014, 08:56:15 PM »
Ok, Sol, we are in the situation you are considering.  Well, with different details, the largest being that we are not yet near enough to FIRE.

We paid off our mortgage early, but it was a no-brainer for us, the rate was 9.75%.  We have never been high earners, so we didn't have a taxable account to liquidate, we actually used our decent sized tax refunds from EITC and CTC to make large lump payments every year.  We weren't saving much in retirement accounts at that point, just 5% in DH's to get the match.  When they did away with the match, DH wanted to quit contributing, but I tweaked his withholdings and doubled his contribution to 10% with little change in take home pay.  That showed me how pre-tax contributions increased our EITC (actually, lowered the phaseout), so I kept finding excuses to increase his 401k contributions: paid off student loans, I began working part-time, etc.  When we reached the point where we could just raid savings to kill the last $10k on the mortgage, our oldest DD1 was beginning college.  Ultimately we decided to hold onto that $10k in case we needed it for college expenses, and pay the mortgage normally to a a year to see how things shook out.  No unexpected college costs, and we paid the mortgage off fifteen years early, and I bumped DH's 401k contributions up to 40+% of his pay, while agreeing that he could stop working summers.  Also opened Roths for both of us, funded by our tax refunds now.  As my part-time pay increased, I increased his 401k contributions to over 50%, finally maxing it out.

Our state matches the EITC at 30%, and the CTC at 33% (for kids over 4), so reducing our AGI is even more beneficial to us.

Look closely at the FAFSA rules for the simplified needs test and auto EFC = 0.  There are two parts to the test, the AGI section PLUS another test you need to meet to qualify.  Being eligible to file a 1040EZ or 1040A will work, but I have a feeling many mustachians must file a 1040 for some reason or other (we do since we have an HSA).  Other qualifiers include receiving free reduced school lunches (that's our qualification), SNAP, TANF, etc.  The rules and income charts change every year.  We were easily eligible for auto EFC = 0 when DD1 began college, but by the time DS2 joined her the threshold had been retroactively dropped from $32k to $23k AGI.  I've watched the income protection chart shrink every year since 2008 when DD1 began - the figures should be larger, not smaller, due to inflation!  Luckily, the majority of our stash is in retirement accounts (effectively invisible, to the FAFSA) so our assets haven't been part of the EFC formula, so far.

Financial aid is complex, though.  The fafsa is just the so called Federal Methodology, for federal aid.  Each college also has its own Institutional Methodology, as well, and that can include anything they want to consider for handing out their scholarships and grants.  They can consider home equity, if they want.  Each college is different, and just because you have an EFC = 0 does not mean they won't gap you - or just tell you to take loans.  Our kids have chosen schools that given them scholarships, grants, PELL, TAP, work study, and federal loans.  Family size, relative to income, has helped them qualify for aid, too.  We have five kids, with DS2 and DD3 currently in college.  I'm concerned about when DS5 is college age, though.  At that point we will be considered a family of three, and unless we are FIREd, our income may no longer be in a favorable spot for FA.

Now, I've been trying to figure out if we could fire before DS5 leaves HS, and setting up a Roth pipeline and how it will affect taxes and credits.  I was SAHM for 20 years, so I'm behind in retirement savings, but just getting started in a semicareer and still having fun with it, so FIRE for us may be DH retires and I keep working part-time, enough to fund Roths for both of us and be eligible for EITC while DS5 is a dependent, and convert IRAs to Roths.  If I put $2k in retirement accounts for each of us, and keep AGI in range, I could convert more tax free using the retirement savers credit, to $35k ish AGI. But, increasing the amount converted to any AGI over $23k ish decreases our EITC.  ACA subsidies throw another wrinkle in - depending on family size, we may need higher AGI to qualify.  How many people are included in family size at any time depends on whose rules they are.  DS2 is 21, and has not been our tax dependent since he started college (earnings and scholarships), but colleges consider him a dependent until 24, and he can stay on our health insurance until 26.  We range from a family of four (at home) to a family of six, depending on rules.

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #37 on: December 16, 2014, 07:53:02 AM »
Quote
I'm also guessing you'd qualify for giant ACA subsidies at that level.

I'm still trying to figure this out.  The Apple Health website says a family of five will qualify for free insurance if they make less than $58k/year (see link above) but other sources say you don't qualify unless you make less than 138% of the FPL, and that's only like $38.5k.  I think the discrepancy is because the higher limit applies to insurance for children only, but not adults.  So we'd be buying subsidized insurance through our state exchange at a cost of about $4k/year combined premiums+deductibles.

I believe you are correct about the reason for the discrepancy.  Personally, my ideal income level for healthcare purposes (under the system as it currently exists) would be right above the cutoff for ACA subsidies (but not so close as to risk falling below the cutoff when the dust settles at the end of the year), which gives you nearly free coverage that is, generally speaking, superior to Medicaid (which is just my general impression from anecdotal evidence after having done some limited research on this topic, and maybe your state is an exception).  This discussion has reminded me that this was actually another factor in my decision to keep my mortgage outstanding -- without it, I may have found myself struggling to find enough unsheltered income to meet the ACA threshold.

Quote
In addition, keeping the mortgage outstanding operates as a better inflation hedge.

I think that's more true for the rental properties than it is for our primary residence.  I don't include home equity in our primary residence as part of my net worth because I can't spend it.  It doesn't contribute to my 4% SWR.  Yes, my home is an inflation hedge, but it's one that I never intend to realize.

The rental properties, on the other hand, appreciation there is money in my pocket.  Selling them off would remove that hedge, which probably means part of the returns would get allocated to something like TIPS.  Though honestly, I think the stock market is the best inflation hedge available.  Stagflation notwithstanding, recession and inflation are supposed to be mutually opposed.  The Phillips Curve is a thing for a reason, after all.

I didn't follow this.  Keeping your mortgage outstanding would decrease your home equity, not increase it, but either way the amount of your home equity is irrelevant to how much your home's appreciation benefits you--assuming you did choose to consider home equity as part of your net worth, if you home appreciates by $X then your net worth also increases by $X, whether you have a mortgage or not.

What I meant when I said that carrying a mortgage is a good inflation hedge is the fact that it is long-term, fixed-rate debt--during periods of high inflation, you will be repaying those borrowed dollars with increasingly less-valuable dollars.  And because of the artificially low interest rates on U.S. mortgages that result from the unique dynamics of the quasi-government-subsidized American mortgage market, it is hard to find a better tool for protection against inflation than a 30-year mortgage.

What was your point about property appreciation and inflation?  Did you mean that holding real estate operates as an inflation hedge (to the extent you are willing to tap the appreciation by selling the property or otherwise) because the property's value will tend to increase with inflation?

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #38 on: December 16, 2014, 09:56:53 AM »
Sorry for the consecutive posts, but I've thought about this some more and here is some additional food for thought:

Like you said, it appears that you can probably obtain most of the desired benefits by going the opposite route and refinancing into a long term mortgage, except for the college aid.  So let's analyze whether it makes sense to pay off the mortgage solely for the purpose of qualifying for college aid.

If you refinance to a 30 year mortgage of $300k with a 4% interest rate, cfiresim tells me that historically the median amount left over in your pocket at maturity would be approximately $800k in inflation-adjusted dollars (assuming the funds were invested using cfiresim's default settings, including a 75/25 stock/bond allocation).  For a break-even expected result, your lack of a mortgage would need to provide you with savings in college expenses equal to the equivalent of approximately $170k upfront on your retirement date (which translates into a much bigger number, in nominal terms, over the 17 year period from your retirement start date through your youngest kid's expected college graduation date).

Do you expect to achieve that much in savings?  I would guess the answer is no.  For purposes of your original analysis, you totally disregarded those savings (though you recognized they will most likely be greater than zero) because of the difficulty in quantifying them.  Following the methodology of Go Curry Cracker's excellent analysis, I would guesstimate that even if each of your three kids obtained a completely free ride at an elite private university purely as a result of need-based aid obtained solely because you paid off your mortgage, you still would be likely to come out ahead by taking the opposite path.

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Re: Should I pay off my mortgage early?
« Reply #39 on: December 16, 2014, 12:33:13 PM »
Thanks for your answers Sol. Your situation is remarkably close to mine, except I am right now where you're planning to be when you ER in 2018 (same family size, same children's ages, etc.). I think you're going to make it work easily without too many gymnastics, and obviously you've planned it out exceedingly well.

My first pass through the FAFSA was pretty discouraging.  At $45k of income (to stay under the $50k asset exclusion limit) your EFC is still like $14k/year.  I'll look into it in more detail, but it looks like $24k/year is the cutoff to have a zero EFC.

?????

I don't get this. I just went through this estimator from the Dept. of Education:

https://fafsa.ed.gov/FAFSA/app/f4cForm?execution=e1s4

and using a family of 5, with an AGI of $40,000, and only one student in college, got an Estimated Family Contribution of $0*

* This estimator makes an assumption on the family's assets based on the AGI entered, but you can override it. Even when I overrode their estimate and entered higher cash and investments totaling $60,000, it still came up with an EFC of only $546. It seems to me that with an AGI of $40,000, you could easily have a gross income of $50-60,000, and still end up with $0 contribution for financial aid. As long as you're not hoarding cash and taxable investments, you should be good to go. Paying off the mortgage just before filling out the FAFSA may be one way to accomplish that, but personally I'd wait until then to do it (so you wouldn't be house rich/cash poor in the interim, just in case).

sol

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Re: Should I pay off my mortgage early?
« Reply #40 on: December 16, 2014, 10:01:35 PM »
We paid off our mortgage early, but it was a no-brainer for us, the rate was 9.75%. 

Yea, that's an easy one.  We're at 3.25%, which makes it less obvious.

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Look closely at the FAFSA rules for the simplified needs test and auto EFC = 0.

I'll start a new thread sometime soon, unless I can find an old one to revive.  The FAFSA is an interesting topic all by itself.

I believe you are correct about the reason for the discrepancy.

The differing levels of income eligibilty for free healthcare for different members of a family is weird.  Why bother to offer free healthcare for the kids if the two adults in the family are going to be forced to buy a family policy anyway?  Is this just designed to be a tax break for single parents?

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This discussion has reminded me that this was actually another factor in my decision to keep my mortgage outstanding -- without it, I may have found myself struggling to find enough unsheltered income to meet the ACA threshold.

In our case, we can show more income by doing larger Roth conversions each year.  As long as your tax-free conversions amount is larger than 138% of the FPL, you're golden.  Which it usually should be, just from the standard deduction and exemptions and child tax credits.

So I think the only people who won't be able to show enough income to stay out of Medicaid are people who either have living expenses well below the standard deduction, or who have too much in taxable accounts vs sheltered accounts and therefore can't show conversions as income.

What I meant when I said that carrying a mortgage is a good inflation hedge is the fact that it is long-term, fixed-rate debt--during periods of high inflation, you will be repaying those borrowed dollars with increasingly less-valuable dollars. 

Yes, that's clear to me now but that's not what I meant.  I was thinking of the rising equity in the home due to appreciation as an inflation hedge, in much the same way that the stock market is an inflation hedge, because they both tend to rise more when inflation is high.  I wasn't thinking of the loan repayment with future dollars angle.

Mr. Frugalwoods

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Re: Should I pay off my mortgage early?
« Reply #41 on: December 17, 2014, 06:20:05 AM »
Well written collection of thoughts, Sol!

I've been thinking a lot about this too.  Seems like the correct vocab word here is Imputed Income:

http://en.wikipedia.org/wiki/Imputed_income

And how the US tax system doesn't tax the money you save by owning something.

The flip side though is inflation.  If inflation picks up, it would be great to still be paying a mortgage with dollars that are worth a lot less... while gaining the income from investments that have beat the rate of inflation.

I don't know how to meaningfully model the probability of future inflation into the payoff model.  Something I'm still working on :-)

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #42 on: December 17, 2014, 07:41:10 AM »

The differing levels of income eligibilty for free healthcare for different members of a family is weird.  Why bother to offer free healthcare for the kids if the two adults in the family are going to be forced to buy a family policy anyway?  Is this just designed to be a tax break for single parents?

Good question.  Maybe policymakers believed there should be a broader safety net for society's children than its adults?  These discrepancies existed before the advent of the ACA, so they may have been intended ensure that a broader group of children in low income households don't go without coverage (even if their parents do).  I don't know enough about this stuff so really I'm just guessing.

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In our case, we can show more income by doing larger Roth conversions each year.  As long as your tax-free conversions amount is larger than 138% of the FPL, you're golden.  Which it usually should be, just from the standard deduction and exemptions and child tax credits.

So I think the only people who won't be able to show enough income to stay out of Medicaid are people who either have living expenses well below the standard deduction, or who have too much in taxable accounts vs sheltered accounts and therefore can't show conversions as income.

My problem is that I have a rental unit that will cover a significant portion of my spending during retirement (and that income is sheltered by large depreciation deductions, so much of it won't count towards the ACA income threshold), and I'm worried that if I need to manufacture almost all of the income needed to meet the threshold through Roth conversions I will entirely deplete my tax-deferred accounts too soon.  (And, again, I think have more faith in the market's ability to outperform my mortgage than I do in government entitlement programs' steadfastness and my ability to exploit them.)

I will say, though, that this discussion has gotten the gears turning and I'm re-running the numbers, so I am open to reevaluating my strategy.

sol

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Re: Should I pay off my mortgage early?
« Reply #43 on: December 17, 2014, 08:55:19 PM »
Well written collection of thoughts, Sol!

Thanks, my momma raised me to talk good.

Quote
The flip side though is inflation.  If inflation picks up...

I was just reading an article today that argued that inflation "no longer exists", and the Fed is consistently failing to get it as high as their 2% target.  If that trend continues for the next ten years, which I think isn't totally unreasonable, then that makes prepaying more attractive by removing some of the benefit of the mortgage.

Good question.  Maybe policymakers believed there should be a broader safety net for society's children than its adults?

Sure, I can understand the historical argument, but in practice it's now pretty silly.  For lots of families, healthcare is now free for their kids but not for the parents, but the parents are legally required to buy family coverage health insurance which automatically covers the children.  What's the point in proving free coverage for the kids if you require them to pay for it anyway?

Quote
I will say, though, that this discussion has gotten the gears turning and I'm re-running the numbers, so I am open to reevaluating my strategy.

Glad to be of service.  And thanks for all of your input on this thread, it's helpful to be able to talk through these decisions.

milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #44 on: December 17, 2014, 09:23:26 PM »

Well written collection of thoughts, Sol!

Thanks, my momma raised me to talk good.

Quote
The flip side though is inflation.  If inflation picks up...

I was just reading an article today that argued that inflation "no longer exists", and the Fed is consistently failing to get it as high as their 2% target.  If that trend continues for the next ten years, which I think isn't totally unreasonable, then that makes prepaying more attractive by removing some of the benefit of the mortgage.

Good question.  Maybe policymakers believed there should be a broader safety net for society's children than its adults?

Sure, I can understand the historical argument, but in practice it's now pretty silly.  For lots of families, healthcare is now free for their kids but not for the parents, but the parents are legally required to buy family coverage health insurance which automatically covers the children.  What's the point in proving free coverage for the kids if you require them to pay for it anyway?

Quote
I will say, though, that this discussion has gotten the gears turning and I'm re-running the numbers, so I am open to reevaluating my strategy.

Glad to be of service.  And thanks for all of your input on this thread, it's helpful to be able to talk through these decisions.

That's an interesting article. But I might have liked this piece by Krugman even better.

http://mobile.nytimes.com/blogs/krugman/2014/12/16/the-limits-of-purely-monetary-policies/?smid=tw-NytimesKrugman&seid=auto&_r=0&referrer=

In it he argues that central banks are in fact helpless to increase inflation once The economy has reached the zero lower bound.

So the question I have is; has any country ever successfully pulled itself out of a liquidity trap?or is the whole world doomed to just keep inflating bubbles and having them popped every five or six years, without any real sustained growth from now on?

I lack the macro economic bonafides to even know if such a question is reasonable, let alone to guess at what the answer is, but Japan seems to of been swimming in a deflationary trap for the past 30 years.

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Re: Should I pay off my mortgage early?
« Reply #45 on: December 18, 2014, 07:42:42 AM »
Although there is a lot of trees being looked at, the conclusion seems to be the same as I have seen many times over:

Pay off the mortgage prior to retirement, to eliminate the exposure of carrying debt.  Maybe there are some additional benefits related to subsidies, taxes, etc. but the main one is to reduce your non-discretionary spending / increase flexibility.  I have very little confidence that you will get a consistent 9% total return by paying off the mortgage, but you are the one with the spreadsheet.

Although debated endlessly, I still think it makes sense to carry a mortgage while you are working, especially if you have to pay additional tax to raise the funds, or miss out on passive income, to pay off the mortgage.  I choose to use my discretionary income for investing and leave my 2.875% tax deductible mortgage in place, and will do that for as long as I continue working (or if the balance gets low, the deduction tiny, I want to retire a little earlier, or it is just a simplification to pay it and not have a monthly payment, but I digress).  Basically, a bank is lending me money, I can't get 9% return at least until my children go to college, and 7% expected return on my S&P index fund is as good a place as any. 

So the takeaway for me is, if you have set a date for retirement, maybe a better option is to refinance to best match the duration of the liability to that date... you keep the majority of investments exposed for as long as possible. 

brooklynguy

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Re: Should I pay off my mortgage early?
« Reply #46 on: December 18, 2014, 07:44:26 AM »

I was just reading an article today that argued that inflation "no longer exists", and the Fed is consistently failing to get it as high as their 2% target.  If that trend continues for the next ten years, which I think isn't totally unreasonable, then that makes prepaying more attractive by removing some of the benefit of the mortgage.

On these boards, arebelspy is fond of pointing out that inflation is the retiree's number one enemy, exponentially so for the early retiree (and I agree with him).  I think it's dangerous to plan around any sort of prognostication of low inflation levels in the future, but in any event why limit your analysis to the next ten years?  You want to protect your retirement's success over the multiple decades that constitute the remainder of your life.  Run the numbers for the alternative of refinancing into a 30 year mortgage and see where the results of the cost-benefit analysis fall; I'm interested in hearing your take on post # 40 above.  If it's anywhere near a close call, you might decide that the built-in benefit of long-term inflation-protection tips the scales in favor of that option.

For my personal situation, all things considered, I'm still leaning towards carrying my mortgage to maturity (which is 25 years from today, and I'm hoping to FIRE within 3-5 years).  However, I have the additional consideration that a portion of my mortgage is allocable to the rental unit in my two-family house, and therefore provides a deduction against rental income that will continue into retirement (while the benefit of the itemized tax deduction against my ordinary income that I currently enjoy will disappear after I transition from a high-income member of the workforce to a low-income early retiree).

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Glad to be of service.  And thanks for all of your input on this thread, it's helpful to be able to talk through these decisions.

Likewise.

teen persuasion

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Re: Should I pay off my mortgage early?
« Reply #47 on: December 18, 2014, 07:49:37 AM »
Thanks for your answers Sol. Your situation is remarkably close to mine, except I am right now where you're planning to be when you ER in 2018 (same family size, same children's ages, etc.). I think you're going to make it work easily without too many gymnastics, and obviously you've planned it out exceedingly well.

My first pass through the FAFSA was pretty discouraging.  At $45k of income (to stay under the $50k asset exclusion limit) your EFC is still like $14k/year.  I'll look into it in more detail, but it looks like $24k/year is the cutoff to have a zero EFC.

?????

I don't get this. I just went through this estimator from the Dept. of Education:

https://fafsa.ed.gov/FAFSA/app/f4cForm?execution=e1s4

and using a family of 5, with an AGI of $40,000, and only one student in college, got an Estimated Family Contribution of $0*

* This estimator makes an assumption on the family's assets based on the AGI entered, but you can override it. Even when I overrode their estimate and entered higher cash and investments totaling $60,000, it still came up with an EFC of only $546. It seems to me that with an AGI of $40,000, you could easily have a gross income of $50-60,000, and still end up with $0 contribution for financial aid. As long as you're not hoarding cash and taxable investments, you should be good to go. Paying off the mortgage just before filling out the FAFSA may be one way to accomplish that, but personally I'd wait until then to do it (so you wouldn't be house rich/cash poor in the interim, just in case).

Here are the actual FAFSA formulas: http://ifap.ed.gov/efcformulaguide/attachments/090214EFCFormulaGuide1516.pdf

Start at page 9.  They begin with AGI, but then add back all sorts of payroll deductions, so gross income matters, too.  There are deductions for fed tax paid, an estimate of state tax burden, SS paid, and an employment expense allowance if both parents work.  Many of these will not apply to anyone ER.

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Re: Should I pay off my mortgage early?
« Reply #48 on: December 18, 2014, 04:50:10 PM »
I was just reading an article today that argued that inflation "no longer exists"

This time it's different?

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milesdividendmd

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Re: Should I pay off my mortgage early?
« Reply #49 on: December 18, 2014, 08:59:21 PM »

I was just reading an article today that argued that inflation "no longer exists"

This time it's different?

It may be ARS.

I don't think The world's economy has ever been here before.

I know that your comment is ironic, but this is not the case of someone justifying a harebrained investment idea by touting that "this time it's different."

According to Krugman's analysis, central banks can print as much money as they want, and it will have zero effect on inflation.

We won't know that this time it is not different, until we once again see inflation above 2% in a growing economy.

My goal in my own investment strategy is to hedge against every possible problem, inflation, deflation, stagflation, government bankruptcy, Government seizure, you name it. (I aim to be a good coward.) so these Macro economic questions certainly do not argue against guarding against inflation. Just don't forget to guard against deflation while you're at it!