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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: diversify on January 03, 2015, 05:49:18 PM

Title: What is the magic pay down your mortgage rate?
Post by: diversify on January 03, 2015, 05:49:18 PM
Obviously there is lot's of back and forth on whether to pay down a mortgage or instead invest those assets at what will hopefully be a higher after tax return.  My question is, what do most people feel is the magic number (mortgage rate) that would justify paying down the mortgage vice investing the money elsewhere?
Title: Re: What is the magic pay down your mortgage rate?
Post by: ruraljuror on January 03, 2015, 07:01:18 PM
For me, I would be paying extra toward the mortgage, or any debt, if it were over 4.5. Maybe not all investable funds, but at least a sizeable portion.
Title: Re: What is the magic pay down your mortgage rate?
Post by: YeahNo on January 03, 2015, 07:05:23 PM
I'm at 4.25% and aggressively paying down principal each month.
Title: Re: What is the magic pay down your mortgage rate?
Post by: arebelspy on January 03, 2015, 09:55:35 PM
It depends on a number of factors, among them: if you itemize on your taxes, what your opportunity cost is, your thoughts on debt/leverage, etc.

For me, I've mentioned before I'd borrow money at 10% if it was fixed, long term (i.e. no balloon).  8% if it was short term.

For me without certain opportunities I have right now (say in a few years), maybe 7-8% if it was fixed long term.

I think anyone paying down something under 5% is a little silly, and under 4% is quite silly, and under 3.5% is giving away free money due to inflation, reducing the success chances of their FIRE, and misguided if their SWR is above their mortgage rate (i.e. they're depending on a 4% SWR).
Title: Re: What is the magic pay down your mortgage rate?
Post by: waltworks on January 03, 2015, 10:21:45 PM
I'll pay down 4% and up because I'm neurotic and overly conservative. You could make an argument for a 5% limit or even a bit more. As Arebelspy notes, it's going to depend on the circumstances. It also will depend on your risk tolerance. There is not a right or wrong answer, really. Mathematically, and over a long period of time, anything below the expected return of your investments isn't worth paying off, but you can get yourself in a lot of trouble in the short term that way.

-W
Title: Re: What is the magic pay down your mortgage rate?
Post by: sol on January 03, 2015, 10:36:16 PM
Lately I've been thinking about this question in much the same way I think about Lending Club loans.  The whole point is to build a risk/return spread that you're comfortable with.  That means there isn't any one rate that is "inappropriate" for your asset mix as long as the risk is proportional to the reward, and the balance fits in with the rest of your investments as defined by your objectives.

So to translate to the mortgage question, I wouldn't normally commit ALL of my investment money to a single low-return investment like paying off my mortgage, but I can see the benefit in allocating a portion of my monthly investments to that purpose as long as there is a balancing portion going to something else with a higher return, and presumably a higher risk.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 03, 2015, 10:39:27 PM
5.5% +/- 3% would cover most cases. ;)

The correct number is best viewed using hindsight glasses.  My crystal ball currently displays a hazy 5ish% as the over/under for your question.

Title: Re: What is the magic pay down your mortgage rate?
Post by: diversify on January 03, 2015, 11:49:21 PM
Thanks for the responses, they pretty much confirm what I was thinking.  I have a number of mortgages and HELOCs ranging from 3.5% - 4.625% due to owning a few rental inexpensive properties as well as my residence.  They don't bother me too much because I am very cash flow positive on the rentals and the properties have already appreciated substantially. My wife, however, tends to be more conservative and thus worry more about them which in turn can cause me pain/aggravation. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: Hey It's Me on January 04, 2015, 12:06:35 AM
Inflation averages around 3.8% (although it's been lower in the past few years,) so paying down a mortgage with an interest rate of under 3.8% is just plain silly in the long-term. That said, there is a certain degree of bliss, I'd imagine, from not having to pay that mortgage payment each month after you're free of that debt...
Title: Re: What is the magic pay down your mortgage rate?
Post by: gooki on January 04, 2015, 01:25:00 AM
5%
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 04, 2015, 02:26:07 AM
I think it totally depends on how much is in your investment accounts, and what your mortgage balance is, too. I would look at the amortization table of the loan and calculate how much interest you are paying in a year, and compare that to your investments with a moderate gain.

For example, my mortgage is 3.85% with balance around $275k. My monthly payment is about $1400, and $900 of that is interest every month. This year, I'll pay about $11k in interest. My brokerage account would have to have $100k balance already and earn over 10% interest to even break even!

So even with a low interest mortgage, it might not be the right choice.
Title: Re: What is the magic pay down your mortgage rate?
Post by: clifp on January 04, 2015, 03:22:50 AM
It depends on a number of factors, among them: if you itemize on your taxes, what your opportunity cost is, your thoughts on debt/leverage, etc.

For me, I've mentioned before I'd borrow money at 10% if it was fixed, long term (i.e. no balloon).  8% if it was short term.

For me without certain opportunities I have right now (say in a few years), maybe 7-8% if it was fixed long term.

I think anyone paying down something under 5% is a little silly, and under 4% is quite silly, and under 3.5% is giving away free money due to inflation, reducing the success chances of their FIRE, and misguided if their SWR is above their mortgage rate (i.e. they're depending on a 4% SWR).

More than most decision taxes matter a lot in paying off mortgage or not. So it is real important not only to figure out what your likely tax savings are next year but what they might be in 3-5 years with raises etc. figured in.  After you have factored in taxes this will you give a true after tax cost of the money. I then compare to investment opportunities.

So for instance if you are firmly in the 25% bracket, with other deductions a 4% mortgage really only cost 3%.  If you invest the money in the stock market you'll earn on average 9% which after15% capital gain tax is equal 7.65%.  7.65% is a lot of higher than 3%. Of course paying off the mortgage is a guaranteed return and investing in the stock market in any one year is anything but. However, after 5 year period of time more than 75% they will be greater than 3%, and more 50% of the time they'll exceed 10% after tax.  I expect the number are similar for most real estate investment.

As rule of thumb goes I completely agree with Arebelspy.
Title: Re: What is the magic pay down your mortgage rate?
Post by: chasesfish on January 04, 2015, 06:06:57 AM
It depends on a number of factors, liquidity, taxes, alternate investments available, and your personal comfort.
If the rate is under 5%, you mathematically win by investing the difference over a 15 year time frame.  This is even better if you aren't maxing out your retirement accounts and you don't have to take into account the deterioration tax rates have on your annual return. 

That being said, there are other things to consider:  How much do you value a free and clear house? Are you in a situation where you need to manage your income and a free and clear house is worth more than investments generating cash?  Are you already on a 15 year or less mortgage (the spread in rate is significant between getting a 15 year or a 30 year).

Personally, I aggressively paid down our second house we spent almost 7 years in and got very close to paying it off.  The next house rates were so good I put 20% down and took out a 15 year and didn't prepay that one much, mainly because it was 3.25% and I could still pickup some nice dividend paying stocks that exceeded that number.
Title: Re: What is the magic pay down your mortgage rate?
Post by: JLee on January 04, 2015, 09:46:40 AM
I think it totally depends on how much is in your investment accounts, and what your mortgage balance is, too. I would look at the amortization table of the loan and calculate how much interest you are paying in a year, and compare that to your investments with a moderate gain.

For example, my mortgage is 3.85% with balance around $275k. My monthly payment is about $1400, and $900 of that is interest every month. This year, I'll pay about $11k in interest. My brokerage account would have to have $100k balance already and earn over 10% interest to even break even!

So even with a low interest mortgage, it might not be the right choice.
If you paid an extra $1000/mo on your mortgage, how much interest would you save?

If you invested an extra $1000/mo at 8% average return, how much interest would you earn?
Title: Re: What is the magic pay down your mortgage rate?
Post by: C-note on January 04, 2015, 10:01:50 AM
For us, there are lots of factors in the decision to pay down the mortgage.  The mortgage rate is just one factor.

Our rate is 3.25% so many may feel we should not be paying down our mortgage.  The other factors are our ages (early/mid 50's), our current nest egg ($1.25M), our mortgage ($200K), and our ability to continue to chuck money at our nest egg and pay down the mortgage.

We plan to have it paid off in 8 - 9 years.  Projections put our nest egg at about $2M (based upon our current contributions and our past performance (ROI).  Within a couple of years of paying off the house, we'll sell it and downsize.

We believe now is the time to knock off our last debt - the mortgage.

Lots of things to consider beyond the mortgage rate.
Title: Re: What is the magic pay down your mortgage rate?
Post by: apennysaved on January 04, 2015, 10:44:13 AM
My husband and I are paying down our mortgage and it is at 3%.  The primary reason is that we realized that it could be paid off in less than 2 years, so sometime between May - October of this year.  We have been living in the same house for a number of years. The house payment is our only debt, so having that monkey off our back will pretty much allow my husband to walk away from his job at anytime.  We do have other investments that should be able to cover the rest of our expenses, and I am a realtor and plan to take a few jobs here and there just in case. We are so close to FIRE, we can barely control ourselves.

If we weren't so close in paying off our house than I agree that it would make more sense to invest in something else.   Everyone's situation is different.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Mr. Frugalwoods on January 04, 2015, 11:19:26 AM
Ours is 3.85% for 30 years and I'm in no hurry to pay it off.

If I had to pick a number... maybe keep anything under 5%?  Historically that's a pretty awesome rate, and over the course of 30 more years it's likely to look more awesome.

But only if you have the discipline to invest the difference long term.  That's the key.  Most normal folks fail that test and would be better served paying down their cheap mortgage :-)
Title: Re: What is the magic pay down your mortgage rate?
Post by: BlueHouse on January 04, 2015, 05:37:26 PM
The magic number for me is 60 (to get it paid off (early) by the time I retire).  I'm putting about 1/3 of my monthly savings toward extra principal payment and the rest in what I've learned is called a "sinking fund".  I like the thought of getting rid of the pressure of the debt, but also want the benefit of the market forces.  So when I get enough in the sinking fund, I may pay off the mortgage altogether.  If I decide not to use it to pay off the mortgage balance, then at least the 1/3 extra principal will get me to house paid off before normal retirement. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: powersuitrecall on January 05, 2015, 01:51:51 PM
In case there are other Canadians reading this, I'd like to hear your perspective.  There are some notable differences which make paying down mortgages early a little more attractive than in the US:

1. There is no tax write-off on mortgage interest.  Mortgages are paid with after-tax dollars, and income tax is relatively high here compared to the US, so your investments have to beat your mortgage rate to make it worthwhile.

2. Terms are typically 5 years max.  It is possible to lock in for 10 years, but it comes with a cost and most people don't do it (The current 5 year rate is ~3% while the 10 year rate is ~5%).  Paying off the mortgage earlier protects you against future rate hikes.

Our story: We decided to do triple payments on our 3.69% mortgage.  We are about 4.5 years in and have knocked off 75% of the principle.  We always assumed that the rates would have shot sky high by now, but obviously they haven't!

We plan on keeping up this strategy until our renewal in half a year, when we'll refinance at a great rate and pay the rest out at the minimum.
Title: Re: What is the magic pay down your mortgage rate?
Post by: ShoulderThingThatGoesUp on January 05, 2015, 01:59:57 PM
My house is paid off because I don't like debt and paying it down has a guaranteed return. To those advocating keeping it - would you suggest I get a hypothetical HELOC at 4%? That sounds like craziness, but it's equivalent to not paying off your mortgage (depending where you are in the amortization table).
Title: Re: What is the magic pay down your mortgage rate?
Post by: Goldielocks on January 05, 2015, 02:12:05 PM
In case there are other Canadians reading this, I'd like to hear your perspective.  There are some notable differences which make paying down mortgages early a little more attractive than in the US:

1. There is no tax write-off on mortgage interest.  Mortgages are paid with after-tax dollars, and income tax is relatively high here compared to the US, so your investments have to beat your mortgage rate to make it worthwhile.

2. Terms are typically 5 years max.  It is possible to lock in for 10 years, but it comes with a cost and most people don't do it (The current 5 year rate is ~3% while the 10 year rate is ~5%).  Paying off the mortgage earlier protects you against future rate hikes.

Our story: We decided to do triple payments on our 3.69% mortgage.  We are about 4.5 years in and have knocked off 75% of the principle.  We always assumed that the rates would have shot sky high by now, but obviously they haven't!

We plan on keeping up this strategy until our renewal in half a year, when we'll refinance at a great rate and pay the rest out at the minimum.

In addition to the age / personal comfort factor  noted by others, (e.g., no mortgage when retired) a specific concern for me (a canadian) is imagining the risk to me of an increased mortgage rate at renewal (or if variable), and whether I can easily absorb an increase of 3% on the mortgage rate.

I don't want to be forced into selling my home or taking out equity to meet mortgage payments in future.   In a high COL area, with an excessive mortgage amount, this really matters.

This leaves two solutions -- a sinking fund / investment pool to draw upon for mortgage payments (if needed) in future, (my current choice) or faster pay-down of the mortgage directly,now, with refinancing to longer armortization in the event rates increase a lot.  I don't like the second option as it impacts my goal of retiring without a mortgage debt.   The first option has a benefit of being invested outside of RRSPs and can be used for anything, including long term savings, with minimal tax impacts, if everything works out well.
Title: Re: What is the magic pay down your mortgage rate?
Post by: minimustache1985 on January 05, 2015, 02:13:05 PM
I'd say 5% UNLESS there is PMI, which effectively raises the rate way higher on a portion of the loan.

I will stop adding extra principal to the payments once our PMI is gone, but until then it's the best use of $ I have once retirement accounts are maxed.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Guses on January 05, 2015, 02:17:13 PM
In case there are other Canadians reading this, I'd like to hear your perspective.  There are some notable differences which make paying down mortgages early a little more attractive than in the US:

1. There is no tax write-off on mortgage interest.  Mortgages are paid with after-tax dollars, and income tax is relatively high here compared to the US, so your investments have to beat your mortgage rate to make it worthwhile.

2. Terms are typically 5 years max.  It is possible to lock in for 10 years, but it comes with a cost and most people don't do it (The current 5 year rate is ~3% while the 10 year rate is ~5%).  Paying off the mortgage earlier protects you against future rate hikes.

Our story: We decided to do triple payments on our 3.69% mortgage.  We are about 4.5 years in and have knocked off 75% of the principle.  We always assumed that the rates would have shot sky high by now, but obviously they haven't!

We plan on keeping up this strategy until our renewal in half a year, when we'll refinance at a great rate and pay the rest out at the minimum.

We throw every extra "loonie" that we have at our mortgage after maxing* our registered retirement accounts and TFSA.

Although our mortgage is under 3%, we would need to earn a garanteed 5% to beat paying down the mortgage. I am not seeing this anywhere in the market right now. Also, my mortgage will be ballooning upon renewal next year.

From a cashflow perspective, having a mortgage 75% paid off is no better than having it 0% paid off. As long as you have a mortgage, you need to make your payments or you a screwed. Because of this, we are aiming to finish paying off our mortgage completely mid next year.

*Maxing our accounts represents investing 20-25K/year

Title: Re: What is the magic pay down your mortgage rate?
Post by: SK Joyous on January 05, 2015, 02:45:08 PM
In case there are other Canadians reading this, I'd like to hear your perspective.  There are some notable differences which make paying down mortgages early a little more attractive than in the US:

1. There is no tax write-off on mortgage interest.  Mortgages are paid with after-tax dollars, and income tax is relatively high here compared to the US, so your investments have to beat your mortgage rate to make it worthwhile.

2. Terms are typically 5 years max.  It is possible to lock in for 10 years, but it comes with a cost and most people don't do it (The current 5 year rate is ~3% while the 10 year rate is ~5%).  Paying off the mortgage earlier protects you against future rate hikes.

Our story: We decided to do triple payments on our 3.69% mortgage.  We are about 4.5 years in and have knocked off 75% of the principle.  We always assumed that the rates would have shot sky high by now, but obviously they haven't!

We plan on keeping up this strategy until our renewal in half a year, when we'll refinance at a great rate and pay the rest out at the minimum.

In response to this (and in general) we look at pre-paying our mortgage in two ways:

1. Something that MUST be paid off by the time we retire, and hopefully earlier to free up cash flow to throw at the nest egg for the last few working years; and

2. As a part of our portfolio, in the 'low-return' area at current interest rates.  Even though it has a 'low return' at our 3.25% interest rate, that is still better than what many bonds are getting, and so I put it in that category of our investments.  Just because something has a lower return (and low risk) doesn't make it pointless; it is about a balanced approach to risk management. 

Discussions like this are always so interesting for getting different perspectives!  Thanks everyone!
Title: Re: What is the magic pay down your mortgage rate?
Post by: RFAAOATB on January 05, 2015, 03:02:06 PM
I am two years in on a $130k 3.25% 30 year fixed and payed ahead to get it down $117.8k.  I pay about $1000 a month when the payment is at $720.  I am paying ahead on my mortgage for two reasons.  One is I'm worried about job loss so the faster I pay it off the safer I will be.  The second is Fuck Wells Fargo.  My retirement savings are about $250 a month pre tax and maxout $460 Roth IRA. so realistically I should be bumping up my pre tax savings at the expense of bigger mortgage payments.  Of course, I want to go absolutely nuts on the mortgage, paying 2k a month and burn it all off in six or seven years, then immediately bump up pretax contributions to max out level.  If I don't do that, I'll be tempted to upgrade the house and use the current condo as a rental.  Hell I'm tempted to do that now even if the mortgage/condo fees/ property manager fees would cause me to break even on the rent.

I would be suspect to more lifestyle inflation if I did not send money to pre tax retirement, roth IRA, or the mortgage, and it's a lot easier to scale back when we go from 2 income to 1 income when the extra money.  As I am expecting a more expensive 2015 with less income, obviously I have to be willing to cut the extra payments and possibly the Roth contributions, but it is still a mental hurdle.

2. As a part of our portfolio, in the 'low-return' area at current interest rates.  Even though it has a 'low return' at our 3.25% interest rate, that is still better than what many bonds are getting, and so I put it in that category of our investments.  Just because something has a lower return (and low risk) doesn't make it pointless; it is about a balanced approach to risk management. 

Indeed, all my retirements are in stock indexes.  Mortgage prepayment is the substitution for conservative investment holdings.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Astatine on January 05, 2015, 03:24:54 PM
With the caveat that I'm new to mustachianism and investing and the like, this is what went into my thinking about prioritising paying off our mortgage fast (we still contribute the maximum to our superannuation accounts though):

1) We're in Australia, not the US.

2) We have a redraw mortgage with a reasonable (although not great) interest rate for Australia of just over 5%. No restrictions on number of transactions or size of transactions in or out of the redraw account. So paying off the mortgage fast does not lock our savings away - they're very liquid and takes at most 3 days to get money from our redraw account.

3) When the mortgage balance gets close to zero, I will keep it at very close to zero (so we pay very little interest) while I gradually siphon off the redraw account for an emergency fund, and then start investing in an index fund. And THEN I will close off the mortgage.

4) Interest from investments will be taxed at a high rate as DH and I are both in fairly high tax brackets at the moment. TBH, I haven't checked this out in detail but in the past I have earned enough interest from parking house deposit money in an online bank account to have to pay significant tax on the interest (and then talk ATO out of billing me quarterly for interest, but that's another story).

5) Primary residence does not earn any tax deductions in Australia.

6) I thought through 3 scenarios when I got the mortgage: pay off as fast as possible, pay off a bit extra (I have a 30 year mortgage) so it gets paid off after 15 years or pay no extra and do the full 30 years while investing. The first and third options make sense to me but the second seems to be the worst of both worlds. The first option gives me essentially 5.1% return tax free, minimises the total amount of interest paid by a lot, and most importantly (given I have several conditions that could kill or disable me anytime from 5 years from now or I could have decades - who knows, plus my job security is a lot lower these days than it used to be), peace of mind for owning a house that cannot be taken away from me. The third option takes advantage of inflation, which is relatively low at the moment, but risks 7) below, health issues, loss of job only partway through the 30 years etc and doesn't give me peace of mind.

7) Our mortgage rate is variable. In the 80's in Australia, interest rates went up to the high teens. There is always that possibility again in the future. Paying down fast while interest rates are at historically lows is good for my peace of mind. I do not want to be in worst case scenario.

8) Emotional reasons. I'm aware that this is not fully rational looking at it objectively but it is rational for my mental health and peace of mind. Having my own place is something I value extremely highly and I do not want to risk losing it. Paying off my mortgage fast is the best way to guarantee to keep my house, balancing the broader economy and my own personal situation.
Title: Re: What is the magic pay down your mortgage rate?
Post by: jopiquant on January 05, 2015, 03:34:44 PM
+ to what Astatine said.

I'm in Canada, and our situation is different here too. No tax benefit from the mortgage, and we can't lock in a rate for 30 years. Instead, everyone renews their mortgages at the new balance at the end of the mortgage term, 1-7 years. The longest fixed rate terms are around 7 years, and the rates are higher for the peace of mind of having such a long term.

We are maxing out our retirement savings and only carry mortgage debt, so even though our rate is low now, we are paying fairly aggressively, and hope to be done with our mortgage at 12-13 years after we bought our home (we'll be just over 40). From a pure investing and opportunity cost perspective, sure we could do better investing our extra principal but we'd have to learn a lot more than we know today about investing, and we're pretty financially conservative. It works for us.
Title: Re: What is the magic pay down your mortgage rate?
Post by: powersuitrecall on January 06, 2015, 08:13:20 AM
And here I thought I might be one of the few mustachian Canadians paying down early, despite the possibility of making more with investments.  We still contribute to the RESP and TFSA (RRSPs are always maxed too).  We currently have no taxable accounts, and I'd like to keep it that way for as long as possible (and when we do, oh what a great problem to have).

2. As a part of our portfolio, in the 'low-return' area at current interest rates.  Even though it has a 'low return' at our 3.25% interest rate, that is still better than what many bonds are getting, and so I put it in that category of our investments.  Just because something has a lower return (and low risk) doesn't make it pointless; it is about a balanced approach to risk management. 

This is a really good way to look at it.  I hadn't considered my mortgage as being part of my allocation of "safe stuff".  As a result, I'm probably underweight in equities ... time to look at that!  Thanks for the perspective.
Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 06, 2015, 08:33:57 AM
I think it totally depends on how much is in your investment accounts, and what your mortgage balance is, too. I would look at the amortization table of the loan and calculate how much interest you are paying in a year, and compare that to your investments with a moderate gain.

For example, my mortgage is 3.85% with balance around $275k. My monthly payment is about $1400, and $900 of that is interest every month. This year, I'll pay about $11k in interest. My brokerage account would have to have $100k balance already and earn over 10% interest to even break even!

So even with a low interest mortgage, it might not be the right choice.

this is 100% the wrong way to think about the OPs question.  by this logic unless you already had sizeable investments prior to purchasing a house it would never make sense to invest over pay down a mortgage. 

Say you have 10k extra to invest each year
Option 1) Invest in mortgage save 3.85%
Option 2) Invest in VTSAX MAKE 10-11% on avg each year

Its a very simple equation. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 06, 2015, 08:36:53 AM
My husband and I are paying down our mortgage and it is at 3%.  The primary reason is that we realized that it could be paid off in less than 2 years, so sometime between May - October of this year.  We have been living in the same house for a number of years. The house payment is our only debt, so having that monkey off our back will pretty much allow my husband to walk away from his job at anytime.  We do have other investments that should be able to cover the rest of our expenses, and I am a realtor and plan to take a few jobs here and there just in case. We are so close to FIRE, we can barely control ourselves.

If we weren't so close in paying off our house than I agree that it would make more sense to invest in something else.   Everyone's situation is different.

This is one of the only reasons i see paying of a mortgage early as valuable.  To reduce your tax exposure in retirement.  I may do the same thing when i get close to retirement.  But all options will have to be weighed to see which is the most tax advantageous. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: GoldenStache on January 06, 2015, 09:03:46 AM
In the U.S. ....5% for me.

10% gained in the market vs 5%(or less) paid to the banks

I see it as leverage.  My house is going up in value (no matter how much I owe on it) so why not keep as much money as I can (avoiding PMI) in the markets and have that grow as well.  If the market takes a huge dip (greater than 25%) I will pull some money out of my house (HELOC) and buy the dip.  It is risky, I understand that, but the bank stops me from going over 80%, giving me 20% equity in case of a major housing crash, not likely in the DC area.     

Those of you living in The Great White North, I see it differently.  Without having the ability to lock in a rate it creates a lot "possible" risk down the line and not having the mortgage deduction tax break would raise my percentage as well.   

Title: Re: What is the magic pay down your mortgage rate?
Post by: Guffeyjon on January 06, 2015, 09:54:19 AM
Depends on the market, and the debt.

I keep a percentage of money on the side for when a stock/ stocks get cheap. If market is going up (everything all the time) I hold my positions and buy index funds, If market is going down I protect gains and increase cash accounts waiting for the market to cut a company too much. As market drops and cash account is ready, I push all money to pay off highest interest debt.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 07, 2015, 01:25:07 AM
I think it totally depends on how much is in your investment accounts, and what your mortgage balance is, too. I would look at the amortization table of the loan and calculate how much interest you are paying in a year, and compare that to your investments with a moderate gain.

For example, my mortgage is 3.85% with balance around $275k. My monthly payment is about $1400, and $900 of that is interest every month. This year, I'll pay about $11k in interest. My brokerage account would have to have $100k balance already and earn over 10% interest to even break even!

So even with a low interest mortgage, it might not be the right choice.

this is 100% the wrong way to think about the OPs question.  by this logic unless you already had sizeable investments prior to purchasing a house it would never make sense to invest over pay down a mortgage. 

Say you have 10k extra to invest each year
Option 1) Invest in mortgage save 3.85%
Option 2) Invest in VTSAX MAKE 10-11% on avg each year

Its a very simple equation.
Respectfully, it's the wrong math. You're comparing interest to interest (incorrectly, at that) when this is actually a matter of net worth (assets vs liabilities).

Putting $10k towards a mortgage is technically not "investing." It's paying down a debt. Even with mortgage interest deductions and the common saying that mortgages are "good debt", debt is still debt on the books. So, it's not a matter of which investment will return more, but what combination of investments/debt payments will increase net worth the most over time.

This is the equivalent of a Balance Sheet for a business. The assets column would include the investment value, and the value of the home. The loan would be on the loss side (it's a liability). Putting money towards a loan would be reducing liability (not increasing assets). Home loan interest is on the "Loss" side because it's lost gains. A $200k loan (4%/30 years) doesn't cost you $200k - it costs you $344k. That's $144k you're paying just for having the loan. But personal finance tends not to separate principal and interest when looking at a budget... but we're missing half of the equation to make a truly educated decision.

I'm not saying that one needs a sizable investment to start with in order to invest. In reality, in most cases, it will probably be more profitable to invest, even starting from zero (especially if the time frame is long term). But, in order to do the math, you need a time basis. Making any sort of comparison without a timeline is pretty much just a shot in the dark.



Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 07, 2015, 06:14:46 AM
I think it totally depends on how much is in your investment accounts, and what your mortgage balance is, too. I would look at the amortization table of the loan and calculate how much interest you are paying in a year, and compare that to your investments with a moderate gain.

For example, my mortgage is 3.85% with balance around $275k. My monthly payment is about $1400, and $900 of that is interest every month. This year, I'll pay about $11k in interest. My brokerage account would have to have $100k balance already and earn over 10% interest to even break even!

So even with a low interest mortgage, it might not be the right choice.

this is 100% the wrong way to think about the OPs question.  by this logic unless you already had sizeable investments prior to purchasing a house it would never make sense to invest over pay down a mortgage. 

Say you have 10k extra to invest each year
Option 1) Invest in mortgage save 3.85%
Option 2) Invest in VTSAX MAKE 10-11% on avg each year

Its a very simple equation.
Respectfully, it's the wrong math. You're comparing interest to interest (incorrectly, at that) when this is actually a matter of net worth (assets vs liabilities).

Putting $10k towards a mortgage is technically not "investing." It's paying down a debt. Even with mortgage interest deductions and the common saying that mortgages are "good debt", debt is still debt on the books. So, it's not a matter of which investment will return more, but what combination of investments/debt payments will increase net worth the most over time.

This is the equivalent of a Balance Sheet for a business. The assets column would include the investment value, and the value of the home. The loan would be on the loss side (it's a liability). Putting money towards a loan would be reducing liability (not increasing assets). Home loan interest is on the "Loss" side because it's lost gains. A $200k loan (4%/30 years) doesn't cost you $200k - it costs you $344k. That's $144k you're paying just for having the loan. But personal finance tends not to separate principal and interest when looking at a budget... but we're missing half of the equation to make a truly educated decision.

I'm not saying that one needs a sizable investment to start with in order to invest. In reality, in most cases, it will probably be more profitable to invest, even starting from zero (especially if the time frame is long term). But, in order to do the math, you need a time basis. Making any sort of comparison without a timeline is pretty much just a shot in the dark.

Incorrect the way i just posted it in looking at WHAT THE MONEY DOES FOR YOU on an ANNUAL basis removes "time basis" from the equationas .  Yes its not 100% as simple the interest being 3.85% vs a market return of 10-11%.  Its actually better due to the tax credits for Mortgage interest.  Over a long time even a loan at 9% a person would be better off investing in the market than investing it into their house (yes you are investing it in your house regardless of what you think, it is an asset you are throwing money at, it may not be a good or lucrative investment depending on market conditions but its an investment none the less).  Its very very short term thinking that would make a person put together a "what will my networth grow by in the next 12 months." 
Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 07, 2015, 06:19:40 AM
this has to be looked at in a few different ways.  Most people make the apples to apples comparison when deciding whether or not to pay down a mortgage or invest.  Consider a 30 year mortgage at 4.5% with 25 years left.  You begin making an extra $100/month in principal payments.  The total interest savings is $17,656 and the payment period is reduced by 6 years and 6 months so 18.5 years later you pay off the mortgage.  Total scheduled payments would have been $182,405 and you ended up with $164,749 in total payments.

Let's say instead that you take that $100/month and invest it in a basic S&P500 index fund; over 18.5 years, the fund conservatively returns 6% with dividends reinvested.  At the end, you have north of $40K.  Even at a 4% return, you still have $32K or at 2%, you have $26K.

Only at about 8% interest rate or more would on the mortgage you begin begin to save ~$40K over the course of the loan.  In other words, $100 put towards a 4.5% mortgage with a $100K balance is not the same as getting a 4.5% return on $100 initially invested in a indexed portfolio.  Very big difference.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 07, 2015, 07:12:30 AM
this has to be looked at in a few different ways.  Most people make the apples to apples comparison when deciding whether or not to pay down a mortgage or invest.  Consider a 30 year mortgage at 4.5% with 25 years left.  You begin making an extra $100/month in principal payments.  The total interest savings is $17,656 and the payment period is reduced by 6 years and 6 months so 18.5 years later you pay off the mortgage.  Total scheduled payments would have been $182,405 and you ended up with $164,749 in total payments.

Let's say instead that you take that $100/month and invest it in a basic S&P500 index fund; over 18.5 years, the fund conservatively returns 6% with dividends reinvested.  At the end, you have north of $40K.  Even at a 4% return, you still have $32K or at 2%, you have $26K.

Only at about 8% interest rate or more would on the mortgage you begin begin to save ~$40K over the course of the loan.  In other words, $100 put towards a 4.5% mortgage with a $100K balance is not the same as getting a 4.5% return on $100 initially invested in a indexed portfolio.  Very big difference.

Under your mortgage scenario, aren't you looking only at the interest savings (while ignoring the principal reduction)?  Conversely, under the 4% return at $100 a month you are including the buildup of principal in the note. 

If you are receiving income on $100,000 of assets at 4.5% and paying debt at 4.5% on the same amount, your net income is zero.  Obviously the S&P returns higher than 4.5%, but you are indicating you come out ahead by investing at 4% and paying interest on debt at 4.5%.
Title: Re: What is the magic pay down your mortgage rate?
Post by: GuitarStv on January 07, 2015, 07:33:07 AM
And here I thought I might be one of the few mustachian Canadians paying down early, despite the possibility of making more with investments.  We still contribute to the RESP and TFSA (RRSPs are always maxed too).  We currently have no taxable accounts, and I'd like to keep it that way for as long as possible (and when we do, oh what a great problem to have).

Interesting that so many of us Canadians are focusing on paying off our mortgages.  We expect to have our house fully paid off in another year or two.  Our mortgage rate is very low right now, but we're not sure what it will jump to in two or three years.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MustachianAccountant on January 07, 2015, 07:46:23 AM
this has to be looked at in a few different ways.  Most people make the apples to apples comparison when deciding whether or not to pay down a mortgage or invest.  Consider a 30 year mortgage at 4.5% with 25 years left.  You begin making an extra $100/month in principal payments.  The total interest savings is $17,656 and the payment period is reduced by 6 years and 6 months so 18.5 years later you pay off the mortgage.  Total scheduled payments would have been $182,405 and you ended up with $164,749 in total payments.

Let's say instead that you take that $100/month and invest it in a basic S&P500 index fund; over 18.5 years, the fund conservatively returns 6% with dividends reinvested.  At the end, you have north of $40K.  Even at a 4% return, you still have $32K or at 2%, you have $26K.

Only at about 8% interest rate or more would on the mortgage you begin begin to save ~$40K over the course of the loan.  In other words, $100 put towards a 4.5% mortgage with a $100K balance is not the same as getting a 4.5% return on $100 initially invested in a indexed portfolio.  Very big difference.

Under your mortgage scenario, aren't you looking only at the interest savings (while ignoring the principal reduction)?  Conversely, under the 4% return at $100 a month you are including the buildup of principal in the note. 

If you are receiving income on $100,000 of assets at 4.5% and paying debt at 4.5% on the same amount, your net income is zero.  Obviously the S&P returns higher than 4.5%, but you are indicating you come out ahead by investing at 4% and paying interest on debt at 4.5%.

Even if you add the $100/month to the interest saved (in the paydown mortgage scenario), you end up with a little less than $40,000 at the end of the 18.5 years. And over half of that is locked up in your house, growing at whatever rate your house is appreciating.
In comparison, the market investment scenario leaves you with over $40,000 in liquid investments. These stocks/bonds could be thrown at the mortgage if it makes sense, or just left in the market.
Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 07, 2015, 08:01:53 AM
From a strict net worth/wealth accumulation perspective, yes, you would want to include the principal accumulation in the comparison.  I didn't because if you're paying off the mortgage (on a primary residence) you're probably doing it with the intention that you want to live there for a bit so the funds are locked up.  If you were planning on selling, then it doesn't make sense to pay down a mortgage unless you're really underwater.  Therefore, in the mortgage pay down scenario, I would really only calculate what you're saving (i.e, the interest) + the less tax deduction you get from having less interest.  Alternatively, in the investing scenario, I would compute the principal + the return and the utility they give you to travel, buy things, cover basic living expenses etc.  In other words, if you choose to pay down the principal of your 8% mortgage over 18 years, you can save about $40K in interest that could have been used for other things (- the reduced tax deduction).  Your principal is locked up in the equity unless you're using it in a HELOC or something.  Conversely, if you invested that $100 over the same period at a 6-7%, you would have a similar amount at the end.  It's a bit of an oversimplification, but meant to debunk the notion that $100 put towards a 4.5% investment is  the same as $100 put towards a 4.5% mortgage.

this has to be looked at in a few different ways.  Most people make the apples to apples comparison when deciding whether or not to pay down a mortgage or invest.  Consider a 30 year mortgage at 4.5% with 25 years left.  You begin making an extra $100/month in principal payments.  The total interest savings is $17,656 and the payment period is reduced by 6 years and 6 months so 18.5 years later you pay off the mortgage.  Total scheduled payments would have been $182,405 and you ended up with $164,749 in total payments.

Let's say instead that you take that $100/month and invest it in a basic S&P500 index fund; over 18.5 years, the fund conservatively returns 6% with dividends reinvested.  At the end, you have north of $40K.  Even at a 4% return, you still have $32K or at 2%, you have $26K.

Only at about 8% interest rate or more would on the mortgage you begin begin to save ~$40K over the course of the loan.  In other words, $100 put towards a 4.5% mortgage with a $100K balance is not the same as getting a 4.5% return on $100 initially invested in a indexed portfolio.  Very big difference.

Under your mortgage scenario, aren't you looking only at the interest savings (while ignoring the principal reduction)?  Conversely, under the 4% return at $100 a month you are including the buildup of principal in the note. 

If you are receiving income on $100,000 of assets at 4.5% and paying debt at 4.5% on the same amount, your net income is zero.  Obviously the S&P returns higher than 4.5%, but you are indicating you come out ahead by investing at 4% and paying interest on debt at 4.5%.
Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 07, 2015, 08:12:55 AM
Interestingly enough, I ran into this scenario when I started seriously contemplating FIRE this year.  We have a few properties.  Rental House in Olympia (30 year mortgage @3.75%); primary residence in DC (30 year mortgage @3.375%); "vacation cabin" in Sault Saint Marie, Michigan (30 yr mortgage @5.75%) and 5 acres in newberry MI (3/1 ARM at 4.15%)

We opted to turn our DC house into a rental and FIRE to the Sault Saint Marie place this fall so we began making extra principal payments on this house ($10-15K per month); I just made the final payment using a 1% CC convenience check for the remaining balance, mainly so I could drop the insurance expensive vacation property insurance policy while I renovate the place and turn it into a homestead.  Even at 5.75%, I'm not sure the ~$75K in accelerated principal payments was a wise idea, but I know going into FIRE I'll never have a mortgage on my primary residence and the place will have a veteran's property tax exemption; so it's probably more peace of mind than anything.
Title: Re: What is the magic pay down your mortgage rate?
Post by: KMMK on January 07, 2015, 08:25:58 AM
Canadian here. I'm not paying extra into the mortgage right now. I agree with around the 5% number. I'd rather invest now and then if rates are higher when our term is up I'll put more towards principle then. However for my husband I've recommended putting more towards the mortgage as his investments are making less than our mortgage rate- he only does "safe" investments -ie savings accounts and GICs.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Goldielocks on January 07, 2015, 10:05:43 AM
Thinking about this...

Our best strategy to retire early is not savings, it is to cut spending.  First and foremost. At some point this means paid off home.

The U.S. tax laws help to hide this fact. But I truly believe a savings fund specific for accommodation offset or added mortgage payment is the way to go.  More so as you reach 10 years to FIRE.

Maybe semantics but keeping focus on the true goal is important
Title: Re: What is the magic pay down your mortgage rate?
Post by: arebelspy on January 07, 2015, 10:09:08 AM
Our best strategy to retire early is not savings, it is to cut spending.  First and foremost. At some point this means paid off home.

I agree with the premise, but not the conclusion.
Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 07, 2015, 10:43:04 AM
it doesnt have to mean a paid off home SOL has an interesting post on here about his analysis and which makes the most sense in his case.  And in the case of GOCURRYCRACKER it meant anything but a paid off home as they travel the world.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 07, 2015, 01:03:43 PM
It's a bit of an oversimplification, but meant to debunk the notion that $100 put towards a 4.5% investment is  the same as $100 put towards a 4.5% mortgage.

With the exception of liquidity and the tax deduction, I'd say that putting $100 towards a 4.5% mortgage is exactly the same as putting it in an investment yielding 4.5%.  Whether you think 4.5% is a good return is another matter. 
The Heloc takes care of the liquidity and allows for opportunistic investments.

Personally, I view my mortgage reduction as part of my bond portfolio.  The liquidity issue is taken care of via a heloc that can be tapped as needed.
Title: Re: What is the magic pay down your mortgage rate?
Post by: zolotiyeruki on January 07, 2015, 01:15:28 PM
For me, paying down the house is a much higher priority.  Here's why:  once the house is paid off, I plan on sinking that monthly payment into retirement savings.

I actually ran the numbers, and IIRC by paying down the house early, I came out slightly *ahead* financially after 15 years.  It's counter-intuitive, I know, but the numbers don't lie.  I think the difference is that once the house is paid off, my contributions to savings dramatically increase, and by accelerating the pay-off date of the mortgage, I start those larger contributions far earlier, so there are more of them, and it counteracts the loss of returns.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 07, 2015, 01:21:28 PM
With the exception of liquidity and the tax deduction, I'd say that putting $100 towards a 4.5% mortgage is exactly the same as putting it in an investment yielding 4.5%. 

+1

Math is math.  As Midwest and others have allowed, there can be reasons beyond the straightforward interest rate comparison to pre-pay the mortgage vs. invest.

But without those other reasons, the effects of "investing" vs. "pre-paying" are identical for the same interest rates.

Take a $100K mortgage at 4% for 30 years.  Monthly payment is $477.42.  In the first month an extra $100 is available when the payment is due. 
Option A: Put the $100 toward the mortgage principal.
Option B: Invest the $100 and earn 4%

After 30 years:
Under option A, the final payment will be $146.67, so the payer has an extra $477.42 - $146.67 = $330.75.
Under option B, the mortgage is also paid and the $100 has grown to $100*(1+4%/12)^359 = $330.25.
The difference of $0.50 is round-off error.


Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 07, 2015, 01:36:11 PM
this has to be looked at in a few different ways.  Most people make the apples to apples comparison when deciding whether or not to pay down a mortgage or invest.  Consider a 30 year mortgage at 4.5% with 25 years left.  You begin making an extra $100/month in principal payments.  The total interest savings is $17,656 and the payment period is reduced by 6 years and 6 months so 18.5 years later you pay off the mortgage.  Total scheduled payments would have been $182,405 and you ended up with $164,749 in total payments.

Let's say instead that you take that $100/month and invest it in a basic S&P500 index fund; over 18.5 years, the fund conservatively returns 6% with dividends reinvested.  At the end, you have north of $40K.  Even at a 4% return, you still have $32K or at 2%, you have $26K.

Only at about 8% interest rate or more would on the mortgage you begin begin to save ~$40K over the course of the loan.  In other words, $100 put towards a 4.5% mortgage with a $100K balance is not the same as getting a 4.5% return on $100 initially invested in a indexed portfolio.  Very big difference.

Under your mortgage scenario, aren't you looking only at the interest savings (while ignoring the principal reduction)?  Conversely, under the 4% return at $100 a month you are including the buildup of principal in the note. 

If you are receiving income on $100,000 of assets at 4.5% and paying debt at 4.5% on the same amount, your net income is zero.  Obviously the S&P returns higher than 4.5%, but you are indicating you come out ahead by investing at 4% and paying interest on debt at 4.5%.

Even if you add the $100/month to the interest saved (in the paydown mortgage scenario), you end up with a little less than $40,000 at the end of the 18.5 years. And over half of that is locked up in your house, growing at whatever rate your house is appreciating.
In comparison, the market investment scenario leaves you with over $40,000 in liquid investments. These stocks/bonds could be thrown at the mortgage if it makes sense, or just left in the market.

 I don't have time or interest to run this through t-value, but if you are paying a 4.5% mortgage and investing at 4%, you are not coming out ahead on the transaction.  I'm not advocating taking every cent and paying off a 4.5% mortgage, but the math of coming out ahead on that transaction is false.

With regard to being locked up, an untapped HELOC provides access to 80% of home value even on a totally paid off home. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: arebelspy on January 07, 2015, 01:40:43 PM
It looks like a 4.5% to 4.5% comparison to me.  Where did you get 4.5% (mortgage) to 4% (market)?
Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 07, 2015, 01:45:40 PM
It looks like a 4.5% to 4.5% comparison to me.  Where did you get 4.5% (mortgage) to 4% (market)?

DoNorth's example includes a 4.5% mortgage (paragraph 1) and a 4% return (paragraph 2).
Title: Re: What is the magic pay down your mortgage rate?
Post by: arebelspy on January 07, 2015, 01:51:55 PM
Gotcha.  Something's off in that math for sure, looks like something got weird when they tried to overcomplicate it.
Title: Re: What is the magic pay down your mortgage rate?
Post by: frugaldrummer on January 07, 2015, 02:52:46 PM
Seems to me, 2 crucial items keep getting left out of most of these analyses:

1) Taxes - if you're in a high tax bracket, the value of paying off a mortgage early may be less than it is for someone in a low tax bracket.  Essentially, if two people have the same mortgage but one person's income is so low that they pay 0% in income taxes, and the other person has a high income and gets a 35% tax break on the mortgage interest, the low-income person has a better benefit from paying the loan off early.  For a mortgage payment of $1,000 a month with 900 of that as interest, the low-income person pays $1,000, but the high-income person only pays $700 (because of their tax break).

2) Risk - many people are comparing pre-paying the mortgage versus investing in the stock market.  This is a false analogy as the risks are far different.  Pre-paying the mortgage is a low-risk, guaranteed rate of return.  If I prepay a 4% mortgage, I am guaranteed to save 4% interest.  The stock market can go up or down (historical averages notwithstanding, as past performance is no guarantee of future performance). The true comparison would be between the mortgage interest rate, and what you can currently get from safe fixed investments like high-grade bonds or CDs (or possibly one might include dividend paying stocks in super-safe giants like Disney, if you only counted dividend income and not stock appreciation). 

Also, I think everyone should at least try to pay down their mortgage to below 70% to protect them against the possibility of being trapped in a location by an underwater mortgage, unless you have enough assets already to ride out that scenario.  A lot of people suffered in the last downturn because they lost jobs and their stock investments dropped at the same time - their houses were underwater and they had to move to get a new job.  This financial meltdown could have been avoided by a paid-off home.

Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 07, 2015, 03:08:48 PM
Put another way:

Original term   30 Years @ $100,000
Remaining   20 Years left when you begin extra principal payments
Annual interest rate   4%
Prepayment amount   $100 per month
Normal payment (PI)   $477
Accelerated payment (PI)   $577
Total scheduled payments   $171,868
Total accelerated payments   $162,545
Prepayment savings   $9,323
Prepayment shortens mortgage by   4 years, 9 months
Over 20 years; $24000 extra in principal reduction; $9323 in interest savings:  total $33,323

----------------------------------------------------------------------
simple compound interest example

Current Principal:   $   0
Annual Addition:   $   1200
Years to grow:       20
Interest Rate:       4 %
Compound interest   time(s) annually: 12

Total  $36799
--------------------------------------------

Although there may be some out there, it's difficult to find a 20 year period where the S&P returned less than 4% annualized with dividends reinvested.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 07, 2015, 03:42:12 PM
Original term   30 Years @ $100,000
Remaining   20 Years left when you begin extra principal payments
Annual interest rate   4%
Prepayment amount   $100 per month
...
Prepayment shortens mortgage by   4 years, 9 months

After 303 months (4 yr 9 mo short of 30 years), with a final month payment of ~$166, the mortgage is fully paid.  There were 182 months with an extra $100 pre-pay.  Because the final month needed only a partial payment, there is $311 in the investment account.

If the $100/mo had instead been invested at 4%, after 303 months the mortgage balance would be $24,746.  After 182 months of $100 invested at beginning of the month, the investment account has grown to $25,057.

At which time the investment account could be used to pay off the mortgage, keeping......$311 in the investment account.

Again, taxes, liquidity, risk, peace of mind, etc. are all valid considerations - but on an "all other things being equal" comparison, pre-paying a mortgage at X% is identical to investing the prepayment amount at X%.

Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 07, 2015, 06:26:32 PM
Original term   30 Years @ $100,000
Remaining   20 Years left when you begin extra principal payments
Annual interest rate   4%
Prepayment amount   $100 per month
...
Prepayment shortens mortgage by   4 years, 9 months

After 303 months (4 yr 9 mo short of 30 years), with a final month payment of ~$166, the mortgage is fully paid.  There were 182 months with an extra $100 pre-pay.  Because the final month needed only a partial payment, there is $311 in the investment account.

If the $100/mo had instead been invested at 4%, after 303 months the mortgage balance would be $24,746.  After 182 months of $100 invested at beginning of the month, the investment account has grown to $25,057.

At which time the investment account could be used to pay off the mortgage, keeping......$311 in the investment account.

Again, taxes, liquidity, risk, peace of mind, etc. are all valid considerations - but on an "all other things being equal" comparison, pre-paying a mortgage at X% is identical to investing the prepayment amount at X%.

MDM - Thanks for doing the math.  4% is 4%. 

Donorth - I agree the S&P most certainly will return over 4% in time.  The S&P yield, however, involves substantially more risk than the mortgage.  Unless you believe you plan on defaulting on the loan (in which case you should pay as little as possible towards the mortgage principal), the yield on repaying the mortgage is risk free. 

You do need to calculate the after tax rate in making your decision, but repaying a mortgage can be part of a diversified portfolio in the right situation.  For instance, if you had a 800lk net worth, a home with zero equity and a 4% loan, $600k of stocks and $200k of savings bonds yielding 2% or same net worth, same stocks, $100k less on the mortgage and $100k in treasuries. 

In the second situation, if your after tax yield on the house is 3%, you are still a point ahead compared to the savings bonds. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: southernhippie on January 07, 2015, 07:03:24 PM
I feel that debt is debt no matter what it is in.  Yes mortgage rates are typically low, especially today. There is nothing more liberating than knowing that you own everything including your home outright.
Title: Re: What is the magic pay down your mortgage rate?
Post by: viper155 on January 07, 2015, 07:25:39 PM
If you did not have a mortgage would you go and borrow money against your house at 4% or under to invest with? I wouldn't, and it's the same thing
Title: Re: What is the magic pay down your mortgage rate?
Post by: Cheddar Stacker on January 07, 2015, 08:19:50 PM
If you did not have a mortgage would you go and borrow money against your house at 4% or under to invest with? I wouldn't, and it's the same thing

I would. I'm not suggesting everyone should. But right now, if I were in that position at this stage in my life and at this net worth, hell yes I would.

Also, +1 to what MDM and Midwest just said. 4% has the same efect whether you are adding income or adding expense. I've been confused reading this thread throughout the day by how many people are trying to squeeze blood from a turnip here. If your calculations are telling you 4% prepayment beats 4% investment return, you did something wrong
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 08, 2015, 01:33:29 AM
If you did not have a mortgage would you go and borrow money against your house at 4% or under to invest with? I wouldn't, and it's the same thing

I would. I'm not suggesting everyone should. But right now, if I were in that position at this stage in my life and at this net worth, hell yes I would.

Also, +1 to what MDM and Midwest just said. 4% has the same efect whether you are adding income or adding expense. I've been confused reading this thread throughout the day by how many people are trying to squeeze blood from a turnip here. If your calculations are telling you 4% prepayment beats 4% investment return, you did something wrong
It's not about squeezing blood from a turnip - for me, I just want to see some proof in numbers. We don't make progress financially by just throwing numbers to the wind and hoping that vague answers to a vague question will get us where we need to go. I know that in all likelihood, compounding is always going to beat paying anything down (with time) - I wanted to see it backed up with some actual accounting.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Guses on January 08, 2015, 05:51:19 AM
I know that in all likelihood, compounding is always going to beat paying anything down (with time) - I wanted to see it backed up with some actual accounting.

That is wrong.

Compounding happens the same in both instances it's just that you don't see it because it's a debt that is paid off.

Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 08, 2015, 05:58:53 AM
to clarify; I agree if you're talking about investing in a fixed rate investment like a CD or savings account that compounds on the same exact schedule as the mortgage amortizes , then the difference between the two decisions would be negligible. Too many other factors like taxes/loss of tax deduction, dividend reinvestment rate, home price appreciation or loss after mortgage payoff vs. investment appreciation or loss, the fact that mortgages are finite and investments are not still indicate there would likely still be some significant variation in the overall return from making one decision over the other; hence why I would still be skeptical to make an apples to apples 4% to 4% comparison in those terms.  I'm still thinking high 6% to 7% is probably a safe bet for making the decision to pay off.  I just made the last payment on a 5.75% note-- not because I thought it was a good investment, but more so because I wanted the predictability of expenses going into FIRE.


 
Title: Re: What is the magic pay down your mortgage rate?
Post by: GoldenStache on January 08, 2015, 06:10:35 AM
Compounding happens the same in both instances it's just that you don't see it because it's a debt that is paid off.

Correct.  The difference between paying off early and investing is the rate of return. 
Many of the examples here are showing 4% and 4%.

My real numbers. 
2013 - Mortgage about 4%, Investment return about 27%
2014 - Mortgage about 4%, Investment return about 13%

Title: Re: What is the magic pay down your mortgage rate?
Post by: Cheddar Stacker on January 08, 2015, 06:36:12 AM
It's not about squeezing blood from a turnip - for me, I just want to see some proof in numbers. We don't make progress financially by just throwing numbers to the wind and hoping that vague answers to a vague question will get us where we need to go. I know that in all likelihood, compounding is always going to beat paying anything down (with time) - I wanted to see it backed up with some actual accounting.

I don't mean people should ignore the numbers/accounting. Run them, just double and triple check. Compounding does not/can not beat debt pay down if the interest rate is equal (net of tax). It just doesn't work. It's the same end result.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Midwest on January 08, 2015, 07:01:34 AM
to clarify; I agree if you're talking about investing in a fixed rate investment like a CD or savings account that compounds on the same exact schedule as the mortgage amortizes , then the difference between the two decisions would be negligible. Too many other factors like taxes/loss of tax deduction, dividend reinvestment rate, home price appreciation or loss after mortgage payoff vs. investment appreciation or loss, the fact that mortgages are finite and investments are not still indicate there would likely still be some significant variation in the overall return from making one decision over the other; hence why I would still be skeptical to make an apples to apples 4% to 4% comparison in those terms.  I'm still thinking high 6% to 7% is probably a safe bet for making the decision to pay off.  I just made the last payment on a 5.75% note-- not because I thought it was a good investment, but more so because I wanted the predictability of expenses going into FIRE.

We agree that a) you can do better than 4% (although possibly with higher risk) and b) you need to calculate the after tax yield on both mortgage paydown and the investment in making a comparison.

With regard to home appreciation, why do you feel that is relevant to the decision to reduce a mortgage once you have purchased the home?  If your $300k house with a $200k mortgage is worth $200k or $1.0M, you still have a $200k mortgage that you are paying interest on. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: DoNorth on January 08, 2015, 08:00:03 AM
Because  I'm looking at the trade-off and it's fundamental to the way in which I invest my capital.  If I put the funds towards the mortgage and pay the mortgage off, then I have a fairly illiquid asset (hopefully an appreciating one) in which I can live and from which I can possibly leverage equity.  Maybe it's appreciating at 3% or maybe less.

Example--I just bought a home with a VA loan; 0 down; no equity to start with.  I bought the house two years ago at 3.375% at $395,000.  It is currently valued at $445K.  I simultaneously invested what I would have otherwise used to pay down the mortgage or put as a down payment and ended up with whatever the returns were for the next two years.  I should be able to either rent or sell the house at a profit.  The house was leveraged at over 100% due to a VA funding fee at purchase; now the leverage is somewhere around 88%.  It provides shelter, a tax deduction and the prospect of future profitability.  Makes no sense to prepay and tie up liquidity in something that's already doing the work for me.

In your example, if the house if worth $1M, then I would tap the equity at a lower rate (if one is available) and clear the mortgage (if a higher rate) or invest it and let it compound (hopefully).  For example, I just took a $25K credit card convenience check and exchanged the last $25K of a 5.75% mortgage for a 1.9% 12 month rate.  This allowed me to take $25K of my own money and max out 2-529's, an IRA, 401k, and my wive's solo 401k + drop the absurd insurance policy.  It would be hard to calculate the overall return over time of making this decision, but it should be favorable.

I have another house that I bought in 2009; 3.75%--same deal over 100% LTV; five years later, it's still underwater by a little, but steadily rented.  Appreciation prospects are average, so again I'm not going to pre-pay because i don't want to tie up my funds in something so illiquid.  I'll take the depreciation in taxes and unload it when I can sell at or above the mortgage.  in the meantime, rent covers PI&T.

I'm not saying everyone should do it, but  home appreciation prospects are something i always consider when determining whether or not to prepay.

Title: Re: What is the magic pay down your mortgage rate?
Post by: brooklynguy on January 08, 2015, 08:52:58 AM
To everyone who is making the point that prepaying your mortgage offers a guaranteed return while investing funds in the market offers only uncertain returns:

Don't forget that if you are planning a stash-based MMM-style early retirement (which I assume is true of many of the folks reading and participating in this forum), your entire retirement strategy is already built on the assumption that market returns will greatly exceed today's low mortgage rates.  If your portfolio will not generate returns that vastly outperform your 4% mortgage over an extended time period, then your retirement strategy is doomed.  So why are you willing to accept this assumption about market returns for the fundamental purpose of planning your retirement, but not for the purpose of deciding whether to allocate funds towards investments rather than mortgage prepayment?

As some people have said, treating low-rate mortgage prepayments as equivalent to (and taking the place of an equal amount of) investments in the conservative portion of their portfolio allocation makes perfect sense and is a valid choice.  But do it consciously and realize that that's what you are doing.  If you had no mortgage and were deciding what to do with some available cash, would you stick it in a bank account paying interest equal to your mortgage rate instead of investing it in stocks?  Because that is equivalent to what you are doing when you prepay your mortgage.
Title: Re: What is the magic pay down your mortgage rate?
Post by: tomsang on January 08, 2015, 09:18:16 AM
It is crazy to see people thinking that paying off a 30 year fixed rate mortgage at 3.5% is a good idea. In the last post on this I put together a spreadsheet that shows the math. The thing that people tend to overlook is that part of their mortgage payment is principal.


http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/200/
Title: Re: What is the magic pay down your mortgage rate?
Post by: Tyler on January 08, 2015, 11:37:42 AM
This topic comes up all the time. IMHO, two common over-simplifications trip people up.

First, the stock market may average 10% over thirty years but it does not make that every year. There have been many periods of ten to twenty years where it had a negative compound annual growth rate. That is usually preceded or followed by a very good period that helps things average out well, but the ride is not at all smooth.

Second, a 30-year mortgage does not always have a horizon of 30 years. Unless you refinance to a new 30-year mortgage every year (which would be stupid as fees would eat you alive), your loan will get shorter as you gradually pay it off.

As a result, the typical advice that you'll make more investing in the stock market over 30 years with a low-rate mortgage than buying a house in cash is solid. However, when you've owned for a while and only have ten years left on your mortgage, the profit from investing is much more of a crapshoot. With three years left, it's basically a coin flip.

So for most young people buying a house, it makes good financial sense these days to get a mortgage and invest the difference rather than to pay cash. However, it's important to revisit the decision every few years to see if your assumptions have changed. There will eventually come a time where it may make perfect sense to pay off the mortgage and move on to a new financial phase in life.
Title: Re: What is the magic pay down your mortgage rate?
Post by: mistershankly on January 08, 2015, 01:35:03 PM
Another factor to throw into the mix is that a house is highly illiquid. Once you put money into the house, you can't get it out nearly as easily. By contrast, publicly-traded stocks can be liquidated at any time. That is another reason I am reluctant to prepay any loans, unless the interest rate is obscenely high.

You can set up a HELOC that will transfer to your checking account within seconds.  I think the main question is if you had your house paid off, would you borrow against it to invest in the stock market?  That is what someone is effectively doing in the question of paying off a mortgage vs investing.  It's a matter of risk tolerance and the scenario above (a Dave Ramsey coined scenario) places the risk tolerance factor into play.

I paid my house off because of my personal situation years ago (caring for an ill parent with unpredictable health care costs) and it suit my risk tolerance to have a house free and clear with what I was dealing with.  Now (parent passed away), I like the freedom of being able to quit my job at any time without the worry of the biggest debt hovering over me.  I have a HELOC open and ready in case I need to tap into the equity but every time I consider it, I compare the risk of debt I will take on to the purpose of taking it on.  If I were to take all of the equity out of my home and invest, I could FIRE in two years and that option is always on the table. 

There are many arguments for and against my approach and most are valid since it also has to do with risk tolerance in every individual's situation (i.e. it's not only about the math involved).
Title: Re: What is the magic pay down your mortgage rate?
Post by: arebelspy on January 08, 2015, 08:27:05 PM
There have been many periods of ten to twenty years where it had a negative compound annual growth rate.

Uh, what?

Name those periods, please.

Make sure dividends are included, because obviously you can't own stocks over that period and decline receiving the dividends.

EDIT:
To save you time, there has NEVER been a period of twenty years with negative CAGR, let alone your claim of "many periods".  The worst 20-year period was a 2.5% return (nominal).

Source:
http://observationsandnotes.blogspot.com/2009/04/best-worst-20-years-in-stock-market.html

As for 10-year returns, 95% of them have been positive, with 5% (4 periods) negative.

Source:
https://www.franklintempleton.com/funds/2020vision/history-favors-long-term-investing

I'd hardly call that "many periods."  5 years is short term, yes.  1 year is absolutely short term.  But once you start talking decade(s), it's not a comparison.  Stock market does great.

(And the above are the WORST.. it's more likely you will be closer to the average than being worse than it's ever been.)
Title: Re: What is the magic pay down your mortgage rate?
Post by: Tyler on January 08, 2015, 09:12:35 PM
Here's a link.  (warning -- PDF)

http://www.crestmontresearch.com/docs/Stock-Matrix-Tax-Exempt-Real3-11x17.pdf

Note that these are real returns.  If you only want to look at nominal, here's the link for that:

http://www.crestmontresearch.com/docs/Stock-Matrix-Tax-Exempt-Nominal4-11x17.pdf

I agree that using the words "many periods" doesn't apply to the nominal returns.  I was thinking of the real returns when I wrote that, but it's valid to prefer nominal returns when discussing mortgages (as your house payment doesn't increase with inflation).  Still, stocks did go negative on an annualized basis for as long as a decade as recently as the 00's.  It does happen.  The great depression sucked the life out of stocks for two decades.  And there was a cold spot throughout the 60s where any mortgage at more than 5% interest didn't look so hot for a long while (average rates were around 6% at the time).

FWIW, I'm not arguing that stocks are a bad investment.  Just that when discussing mortgages, one should not always look at 30-year average returns when you have less than that left on your mortgage.  Stocks do have downswings, and your forward-looking risk depends a lot on your remaining timeframe. 


Title: Re: What is the magic pay down your mortgage rate?
Post by: tomsang on January 09, 2015, 03:45:44 AM
Just to be clear. When talking about investing vs paying down your mortgage you should be talking about nominal returns not inflation adjusted or real returns. Your fixed rate 30 year mortgage eliminates any inflation issues. In fact the greater the inflation the better off you are having a fixed rate loan. Since tracking investment returns within the United States there has never been a time where the market has returned less than 5% over a 30 year period. The SWR and the shockingly simple math calculations are using 5%+ because there have never been times where the market has not achieved greater than 5%+ over these long periods. If you believe that the future is going to be different and that the market will return less than your mortgage rate at 3.5% then you should not retire until your SWR is 1%. If you think the world is going to spiral downward you should not own a house or other longterm investments. You would be better off renting as the rents would decrease with time if you think that the markets are going to crash.
Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 09, 2015, 08:42:34 AM
^^^ oh thats just great.  I love the last sentence. 

Fear mongering apocalypse.  If you believe the market will crash and we will go into a great depression you should be investing nothing. 

In the end though this is all about risk.  And i'm at the super risky end of that spectrum.  So its hard for me to understand anyone prepaying a sub 5% mortgage.  And to those with 3 or below thats just asinine.  Due to inflation.  but to each his own i guess.  i'll bet on the 95% odds 100% of the time. 

Anyone have time to show how many years someone loses from being retired if they pay off their mortgage vs invest at standard market rates.  Assuming Avg annual spending of 30k (this seems to be pretty middle of the road for most here)  and a SWR of 3.8%, the avg mortgage of 170k lets assume no PMI and 4% on a 20 year, and an avg salary of 65k. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: boarder42 on January 09, 2015, 08:47:39 AM
if someone wants to modify those numbers to real avg's i'm cool with that but i thought those were pretty decent ballpark numbers
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 09, 2015, 09:37:53 PM
I know that in all likelihood, compounding is always going to beat paying anything down (with time) - I wanted to see it backed up with some actual accounting.

That is wrong.

Compounding happens the same in both instances it's just that you don't see it because it's a debt that is paid off.
This makes no sense - how is a payment towards a debt compounding? Are you referring to the actual debt that's compounding, or the equity you have in your home?

Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 09, 2015, 10:34:58 PM
I know that in all likelihood, compounding is always going to beat paying anything down (with time) - I wanted to see it backed up with some actual accounting.
That is wrong.
Compounding happens the same in both instances it's just that you don't see it because it's a debt that is paid off.
This makes no sense - how is a payment towards a debt compounding? Are you referring to the actual debt that's compounding, or the equity you have in your home?
May be a semantic issue regarding "compounding happens."  I might say that pre-paying a debt "prevents" compounding from happening on the portion I prepay.  The issue of paying an X% debt vs. investing at that same X%, however, is unambiguous: the effect on your net worth is identical.

The worked examples above don't seem to have been persuasive.  Let's try a thought experiment instead. 

Say you owe a debt to person A who is charging you 5% on that debt.  Person B wants to borrow money from you and offers to pay you 5%.  You have some extra money. 

Q1. Should you loan the money to B while paying A at the same rate, or should you use the extra money to pay A?
Q2. What if A is charging 6% while B offers to pay you 4%?
Q3. What if A is charging 4% while B offers to pay you 6%?

A1.  It doesn't matter - the effects are identical
A2.  Paying A is better
A3.  Loaning to B is better

Note that "loan the money to B" is the same as "invest the money in a stock index fund." 

Does it makes sense that, everything else being equal, paying a mortgage at X% is of identical value to investing in something paying the same X%?
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 10, 2015, 02:37:33 AM
May be a semantic issue regarding "compounding happens."  I might say that pre-paying a debt "prevents" compounding from happening on the portion I prepay.  The issue of paying an X% debt vs. investing at that same X%, however, is unambiguous: the effect on your net worth is identical.

The worked examples above don't seem to have been persuasive.  Let's try a thought experiment instead. 

Say you owe a debt to person A who is charging you 5% on that debt.  Person B wants to borrow money from you and offers to pay you 5%.  You have some extra money. 

Q1. Should you loan the money to B while paying A at the same rate, or should you use the extra money to pay A?
Q2. What if A is charging 6% while B offers to pay you 4%?
Q3. What if A is charging 4% while B offers to pay you 6%?

A1.  It doesn't matter - the effects are identical
A2.  Paying A is better
A3.  Loaning to B is better

Note that "loan the money to B" is the same as "invest the money in a stock index fund." 

Does it makes sense that, everything else being equal, paying a mortgage at X% is of identical value to investing in something paying the same X%?
Thank you for clarifying, and I totally understand your point, but there's a flaw in the example. Person B would be paying back with different rules than Person A. Person A only pays interest on his balance; Person B would be making paying interest on the balance, PLUS making an interest payment on the interest they had already paid you. Using those rules, Person B would be the one you'd want to loan to in all three examples (especially if you have time).

That's why I keep saying it's not a matter of comparing interest rates, because the rules don't work the same when you're paying down mortgage vs investing in an index fund (assuming you are leaving the balance in to compound). The answer to the question is completely dependent on the time frame you're looking at.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Peacefulwarrior on January 10, 2015, 03:03:23 AM
I would pay it off even if it was at 1%. Becoming FI is about mindset not solely about math, and being in any kind of debt is not part of a good mindset.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 10, 2015, 03:43:54 AM
Thank you for clarifying, and I totally understand your point, but there's a flaw in the example. Person B would be paying back with different rules than Person A.
Not true: same rules of compound interest apply.

Quote
Person A only pays interest on his balance; Person B would be making paying interest on the balance, PLUS making an interest payment on the interest they had already paid you.
This actually is true.  Except you are paying person A, not A paying you, but I think I understand what you are trying to say.  But you seem to drawing incorrect conclusions from these facts.  Yes, when you pay a mortgage you pay interest only on the remaining principal - but your payment is calculated based on the compound interest formula.  See http://en.wikipedia.org/wiki/Amortization_calculator if you aren't familiar with the derivation.

Quote
Using those rules, Person B would be the one you'd want to loan to in all three examples (especially if you have time).
If you think so, I'll be happy to loan you money at 6% and you can loan back to my kids' college fund at 4%.  The more the merrier. :)

Quote
That's why I keep saying it's not a matter of comparing interest rates, because the rules don't work the same when you're paying down mortgage vs investing in an index fund (assuming you are leaving the balance in to compound).
The rules of compound interest work exactly the same when you are paying a mortgage vs. investing in an index fund.  That's why the numerical answers match in the worked examples in previous posts.  E.g. see http://forum.mrmoneymustache.com/ask-a-mustachian/what-is-the-magic-pay-down-your-mortgage-rate/msg509347/#msg509347: it's not a coincidence that paying vs. investing leads to an identical result.
Title: Re: What is the magic pay down your mortgage rate?
Post by: train_writer on January 10, 2015, 05:04:39 AM
One big assumption here from the not-paying-off? 100 % discipline and determination of investing exactly the same amount as the amount one would be paying off.

Yes, the math tells you how it adds up in a perfect world, but it ain't..

If you commit yourself to say 250 euros per month extra payment to the principal, how can you know you would be as determined in investing? Personally, I have committed myself to a semi-annual principal payment and at the same time to a monthly investment of 400 euros in index funds. It is only guestimation, but I suspect I would not invest the surplus of not-paying-off in stocks/ index.

Title: Re: What is the magic pay down your mortgage rate?
Post by: tomsang on January 10, 2015, 07:19:24 AM
I would pay it off even if it was at 1%. Becoming FI is about mindset not solely about math, and being in any kind of debt is not part of a good mindset.

Wow. Math is what defines when you are FI. Your actions could be causing you to pull a huge anchor to the finish line. If you can borrow at sub 4% and invest at greater than 7%, then surely you can see that you are screwing over your future self by paying down a 1% or even a 4% 30 year fixed rate mortgage.

I think Mustachian is about making logical choices, not buying consumeristic trinkets and not making bad financial decisions.  With your mindset you would put zero in your 401k and not invest in after tax investments until all of your debt was paid off. This would cost you years to FI with the loss of tax benefits for the 401k and mortgage and the lost returns on your investments exceeding today's low mortgage rates.

Would you invest in businesses with debt?  You are a business. If used properly debt is a wonderful thing.

You will get there with your method, but it will take significantly longer. Interesting perspective.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Peacefulwarrior on January 10, 2015, 10:10:19 AM
I would pay it off even if it was at 1%. Becoming FI is about mindset not solely about math, and being in any kind of debt is not part of a good mindset.

Wow. Math is what defines when you are FI. Your actions could be causing you to pull a huge anchor to the finish line. If you can borrow at sub 4% and invest at greater than 7%, then surely you can see that you are screwing over your future self by paying down a 1% or even a 4% 30 year fixed rate mortgage.

I think Mustachian is about making logical choices, not buying consumeristic trinkets and not making bad financial decisions.  With your mindset you would put zero in your 401k and not invest in after tax investments until all of your debt was paid off. This would cost you years to FI with the loss of tax benefits for the 401k and mortgage and the lost returns on your investments exceeding today's low mortgage rates.

Would you invest in businesses with debt?  You are a business. If used properly debt is a wonderful thing.

You will get there with your method, but it will take significantly longer. Interesting perspective.

If investering instead of having a paid off house is such a good idea, would you recommend everybody to borrow against house equity as much as possible and spend the money on investments?

And no, with my mindset I wouldn't do that. Because I wouldn't have a mortgage in the first place. I don't borrow money.

I'm not saying that "your" model is stupid or anything. It's just not how I do things myself.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Tyler on January 10, 2015, 11:32:31 AM
Rather than continuing to argue about theory, here's my testimony. I'd love for others to share their own.

I'm currently FI and have enough saved up to own a house with no mortgage and still have enough invested to support my conservative 3% SWR. Like MMM, I've chosen to pay off the mortgage (my last remaining debt) and enjoy the fruits of the good decisions that got me here rather than continue chasing additional money in the markets I really don't need. I'm very satisfied with my financial decisions to date, and have zero interest in mortgage debt anymore.

I've had two mortgages in the past, spanning about eight years of my fifteen year career. In retrospect, investing the difference in the stock market really made very little progress towards my goal. I basically broke even. If it took me thirty years to retire that would have been a much different story and my investments would have most likely kicked in. But my retirement timetable couldn't wait thirty years. ;).

Referencing the "shockingly simple math" graph, my income from investing my mortgage balance was pretty much dwarfed by my aggressive saving. This certainly has influenced my views on the whole mortgage/payoff debate, and may not apply to everyone. YMMV. I have no problem at all with anyone who looks at their own plans and decides that a mortgage is a great financial decision. In many cases, it is!




Title: Re: What is the magic pay down your mortgage rate?
Post by: bacchi on January 10, 2015, 12:14:35 PM
If you believe that the future is going to be different and that the market will return less than your mortgage rate at 3.5% then you should not retire until your SWR is 1%.

This is the really the only thing that needs to be written.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 10, 2015, 07:57:28 PM
Quote
That's why I keep saying it's not a matter of comparing interest rates, because the rules don't work the same when you're paying down mortgage vs investing in an index fund (assuming you are leaving the balance in to compound).
The rules of compound interest work exactly the same when you are paying a mortgage vs. investing in an index fund.  That's why the numerical answers match in the worked examples in previous posts.  E.g. see http://forum.mrmoneymustache.com/ask-a-mustachian/what-is-the-magic-pay-down-your-mortgage-rate/msg509347/#msg509347: it's not a coincidence that paying vs. investing leads to an identical result.
Thanks for sticking with me to explain that - now I get it, and see that you're totally right. I think I've been confused about how debt compounds (and I still don't entirely understand it - it totally works by your math above, but it doesn't look how I'd expect when you graph a curve of payoff over time). The amount your investment goes up is not the same amount that the loan goes down by (at the same interest rate). It appears as though the earnings are increasing at a faster rate than loan balances are decreasing, but obviously that must not be the case.
Title: Re: What is the magic pay down your mortgage rate?
Post by: rmendpara on January 10, 2015, 08:11:52 PM
Obviously there is lot's of back and forth on whether to pay down a mortgage or instead invest those assets at what will hopefully be a higher after tax return.  My question is, what do most people feel is the magic number (mortgage rate) that would justify paying down the mortgage vice investing the money elsewhere?

10 yr treasury rate + 150 bps.... I would pay the minimum

10 yr treasury rate + 350 bps.... I would pay something toward paying it down

in between 150 and 350 bps... it's up to you

Of course other factors are important as well. Your overall risk tolerance and portfolio expected returns, the lost opportunity of whatever you would invest in otherwise, the $ amounts of the mortgage relative to your investments and income, etc, could all contribute to whether and how much it makes sense to pay down a mortgage.
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 10, 2015, 09:34:41 PM
...it doesn't look how I'd expect when you graph a curve of payoff over time). The amount your investment goes up is not the same amount that the loan goes down by (at the same interest rate). It appears as though the earnings are increasing at a faster rate than loan balances are decreasing, but obviously that must not be the case.
Yeah, definitely not straightforward at all.  One doesn't need to know all the gory details of Future Value, loan payment calculations, etc., just as one doesn't need to know the inner workings of each company to make money with a total stock market index fund.  But it the right situation it can be helpful.

Not all that long ago I couldn't have explained this.  One reason (among several) this forum is useful is because "you never learn something as well as when you try to teach it."  If it interests you, stick with it and you can learn much from others here - we all can and do, at least when we keep our ears/eyes wide open and restrain our mouth/fingers. ;)

One thing about loan payments: only the principal amount "counts as an investment."  Think of an interest-only loan: you would make payments forever, but never "earn" (i.e., decrease the principal) anything.  In a real loan the early regular payments go overwhelmingly to interest so the "amount invested" (the principal payment) is low.  But when we talk about pre-paying the principal, that is 100% "investment."  Does that help?


Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 10, 2015, 10:36:33 PM
MDM For some odd reason I find all the inner working really fascinating right now. :) I've been paying my mortgage with the amortization schedule for years (using that to calculate extra principal payments, follow how it's shortening the loan, etc.) What I don't quite understand is if there's a benefit to paying a loan vs investing (if the interest rates are the same) but the balances are significantly different. You've been saying there's not, right?
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 10, 2015, 10:57:35 PM
MDM For some odd reason I find all the inner working really fascinating right now. :) I've been paying my mortgage with the amortization schedule for years (using that to calculate extra principal payments, follow how it's shortening the loan, etc.) What I don't quite understand is if there's a benefit to paying a loan vs investing (if the interest rates are the same) but the balances are significantly different. You've been saying there's not, right?
Right - assuming (as we have been) that all other things (tax treatment, etc.) are equal.

There has to be some combination of loan interest vs. investment return that makes the choice equal to you, correct?  Here the answer happens to be the "obvious" one: when the interest rates are equal.

You can force the balances to be equal by dividing either the loan or the investment (whichever is larger) into two pieces.  Let's say you split your investment into two pieces, one equal to your loan balance and the other holding the remainder.  The performance of the remainder is irrelevant, correct?
If you are getting 5%, the applicable algebraic identity is  (A + B) * 1.05^n = A * 1.05^n + B * 1.05^n.   Thus the total balance has no effect on the comparison.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Jags4186 on January 10, 2015, 11:30:22 PM
Would it ever make sense to treat your mortgage as a bond allocation and to pay it down in accordance to your chosen asset allocation?  If you keep say an 80/20 equity/bond portfolio, and say you choose to hold BND for you bond holdings, why would you invest money at a 2.75% yield when you can get a guaranteed return on additional mortgage payments of 3.5%-5%?
Title: Re: What is the magic pay down your mortgage rate?
Post by: TheNewNormal2015 on January 11, 2015, 05:24:16 AM
The rate cannot be the only factor in determining whether to pay down a mortgage, be it with either periodic payments or a lump sum.

The risk of financial ruin also has to be taken into account, and that % chance of ruin increases disproportionately with the size of the debt as a % of income to service the debt.

The propensity to pay down debt vs (hopefully) investing at a spread (based on historical returns) should dramatically increase the closer one gets to the FIRE date and also with age.  This decision has to be different for someone who is 65 vs 25yo.

Additionally one should take into account whether the investment alternative to paying down the mortgage already has a significantly large allocation in one's portfolio, as well as how the it became so large (recent appreciation vs recent large lump sum investment vs steady investments over a long period of time).  If your portfolio is already heavily invested in stocks, you are simply concentrating your risk even further in investing extra principal instead of paying down the debt.  And, I would argue, that concentrating risk in an asset class that has recently had a bigger than normal appreciation OR in an asset where you have recently invested a large sum increases your propensity to act emotionally and make a mistake if markets were to fall sharply.  And yes I believe financial markets mean revert in the long run.

Lastly, a lot of ppl (myself included) are very close to FIRE due to the recent strength of the stock markets.  You only need to get rich once.  In my opinion there is no reason to take chances when 1) the finish line is in sight and 2) I am in this position BECAUSE OF the recent larger than normal gains from the markets.  Historical averages are great to use in setting a general asset allocation, but I think it would be foolish not to consider the fact that markets tend to mean revert over time and the prospective returns investing today are not the same as even 5 years ago.  Does this matter if your time horizon to retirement is 20 or 30 years?  No - but it certainly does if it is you are looking to FIRE in the next 5. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: NICE! on January 11, 2015, 08:53:58 AM
In retrospect, investing the difference in the stock market really made very little progress towards my goal.

This is an excellent point I haven't seen discussed much on these forums.

I plan for my working career to be 6-8 years total. With that kind of timeframe, investment gains during your working career are, on average, unlikely to affect your time to retirement compared to just using a 1% savings account. If you get lucky, investment gains might shave some time off, but it could also be the opposite. The expected value is basically a wash, unless you choose very aggressive investments (for example, highly leveraged real estate).

However, it's not just the accumulation phase where investments matter. You also need to support yourself for the rest of your life and that will definitely require real investments, not a savings account. And that's where the 30 year timeframe on these mortgages is very useful, because the mortgage can far outlast your working career and continue to provide additional money during your retirement.

Cathy/Tyler, I think that this is a good point for extremely aggressive savers. Yes, it isn't discussed here but it is certainly discussed over at ERE. During the accumulation phase, Jacob's model was 100% based upon saving and not investing. In fact, I think he did have his money in savings, CDs, or something along those lines before he went heavily into equities/dividend investing. Jacob retired 5 years into his working career.

MMM covers this in the Shockingly Simple post. 80+% savings rate net you a working career of 5 or less years. In that timeframe you could have a great market, like 2009-2014. That would certainly cut your working career a decent bit. Alternatively, you could have 2003-2008 and not be able to retire right after the crash.

I'd say that this means people with extremely high savings rates need to change their strategy, but unfortunately they have to make their money last in perpetuity like the rest of us. As such, I think they still need to be heavy in equities.

Jacob said something pretty astute in his post on savings rates:
"Therefore you gotta ask yourself a question: How much of your retirement strategy is based on things, like your savings rate, which you can control, and how much of your strategy is based on things, like the future return and inflation rates, which nobody know and which are out of your control?"
Source: http://earlyretirementextreme.com/what-should-my-savings-rate-b.html (http://earlyretirementextreme.com/what-should-my-savings-rate-b.html)
Title: Re: What is the magic pay down your mortgage rate?
Post by: newnewman on January 11, 2015, 09:06:03 AM
+ to what Astatine said.

I'm in Canada, and our situation is different here too. No tax benefit from the mortgage, and we can't lock in a rate for 30 years. Instead, everyone renews their mortgages at the new balance at the end of the mortgage term, 1-7 years. The longest fixed rate terms are around 7 years, and the rates are higher for the peace of mind of having such a long term.

We are maxing out our retirement savings and only carry mortgage debt, so even though our rate is low now, we are paying fairly aggressively, and hope to be done with our mortgage at 12-13 years after we bought our home (we'll be just over 40). From a pure investing and opportunity cost perspective, sure we could do better investing our extra principal but we'd have to learn a lot more than we know today about investing, and we're pretty financially conservative. It works for us.

Also Canadian here and agreeing with you. We are still working on paying off two lines of credit (yes- embarassing!) but after that our plan is to max RRSP/TFS and tackle the mortgage. We aren't knowledgeable about investing. Perhaps I will learn a thing or two from all of you on this board. So happy to have discovered MMM yesterday!!!
Title: Re: What is the magic pay down your mortgage rate?
Post by: Cheddar Stacker on January 11, 2015, 09:26:40 AM
We aren't knowledgeable about investing. Perhaps I will learn a thing or two from all of you on this board. So happy to have discovered MMM yesterday!!!

Welcome to the party. There's a lot to learn around here.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Spondulix on January 11, 2015, 02:44:48 PM
The risk of financial ruin also has to be taken into account, and that % chance of ruin increases disproportionately with the size of the debt as a % of income to service the debt.
I just ran across an article the other day that explains this exact concept (using mortgages as an example) - I wasn't familiar with it before. For anyone interested, start reading page 11, "Example of why debt adds risk to equity" (warning pdf)
http://wpui.wisc.edu/docs/effect_of_debt.pdf
Title: Re: What is the magic pay down your mortgage rate?
Post by: Kyle Schuant on January 11, 2015, 02:52:09 PM
We always pay down, no matter what. Unless the rate is fixed for the entire 20-30 year term of your loan, you never know what the interest rate might be in a few years. In my lifetime I've seen it as high as 17%. By paying less we'd be gambling on the long-term stability of the economy. Recent history shows this is not a good gamble.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Astatine on January 11, 2015, 07:29:36 PM
We always pay down, no matter what. Unless the rate is fixed for the entire 20-30 year term of your loan, you never know what the interest rate might be in a few years. In my lifetime I've seen it as high as 17%. By paying less we'd be gambling on the long-term stability of the economy. Recent history shows this is not a good gamble.

The more posts and threads I read on here discussing paying off mortgages vs investing, the more I think the threads should be country-specific. US seems to have low interest rates (at the moment) and fixed interest rates, and very different tax rules. The arguments about not paying off the mortgage fast seem to be based entirely on those assumptions, and don't seem to ever reference the risk of variable interest rates, or the fact the primary residences in Australia, for eg, don't have tax deductions. So may be all of these threads should be "pay down mortgage or not? US" or "pay down mortgage or not? Australia" and so on. 
Title: Re: What is the magic pay down your mortgage rate?
Post by: Kyle Schuant on January 11, 2015, 11:26:42 PM
I said that over the 20-30 year period of a mortgage, rates might go very high. This is not particular to Australia.

(http://b-i.forbesimg.com/phildemuth/files/2013/07/image001.png)
Title: Re: What is the magic pay down your mortgage rate?
Post by: MDM on January 11, 2015, 11:31:48 PM
I said that over the 20-30 year period of a mortgage, rates might go very high. This is not particular to Australia.
Kyle, in the US once you have a 30 year (or whatever length) mortgage the rate for your mortgage never changes.  Unless it is an Adjustable Rate Mortgage, but conventional mortgages are at a fixed rate for the mortgage term.
Title: Re: What is the magic pay down your mortgage rate?
Post by: Lmoot on January 17, 2015, 09:58:24 AM
Personally I'd say if you can pay it off in less than 5 years, I'd be more inclined to do that. THEN after that you can invest if you'd like, without worrying if you missed out too much.