Big mortgage plus holding mostly equities - is this a disaster in waiting?

[Albatross]

Hi All - I note a lot of Mustachians on here:
 - have a large mortgage (and pay it off as slowly as possible);
 - but at the same time hold most of their assets in equities.

At the same time, most people would advise that borrowing money just to put it in the stock market is not wise, because if the stock market goes down, and you possibly lose your job or have to find a lower paying job, you may have to sell your equities at a lower value.

I'm gonna get a lot of hate for this as the above appears to have become a 'Mustachian' tenet due to low interest rates - but isn't this the same as people keeping a large mortgage and putting the rest of their money in equities? Am I missing something and isn't this inherently dangerous? I'm not a doom and gloom tin-foil hat and gold man, but I think being highly-geared in this way might cause heartache in the next downturn.

Happy to be enlightened.

[MDM]

A couple of things:
- Mortgages can be long term, low interest, and non-callable.  Margin loans are typically the opposite.
- Buying a home is a "necessary" expense (at least, compared with a margin loan).  That makes having a mortgage qualitatively different from choosing leveraged investing.

[Laura33]

Mathematically, you are right:  there is no difference between buying a house with a mortgage when you could buy it with cash and refinancing to take out equity to invest in the market.  But you are looking at only part of the picture:

1.  Most Mustachians do not take out “large” mortgages, because they do not buy nearly as much house as a bank would say they can “afford.”  In our case, our mortgage was always at a level that we could continue to pay even if one of us lost our job.  That mitigates the risk quite significantly (as does the fact that we are in different industries, making it unlikely we would both lose our jobs at the same time).

2.  That’s what an emergency fund is for.

3.  If you lose your job, you either find a new one locally, or you move.  If you have to move, you sell the house, in which case that debt goes away.  (Also see 1:  another advantage of not maxing out the size of the mortgage is it means you are less likely to need to bring more money than you can afford to the table if you are underwater.)

4.  Life cycle also plays into the appropriate degree of risk.  While we are working and socking it away, we have a low mortgage that we are not prepaying, because, again, the two jobs make for a nice insurance policy that allows us to take that extra risk.  By the time we retire, though, we will pay off the mortgage, because we will no longer have the same ability to just earn back the difference if something goes wrong down the road (and we will also have more in cash/bonds so we don’t need to sell in a big downturn).

So, yes, there is risk involved.  But it is a reasoned risk in light of the whole picture.  And remember, there is also “risk” in choosing to dedicate those funds to a house instead of investments:  in all but the worst scenarios, you will make significantly less money that way, thus prolonging your working life as you build sufficient investments to be able to FIRE.  The point of Mustachianism is not to avoid risk entirely - it’s not to spend 10-15 years clutching your pearls and hope-hope-hoping nothing goes wrong before you get your ‘stache to the necessary level. It is to acknowledge that everything involves risk, and so to approach risk logically, and with confidence, not fear - not the bullshit overconfidence that nothing will go wrong, but the confidence of knowing that shit is going to hit the fan at some point, but you can handle it.  Partly because you have a plan and a safety net that has already considered those bad outcomes, but even more just because you are a badass and know you have the skills and ability to adapt and manage.

[slappy]

Personally, I would challenge the "large mortgage" assumption. In general, I would think mustachians would be the opposite. If you are seeing "large mortgages" it may be because they are high income/HCOL.

[boarder42]

A couple of things:
- Mortgages can be long term, low interest, and non-callable.  Margin loans are typically the opposite.
- Buying a home is a "necessary" expense (at least, compared with a margin loan).  That makes having a mortgage qualitatively different from choosing leveraged investing.

this sums it up pretty well.

i'll add a couple things

- holding a mortgage and investing vs paying down a mortgage actually creates less financial risk during the paydown period. 
    - Why?  b/c if you ever have a large financial hit due to job loss or something like a large payment on something come unexpected you have more liquid capital to keep your life going for a longer amount of time - regardless of if the market crashes simultaneously.

-for the reason above people who paydown mortgages instead of investing tend to keep larger Emergency Funds - this is often over looked when doing the math as to why its a better financial choice 95% of the time. - those who invest typically end up letting their EF go once the stash in the index funds is large enough - more money invested sooner wins historically!

- the most best risk averse approach IMO would be to invest until you can lump sum pay it off and then at that point determine if you really want to - chances are you wont but you'll have been safer than otherwise.

- also understand that many people had rates around 3% as recent as 2016 - and you can almost get a guarnteed return of that in treasury bonds right now. 

- once you are FIREd having a mortgage does create some Sequence of Return Risk in the early years but actually elminates and improves the longevity of money most of the time - its about 3-5% safer historically to FIRE with high equity allocation and a 4% SWR with a 4% 30 year mortgage equal to 20% of your stache

this is probably one of the more important concepts a person seeking FIRE can wrap their head around.  If you can get over the psychology that all debt is bad and understand this debt is actually beneficial you'll like FIRE sooner and be safer in FIRE.

[ysette9]

I like that concept of building up your investments until you could cover the mortgage in one fell swoop, and then decide whether to actually pay it off or not. In our case our taxable account has been building, and due to the kindness of the market gains, we got our down payment “for free”. A year out from buying, I realized that contributions and market gains now make that account equal to our mortgage balance. It is a bit of a surreal feeling to look at those two screens and realize I could move the numbers here on the left to wipe out the numbers on the right. But then my precious, precious vanguard account would be $0 and that would make me very sad.

Any personal opinions on paying off in a lump sum at the time of FI based on relative size of mortgage versus stash? The other thing I can think that plays into it is paying it off would mean a lower manufactured income in RE and therefore lower taxes, versus pulling enough out to cover a mortgage payment.

[boarder42]

I like that concept of building up your investments until you could cover the mortgage in one fell swoop, and then decide whether to actually pay it off or not. In our case our taxable account has been building, and due to the kindness of the market gains, we got our down payment “for free”. A year out from buying, I realized that contributions and market gains now make that account equal to our mortgage balance. It is a bit of a surreal feeling to look at those two screens and realize I could move the numbers here on the left to wipe out the numbers on the right. But then my precious, precious vanguard account would be $0 and that would make me very sad.

Any personal opinions on paying off in a lump sum at the time of FI based on relative size of mortgage versus stash? The other thing I can think that plays into it is paying it off would mean a lower manufactured income in RE and therefore lower taxes, versus pulling enough out to cover a mortgage payment.

the tax hit makes it not worth the tax savings - i plan to hold mine to full term.  shoot by the time we FIRE you can probably get bonds yielding more if you want insurance against SORR

[jlcnuke]

Hi All - I note a lot of Mustachians on here:
 - have a large mortgage (and pay it off as slowly as possible);
 - but at the same time hold most of their assets in equities.

At the same time, most people would advise that borrowing money just to put it in the stock market is not wise, because if the stock market goes down, and you possibly lose your job or have to find a lower paying job, you may have to sell your equities at a lower value.

I'm gonna get a lot of hate for this as the above appears to have become a 'Mustachian' tenet due to low interest rates - but isn't this the same as people keeping a large mortgage and putting the rest of their money in equities? Am I missing something and isn't this inherently dangerous? I'm not a doom and gloom tin-foil hat and gold man, but I think being highly-geared in this way might cause heartache in the next downturn.

Happy to be enlightened.

Are you arguing that "to be safe, people should pay off their mortgage instead of investing in equities"?

Assuming that's your argument, the answer is "sure, but it's still not 'safe'". Accumulating wealth, in any form, involves some measure of risk (whether it's the risk of inflation's affect on your cash under the mattress or the risk inherent in equities or the risk of investing in the latest cryptocurrency). Each person must determine their level of risk tolerance. A common determination for many with reasonable means is to decide that their accumulated emergency fund is expected to be adequate to handle financial hard-times without needing to access their equity investments or sell their home. As such, the relative risk of investing in equities vs paying off their mortgage is a completely different consideration that doesn't need to account for market fluctuations in poor financial conditions.

[SwordGuy]

I like that concept of building up your investments until you could cover the mortgage in one fell swoop, and then decide whether to actually pay it off or not.

IF, repeat IF, you are going to pay off the mortgage early, this is the safest way to do it.

That does not make it the safest choice, just the safest when it comes to paying off a mortgage early.

Any personal opinions on paying off in a lump sum at the time of FI based on relative size of mortgage versus stash?

I'm only speaking to the US market.  The facts are different in other countries which means different results, thus different choices.

Historical average inflation is about 3% in the US.

That means in year one I have to earn $1 after tax dollar per dollar I pay on my mortgage.
With average inflation, in the 2nd year of the mortgage, $1 is only worth $0.97 in today's dollars.

What does that mean?   If your income adjusts upward to cover inflation, you just got a 3% discount that year.

It gets better.

In the 3rd year, again assuming average inflation, $1 is only worth $0.94 in today's dollars.   That's a 6% discount.

If your income grows as it adjusts to inflation, your mortgage consumes a smaller and smaller portion of that income.

By the time you get to year 30, that mortgage is trivial.

Now, if your income won't adjust to inflation because you chose an annuity that doesn't have inflation protection, you're screwed.

Now, if your mortage rate is 18% -- yes, it's been that high in living memory -- that SOB of a mortgage needs to get paid down pronto.   Pour money into it until you can get it refinanced.  (Or better yet, never get one like that!)

But if your mortgage rate is 3%, the world is your oyster.

The other thing I can think that plays into it is paying it off would mean a lower manufactured income in RE and therefore lower taxes, versus pulling enough out to cover a mortgage payment.

If I'm paying for my mortgage by withdrawing funds from a 401K or IRA, my income just went up by the P&I of my mortgage.

If I'm paying for my mortgage out of taxable accounts, my income only went up by the amount of "profit" the stocks I sold have had.   Plus, unless my income is very high, that's taxed at a very low rate - or even not taxed at all.