Author Topic: Case Study - Pay down mortgage in 7yrs or pay extra retirement contributions  (Read 2625 times)

brickwall1

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Reader Case Study - Pay down mortgage in 7 years or continue extra retirement contributions

EDIT:
Updated asset list with missing line
Updated the expenses with avg of past couple year costs
Updated questions sections with 7% interest along with some of our family philosophy on life.


Life Situation:
Married (late 20's) with one dependent (infant) (we hope to add more children every ~3 years)
Wife and I both have zero debt, both own a car. I tend to bicycle commute (we live in one of the few locations decently priced that has bike paths rather than highways) and she is stay at home with a new infant. Flexible work with job security on both sides. Wife can start work again if needed or go part time.

Recently purchased a house for $260,000 with a 30 year 4.375% rate. 20% was put down to avoid PMI.

Before the house purchase, I routinely put 40% of my income into retirement. Combined, my wife and I have ~$330,000 in retirement accounts, mostly index funds (VTSAX and derivatives).

I can retire from my current employment in 16 years (age 45) with medical benefits and a pension or cut the amount of hours I work to 75% and still keep full benefits (Working indefinitely because my IT job is fun but still with more family time. I get 4 weeks paid vacation plus 14 hours accrued every month)

Honestly we are in a really fortunate place in our life, that even if major set backs happened and we couldn't invest in retirement anymore plus had major expenses we'd still be in a good place financially, especially if the wife picked up work again.



Gross Salary: $81,000 (12% federal tax bracket) single income


Pretax monthly deductions:
Dental Insurance 38.92
Vision Insurance 12.46
Health Insurance 258.18
HSA: 333.00
Retirement (8% of salary with 6% match): 540.00
Parking Fees: 7.34

TOTAL: $1,189.90

AGI: $61,200


Work forces 8% of my paycheck into a retirment plan with a 6% match. I also contribute 6% of my pay into an HSA as a retirement vehicle.
We're down to 14% of income going into retirement accounts: $873 monthly, $10,476 yearly + $3672 match = ~$14,000

EDIT: Updated to average from past years
Current expenses previous month monthly:

Mortgage: $1367
Medical: $345 $1000 (high right now until we hit deductible. Estimated yearly expense is <$8000 including premiums, so real AVG of $666 a month per year. Wife and I both have chronic conditions) EDIT: accidentally included premiums in avg price. Average ~$4144 spent on medical after tax == $345/month
Groceries: $450
Charitable Giving: $300 (supports local parish, homeless, women in crisis pregnancies, and the arts. Non negotiable)
Utilities: avg <$180 (gas, electricity, water, sewage, trash, internet)
Car Insurance: $180 (2 cars, this is the lowest we've been able to get in the state. Before I was paying more than this on a single car and that was considered decent)
Gas: $100
Restaurants: $<40 (twice a month order out)
Music: $10 (Working on convincing SO to drop this)
General Merchandise: $440 (Home improvement, baby, clothes, hobbies, maintenance, gifts) EDIT: Added average cost of general goods

without mortgage: $2045/month, $24,540/year
mortgage 16+,400/year
b]TOTAL expenses[/b]: $40,940/year

Leftover: $20260/year

Assets:
Using rounded numbers for easier math

Everything below is traditional, no ROTH as they were contributed to at a time when our individual earnings put us in the 22% bracket.
IRA: $108,000
403b: $12,000
457b: $68,500
HSA: $17,000
TRSL: $17,000
401k: $43,000
Work Pension: $47500 (fully vested next year)
Savings (Anything breaks/needs replacing. Will be filled back up to amount after spending): $15,000

TOTAL Assets: $327,000

2 cars, paid off. Both are Prius (prii?) a 2011 and a 2015.
House: estimated worth $274,000, ~$87,000 in equity, Brand new roof, appliances, HVAC, water heater, and interiors. Purchased last year 2022
Fancy record player and sound system from my bachelor days: ~$1000
Bike: ~$750


Should we need any additional income say for children costs or surprise maintenance/replacement, the wife can always go back into teaching/tutoring for a time.


Liabilities:
Mortgage: $1367 monthly
Unpaid principal: $191,000
4.375% interest rate on a 30 year loan


Questions:
1) When is enough enough? If we only contributed the 14% of income plus 6% match ($14,000 total) then the $313,000 we have will wind up at a nest egg of ~$1,000,000 by my retirement time (see math below). A 4% withdrawal rate gives $36,291, almost 1.5 times our current expenses (minus the mortgage). Keeping up our 40% into retirement maybe doubles increases the amount in the nest egg later in life, but we do we really need it, you know? Halting the extra retirement contribs helps get us quicker to the security of owning a house. Our life ideal is not really about how much money we've accumulated by the end of our lives but rather how it was lived. I want to make sure I'm not shooting our future in the foot by pursuing paying down the mortgage (even though that is less efficient).

Compounding calculator:
EDIT: Since 5% was considered too conservative, I've adjust below for 7% compounding return on interest as well:

Current Principal: $313,000
Annual Addition: $14,000
Years to grow: 16
Interest Rate: X
FUTURE VALUE at 5%: $1,031,004,88 or ~$900,000 after taxes
FUTURE VALUE at 7%: $1,341,790.30 or ~$1,180,000 after taxes


2) Is it worth continuing putting extra into mortgage instead of retirement? Doing so will allow us to pay it off  in ~7 years. Basically, for the next 7 years, here are a couple things I can do with this extra ~$20,000 a year. Let's assume no major renovations/maintenance costs. If those happen, we'll pull from savings and work on refilling that bucket likely setting back the target goal by a year.

Earlier pay off is desirable as it is right after the first kid starts primary schooling allowing flexibility for private/public schools. Being able to start contributing to college funds and owning our property is a mental security that means more to our family than purchasing power does (time and energy spent in moving, losing current location and bikeability to work, and history with neighbors are all costs that money can't replace).

Taking all retirement except 457b, assuming no more contributions
over 16 years compounding $244,500 at 7%: $721,804.04 (This ~$700,000 with a 10% penalty is an acceptable ~$21,800/yr (assuming 12% tax and 10% penalty, 4% withdrawal)
And at 30 years later when I can withdraw without penalty: $1,861,196.36 (This is way more than we would ever need to the point where withdrawing at 16+ years makes more sense if extra income is needed).


Contributing to 457b and not accelerating paying off mortgage:
   If we contribute $20,000 to the 457b (currently at $68,500) for the full 16 years, it will grow to
   compounding at 5%: $646,334.24
   compounding at 7%: $799,027.56
   If I retire at 45, I can pull ~$28,000/year and drain 457b by 65 years of age (assuming an unlikely no further growth and 12% in taxes). Then I can begin draining other retirement accounts (IRA, 401k, etc)
   If I retire at 45 I can withdraw ~$28,000. EDIT: Thanks Index for catching my misunderstanding on the withdrawal rate.
TOTAL at 16 years 457b + other accounts = $49,000
MINUS $16,400/yr in mortgage payments: $32,600

Contributing to 457b after paying off mortgage:
   If we don't contribute to the 457b until after the mortgage is paid off it'll be 7 years of growth only and 9 years of contributions:
   7 years with no contributions compounding the 457b will be:
      5% interest: $96,386.38 (just 457b)
      7% interest: $109,996.03
   16 years total with 9 years of contributions:
      5% ~$335,000 after 12% tax
      7%: $403,525 after 12% tax
   This gives ~$16,141 a month with %4 withdrawal. Likely wife would go back part time before I retire anyways so we'd have that supplemental income. Or we could just accept the 10% penalty on the IRA and withdraw from that to supplement.
TOTAL at 16 years 457b + other accounts = $37,000    with the advantage of no mortgage payments

   I realize the math might be slightly off, (like tax brackets are not a flat 12% but the first ~$9000 is at 10%. The numbers are close enough for me working at this distance from retirement)
   

3) How would I describe our nest egg? With $313,000 in retirement in stocks and ~$87,000 in estimated home equity can I say this is a 75/25 aggressive split? Does thinking about our egg this way make sense? Right now I feel we have a significant portion in retirement funds and not much liquidity and it makes sense to start "investing" in the house so to speak. EDIT: Explained in posts below
« Last Edit: March 20, 2023, 09:06:34 PM by brickwall1 »

index

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The math looks close because you are assuming a 5% ROR on your investment accounts. If you use 6, 7, 8, 9% etc. the math favors holding onto your mortgage. I would absolutely hold on to your 4.375% mortgage because it is your best hedge as an individual against inflation - you are paying on a negative real rate right now. You can buy 3 month to 2 year treasuries 4.93% - 5.2% right now that yield more than your mortgage, i-bonds 6.9%, or PM 10-yr bonds yielding 5.63% let alone equities. There is NO reason to pay extra on your mortgage!

Your 23k/yr budget does not account for any one-off expenses that are to be expected - new cars, hvac, roof, appliances, furniture, clothing etc. let alone expenses associated with your children. I would track your actual expenses over a long time period to determine your spending. 

RWD

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You may be able to find cheaper car insurance. $180/month seems pretty high. We're paying closer to $125/month on 2 [expensive] cars despite a recent speeding ticket.

1) You only need enough to cover your expenses (not counting mortgage payment) plus enough to cover your mortgage principal. So around $800k right now. cFIREsim is a good tool for modeling various scenarios if you want some deeper statistics than just the 4% rule.

2) You absolutely should not pay extra on your mortgage at that rate. See: investment order post and DPYM Club thread. As index pointed out, 5% is way too conservative of an estimate for investment account growth over 16 years. You will also be much better served by the flexibility of not locking away money in home equity.

3) No, home equity should not be considered like a bond portion of your investment portfolio. Because the part that you should consider is the whole home value. Because it doesn't matter whether you have a loan or not, the home value fluctuations is what would drive that portion of the investment portfolio. Currently you say your home is worth $274k. So if you want to think of home value as being similar in safety to bonds (arguable whether that's the case) that puts you at a 55/45 ratio (stocks to real estate). Paying extra on your mortgage doesn't change the risk profile.

index

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Assets:
Using rounded numbers for easier math

IRA: $108,000
403b: $12,000
457b: $68,500
HSA: $17,000
TRSL: $17,000
401k: $43,000
Savings (oh crap fund): $15,000

This adds up to 280.5k, where is the other 46.5k coming from?

This stuff doesn't count:
2 cars, paid off. Both are Prius (prii?) a 2011 and a 2015.
Fancy record player and sound system from my bachelor days: ~$1000
Bike: ~$750

Home equity -

274k - 191k = 83k
good practice is to knock the value down 6% because of transaction costs so you are around 66.5k if you cashed out. 

2) Is it worth continuing putting extra into mortgage instead of retirement? Doing so will allow us to pay it off  in ~7 years.
   Earlier pay off is desirable as it is right after the first kid starts primary schooling allowing flexibility for private/public schools. And we could start contributing to college funds.

Contributing to 457b and not accelerating paying off mortgage:
   If we contribute $20,000 to 457b for the full 16 years, compounding at 5% 6.5% (in conservative corporate bonds): $1,303,373 by age 45
   As I'll retire at 45, I can withdrawal $45.6k/yr (40k after taxes) at a 3.5% rate  (conservatively) $28,437/year and drain the account by 65 years of age (assuming no further growth and with a 12% tax rate for the rest of your life. Then I can begin draining other retirement accounts (IRA, 401k, etc)

Contributing to 457b after paying off mortgage:
   If we don't contribute until after the mortgage is paid off it'll be 7 years of growth and 9 years of contributions:
   7 years with no contributions compounding at 6.5% interest: $409k
   16 years total with 9 years of contributions: ~$335,000 after 12% tax ~$1,038,181 giving you 32k per year for life.
   This gives ~$16,700 a month for 20 years assuming no growth. Likely wife would go back part time before I retire anyways so we'd have that supplemental income. Or we could just accept the 10% penalty on the IRA and withdraw from that to supplement.


First order of business is to begin a Roth IRA being in the 12% tax bracket. You would also need to recharacterize your IRA and take a big tax hit to be able to withdrawal retirement funds penalty free.

brickwall1

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Thanks guys for taking the time to reply and clarify. I've updated the post with EDIT sections.

I may be misunderstanding how the traditional IRA 10% early withdrawal penalty is applied. I have assumed with was just an extra percentage with the tax. So a 12% bracket + 10% for a 22% tax on any money taken out. Someone let me know if this is incorrect.

@RWD Saying I need ~$800,000 for FIRE puts me in retirement range no matter what I do in 16 years with my current assets growing. So paying down the mortgage before then is icing of the cake to not have that expense for then.

@index I split out the 457b growth from the rest of the accounts growth as this would be the one I contribute to or not. The others are just going to sit quietly growing. And I definitely need to switch to ROTH contributions. The other assets accounts are traditional because at the time my wife and I both were sitting in the 22% tax bracket. MadFientist had a post about traditional + early penalty still made more than ROTH for the long period of growth those accounts are intended towards. I think this is the article that did the breakdown of trad, trad + penalty, and ROTH https://www.madfientist.com/how-to-access-retirement-funds-early/


Edits to original post:
Updated asset list with missing line - Retirement pension line
Updated the expenses with avg of past couple year costs - General merchandising costs
Updated questions sections with 7% interest along with some of our family philosophy on life - Both options I list seem acceptable to our family after writing them out.
Car insurance is already at the bottom of the barrel cheap end for my state.
« Last Edit: March 03, 2023, 01:24:36 PM by brickwall1 »

RWD

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@RWD Saying I need ~$800,000 for FIRE puts me in retirement range no matter what I do in 16 years with my current assets growing. So paying down the mortgage before then is icing of the cake to not have that expense for then.

Sure, but that just means you could retire even earlier than in 16 years (or have more buffer in case things don't go to plan). The mortgage payment will go away eventually (as long as you keep paying on schedule) regardless of whether you pay extra early. By paying it off early you are incurring opportunity cost for for a temporary fixed increase in cash flow. Whether this is advantageous depends on your interest rate (which is very low at 4.375%) and actual investment returns (unknown, but typically 9-10% nominal). Keeping the mortgage is also an inflation hedge. Your mortgage payment (at least the PI portion that would go away if you paid it off) will not increase with inflation, it will always be fixed. Inflation was 6.5% in 2022 so borrowing at 4.375% was an incredibly good deal.

As a minor nitpick (but important because it affects how you frame the mortgage), the mortgage payment is not an expense. The mortgage interest is the expense. The rest of the payment is a transfer from your liquid assets to locked in home equity. Your remaining principal is $191k, so 4.375% of that is $8.4k of actual expense (and decreasing). In exchange, you can have $191k more invested (and available for flexibility) than you would otherwise.

You say you only have $15k in savings. I personally would want a lot more than that before I risked locking up liquid capital in my house. Because partly paying off a house doesn't gain any additional security. The standard advice for someone that still insists they must have a paid off house is to save up the capital in taxable investments instead and then pay off the house in a lump sum. There's plenty more arguments on this in the DPYM thread I linked earlier if you really want to read up on it.
« Last Edit: March 03, 2023, 02:13:03 PM by RWD »

index

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Quote
Contributing to 457b and not accelerating paying off mortgage:
   If we contribute $20,000 to the 457b (currently at $68,500) for the full 16 years, it will grow to
   compounding at 5%: $646,334.24
   compounding at 7%: $799,027.56
   If I retire at 45, I can pull ~$28,000/year and drain 457b by 65 years of age (assuming an unlikely no further growth and 12% in taxes). Then I can begin draining other retirement accounts (IRA, 401k, etc)
   If I retire at 45 I can withdraw ~$28,000. EDIT: Thanks Index for catching my misunderstanding on the withdrawal rate.
TOTAL at 16 years 457b + other accounts = $49,000
MINUS $16,400/yr in mortgage payments: $32,600

Contributing to 457b after paying off mortgage:
   If we don't contribute to the 457b until after the mortgage is paid off it'll be 7 years of growth only and 9 years of contributions:
   7 years with no contributions compounding the 457b will be:
      5% interest: $96,386.38 (just 457b)
      7% interest: $109,996.03
   16 years total with 9 years of contributions:
      5% ~$335,000 after 12% tax
      7%: $403,525 after 12% tax

So play this game - at the end of 16 years you have 110.5k left on the mortgage in scenario 1 - so pay the mortgage off in a lump sum if you want to:
   compounding at 5%: $646,334.24 - $110.5k = $536k > 380k (pretax scenario 2)
   compounding at 7%: $799,027.56 - $110.5k = $689k > 458k (pretax scenario 2)

Laura33

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If you are worried about security, paying off the mortgage is the worst thing you can do for the next 7 years, because if you run into problems paying the mortgage, you can lose the house whether you have 0% equity or 99% equity.  You are currently a single-income household, and you plan on staying that way for at least the next several years.  That means you do not have the safety net of a second income to fall back on if you were for some reason to lose your job.  So what you really need is liquid assets to cover you in that event. 

Focusing on the post-FIRE analysis is a different issue entirely, because your risks and needs are completely different then.  At that point, you no longer have the cash cushion of a job, so having lower mandatory expenses is very good.  So it is very reasonably to want to have your mortgage paid off by your FIRE date.  But it makes no sense to say "I want my mortgage paid off by the time I FIRE" to justify paying it off in 7 years, because you're not planning to FIRE for another 9 years after that.  And it certainly makes no sense to say "I need security for the next 16 years" to justify paying off the mortgage in 7, given that doing so makes you extra vulnerable for the next seven years.  (Not to mention that if you stop your tax-privileged contributions, you'll have more taxes to pay over the next 7 years, and thus less money to pay toward that mortgage).

A better plan is to stash as much as you can away now, particularly while your DW doesn't have paid employment.  That extra $$ maximizes your security for now.  Then, when you're ready to FIRE, you can take some of that extra $$ and use it to pay off the mortgage, if it makes financial sense to do so at that time. 

brickwall1

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@RWD That nitpick gave a perspective shift about the mortgage payment to my wife and I. Once we read that, it makes sense that interest is expense, not the payment. We have been mentally treating the payment like it was rent. It also helps to see the interest payment vs inflation. That wasn't as intuitive mentally.
The DPYM thread has some really good debates that got us thinking. Thanks for the link.

The reason we are aiming for a 16 year mark for FIRE is my current employer pays 75% health benefits then. So we get a 100% coverage plan for in-network and prescriptions for ~$730 instead of ~$2400 a month.

We feel comfortable with the savings amounts as we have family and community support should something drastic happen, our max out of pocket medically is $10,000, and the house is relatively new plus we could survive on one vehicle instead of two.


@index It is something of a lightbulb moment to realize one could pay the mortgage down in one lump sum LATER. In my mind, draining the nest egg with such a huge hit is a no-no, as though dipping past the withdrawal rate should not happen. But I see there is still a significant amount more in the accounts even after lump sum payment.


@Laura33 It helps to split out post-FIRE from before. I think I have been conflating needing/wanting to have a mortgage before FIRE could really be pursued. Probably coming from an erroneously preconceived notion that debt==bad therefore mortgage==debt==bad.


Two additional questions for the thread:
1) Does it make sense to contribute any extra to the mortgage such as to pay it down by the 16 year mark assuming the 457b is maxed out? Or no, any extra contributions should go to other buckets such as HSA and IRA (and let go of the nagging desire to be rid of the mortgage)?

2) The 457b can be withdrawn from with no penalty whenever I leave my current employer. Does a traditional vs ROTH matter here? As we plan to stay in the 12% tax bracket, it seems better to let a traditional grow over the 16 years rather than shortchanging the account by paying tax first.

Thanks all for the time and input. It is a big help to have differing viewpoints to clarify and rethink strategies.
« Last Edit: March 06, 2023, 12:59:23 PM by brickwall1 »

index

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I would imagine the 12% tax bracket will go up or you will make more money one day. I'm not really a fan of Roths for higher income earners but I would use it in your case. Does your work offer a roth option?  I would max out that account at 22.5k, hsa ~7k, Roths 6.5k before messing worh the mortgage.

Zamboni

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Your 23k/yr budget does not account for any one-off expenses that are to be expected - new cars, hvac, roof, appliances, furniture, clothing etc. let alone expenses associated with your children. I would track your actual expenses over a long time period to determine your spending.

I will second this. Tracking is important, and I recommend tracking for a year to catch the semi-annual expenses. A lot of wealthy people I know track quite carefully. It almost seems like the more careful attention you pay to money, the more of it you get.

Kids do cost a little money. Babies are cheap if they aren't in disposable diapers, but after that I probably spent ~$500-$1000 a year on clothing/shoes for my two kids until they stopped growing. Most of it was second hand except for the sneakers, but still not free, especially during growth spurts. They probably also will want to take music lessons or dance lessons or play soccer or something. At a minimum they should learn to swim competently just for safety reasons. They will want bicycles. The school will have field trips that have a nominal cost. None of that breaks the bank unless you are ridiculous about it, but it also is not free. Then they turn 15.5 and want to drive . . . your car insurance bill at that point will be absolutely shocking for a couple of years.

reeshau

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I'm late to this conversation, but two points that stand out for me:

I don't see you mention putting retirement money into an IRA for your wife, while she is off of work.  You also talk about assets and liabilities individually.  Are you comingling your assets, or do you keep them separate?  Regardless, I would at least check with her on her feelings to have "her" money continue to grow, while she is doing the unpaid work of raising your kids.  Also, an IRA can have lower fees and more choices than your company plan.  If you are not satisfied with your 401k, then using the spousal contribution option could address that.  Same for a Roth consideration, too.  You still should capture your full match, but you mention you have to do that.

In regards to kids, many have talked about expenses, but I didn't see anything about college.  Do you and your wife have a clear approach to funding college for your kids?  Particularly if you plan on multiple children, this will be a bigger overall cost than your mortgage.  It is also something you can do something about, by investing money early, and letting it grow.  College is going to start hitting shortly after your planned FIRE date, but it will hit with large upfront costs, so in a way it is more urgent than your retirement.  (Although, as some say, you can take a loan for college, but you can't take a loan for your retirement)

Zamboni

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^Yeah, don't take a loan for college, though. I hate that saying!

I guess go ahead once one is in Med school to become an anesthesiologist or something. Other than that, the kind thing to do for your children is help them find ways to get an associates or undergraduate degree, if that is something they want to go for, without any debt at all coming out of it.

StarBright

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I am a person who prizes feeling secure over the smart math decision. I am ALWAYS pulled towards paying my mortgage off early.

However - someone on this forum told me a about a mortgage recast and that is now our plan. With a recast you put a big chunk of money towards your mortgage, but your term stays the same, so the monthly payment gets lower. You do this instead of paying extra every month.

I really found this to be a best of both worlds scenario.

reeshau

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^Yeah, don't take a loan for college, though. I hate that saying!

I guess go ahead once one is in Med school to become an anesthesiologist or something. Other than that, the kind thing to do for your children is help them find ways to get an associates or undergraduate degree, if that is something they want to go for, without any debt at all coming out of it.

I don't advise it, either.  But putting your own retirement in jeopardy to give your kids "more" or "everything" is also not smart.  Burdening your kids with your long-term care or foreclosure on your house will also cause them grief.  I'm sure many on this forum will be able to handle both, to the degree they want to.

The biggest thing is to think about it early, and be upfront with your kids about it, so they don't start with starry-eyed expectations.

Finances_With_Purpose

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A few thoughts, as someone who has had a similar mortgage and similar retirement account options:

1.  Check your 457(b).  Many if not most allow you to withdraw without penalty as soon as you leave that job.  This is the ULTIMATE tax-deferred account.  It has value far beyond other 401(k)-type accounts because it lets you pick your income if you FIRE, especially in early years. 
2.  That's a huge reason to prefer the 457(b) over the mortgage: you could withdraw if you had a job loss, and you could keep a low tax bracket then - precisely when you need it. 
3.  You get an instant - what? - 25% return on the 457(b) because you didn't have to pay income tax on it.  Then you get the free compounding.  Add that to the other advantages and you're crazy not to max it out. 
4.  Drop the rest into a Roth IRA if you can, because you can always pull contributions out later if you really had to.  So you keep the cushion BUT ALSO the upside.  A 457(b) is similar: you get the tax cushion now plus flexibility later on. 
5.  DON'T PAY THE MORTGAGE OFF EARLY.  I'm a huge fan of paying them in general, for security reasons, but it makes less sense now, and for you, than for almost anyone I see on here. 

A single example: why on earth would you ever do that when you can sink ANY excess cash into i-bonds that are paying 6.8+% right now???  You'll literally come out ahead on the i-bonds, even after taxes.  (And you don't pay tax on the compounding there either.)  Plus they're only tied up for one year before you can cash them out.  It's highly unlikely you could ever come out ahead (as of now) paying off the mortgage, even without the added bonus of a 457(b) (i.e. a 25% instant return via not paying the marginal taxes).

Load up on savings and ignore the mortgage.  You don't even have to risk it on stocks/returns, you can put it in i-bonds.  Or do the 457(b) - those things are usually God's gift to FIRE goals.  (Check your plan first, obviously.)  You have great options, none of which are paying the mortgage. 

reeshau

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One big downside of a non-governmental 457b is that it is the property of the company, not you.  And therefore, it is subject to a bankruptcy by your employer.

https://www.irs.gov/retirement-plans/non-governmental-457b-deferred-compensation-plans#:~:text=Non%2Dgovernmental%20457%20plans%20must,event%20of%20litigation%20or%20bankruptcy).

A bird in the hand, and all.

Finances_With_Purpose

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One big downside of a non-governmental 457b is that it is the property of the company, not you.  And therefore, it is subject to a bankruptcy by your employer.

https://www.irs.gov/retirement-plans/non-governmental-457b-deferred-compensation-plans#:~:text=Non%2Dgovernmental%20457%20plans%20must,event%20of%20litigation%20or%20bankruptcy).

A bird in the hand, and all.

Good point.  I rarely if ever see one that's non-governmental, so I sort of assumed governmental, but you are correct and they do exist out there. 

reeshau

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One big downside of a non-governmental 457b is that it is the property of the company, not you.  And therefore, it is subject to a bankruptcy by your employer.

https://www.irs.gov/retirement-plans/non-governmental-457b-deferred-compensation-plans#:~:text=Non%2Dgovernmental%20457%20plans%20must,event%20of%20litigation%20or%20bankruptcy).

A bird in the hand, and all.

Good point.  I rarely if ever see one that's non-governmental, so I sort of assumed governmental, but you are correct and they do exist out there.

OP didn't specify, so that's why I added it.

The Big 3 autos commonly had them for execs.  I was almost eligble, so I knew about them, but didn't participate.  When GM and Chrysler went bankrupt, they got wiped out, many for millions, with no recourse.  (I know--cry for the execs.  But this led to personal bankruptcies, as most assumed it would never happen, so effectively maxed them out for tax management)

Dicey

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I am a person who prizes feeling secure over the smart math decision. I am ALWAYS pulled towards paying my mortgage off early.

However - someone on this forum told me a about a mortgage recast and that is now our plan. With a recast you put a big chunk of money towards your mortgage, but your term stays the same, so the monthly payment gets lower. You do this instead of paying extra every month.

I really found this to be a best of both worlds scenario.
As a person who lives in a HCOLA, where even the most reasonable housing choice costs a huge pile of money, I hated having mortgage payments hanging over my head. Now I understand that keeping a mortgage and diverting everything else into investments, taxable and otherwise, is a more efficient strategy.

There are some excellent reasons that people absorbed the "kill all the debt" lesson, namely that mortgage loans were callable by the lenders. (See: Great Depression) Nearly everyone had someone up the family tree who lost their home catastrophically. Modern loans are no longer callable. As long as you make your payment every month and pay your property taxes, your house is yours, mortgage or no.

The financial talking heads are selling themselves to "most people" and that's the market they seek to capture . Mustachians are not "most people". We are an elite team of financial warriors. We know how to save and invest. We are not struggling with staggering amounts of debt or massive vehicle loans. We have the discipline to use credit cards for the generous rewards, even manufacturing spending, without paying a penny of interest.

People say they will sleep better at night if their mortgage is paid off. Want to know what's even better? Knowing you have $100,000, then $500,000, then $1,000,000 and beyond, entirely under your control. With that kind of money, the number of "problems" in life diminishes drastically. We all know this mustachian business really, really works.  What we don't get from outside sources is how spectacularly well it works, but most non-mustachian people  simply can't imagine ever becoming that wealthy.

StarBright

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I am a person who prizes feeling secure over the smart math decision. I am ALWAYS pulled towards paying my mortgage off early.

However - someone on this forum told me a about a mortgage recast and that is now our plan. With a recast you put a big chunk of money towards your mortgage, but your term stays the same, so the monthly payment gets lower. You do this instead of paying extra every month.

I really found this to be a best of both worlds scenario.
Snip . . .

The financial talking heads are selling themselves to "most people" and that's the market they seek to capture . Mustachians are not "most people". We are an elite team of financial warriors. We know how to save and invest. We are not struggling with staggering amounts of debt or massive vehicle loans. We have the discipline to use credit cards for the generous rewards, even manufacturing spending, without paying a penny of interest.

People say they will sleep better at night if their mortgage is paid off. Want to know what's even better? Knowing you have $100,000, then $500,000, then $1,000,000 and beyond, entirely under your control. With that kind of money, the number of "problems" in life diminishes drastically. We all know this mustachian business really, really works.  What we don't get from outside sources is how spectacularly well it works, but most non-mustachian people  simply can't imagine ever becoming that wealthy.

In general, I do agree with you. I, personally, have circumstances that make a low to no mortgage payment necessary to facilitate my FIREing. 

A mortgage recast was an acceptable compromise for my household :) I had never heard of one until someone on this board told me about it, so I like to pass it on in case there is ever someone else in my shoes.

Dicey

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Hey @StarBright, I started that post, then took a three hour nap, woke up muzzyheaded and finished it without realizing I'd hit the wrong button in the first place. My response was intended for the OP, not you. Since I bumbled myself into this spot, I will respond to your post specifically,  because if I corrected it now, your quote would still stand. Apologies all around for the confusion.

To anyone reading, please consider what I wrote above general advice to all. It was not my intention to single out StarBright.

Sorry if this is confusing, but anything that continues the DPOYM discussion is worthwhile, even if a bit muddled. This next part is for StarBright specifically:

I am a person who prizes feeling secure over the smart math decision. I am ALWAYS pulled towards paying my mortgage off early.

Now that you've elected a mortgage recast, an option I heartily endorse BTW, this might also be a great time to recast your thinking as well. A mortgage is a brilliant tool for creating wealth and hedging against inflation. I used to feel the way you did, and I promise, it will pass as the years go by. Congratulations on the mortgage recast, you're doing great!!!

brickwall1

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OP here again adding some clarifications and coming in with a question and scenario:

Clarification:
The 457b fund is backed by a state university, its not going anywhere unless the entire state descends into anarchy. And it does allow withdrawals once terminated without penalty.

Hopefully after a year of tracking we'll see reduced expenses. Much of last years came from furnishing a new house and baby supplies. The wife and I have combined funds. So any we/I phrasing refers the same buckets. We're all in together financially.


Question:
Could someone "explain it like I'm five" how having a mortgage is a hedge against inflation? Especially, if my salary historically hasn't/wont increase unless a job change happens. Is it only a hedge if income also increases?


Scenario:
And an very real example/possibly in our future is a new kid every 3 years.
1st 2022, 2nd 2025, 3rd 2028
By the third child, the 1st is starting school which if private is a ~$7000 or if homeschooled "free". Public school really isn't an option as the state (which will remain anonymous) is ranked 48th in schooling...

The original plan between the wife and I was to be done with the mortgage by the time the 1st is starting schooling to allow extra funds to pay for school and while getting to contribute to buckets.
If we stop paying extra mortgage, we'll most likely see contributions to the 457b decrease as each kid starts schools/activities.

 

Finances_With_Purpose

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OP here again adding some clarifications and coming in with a question and scenario:

Clarification:
The 457b fund is backed by a state university, its not going anywhere unless the entire state descends into anarchy. And it does allow withdrawals once terminated without penalty.

Hopefully after a year of tracking we'll see reduced expenses. Much of last years came from furnishing a new house and baby supplies. The wife and I have combined funds. So any we/I phrasing refers the same buckets. We're all in together financially.


Question:
Could someone "explain it like I'm five" how having a mortgage is a hedge against inflation? Especially, if my salary historically hasn't/wont increase unless a job change happens. Is it only a hedge if income also increases?


Scenario:
And an very real example/possibly in our future is a new kid every 3 years.
1st 2022, 2nd 2025, 3rd 2028
By the third child, the 1st is starting school which if private is a ~$7000 or if homeschooled "free". Public school really isn't an option as the state (which will remain anonymous) is ranked 48th in schooling...

The original plan between the wife and I was to be done with the mortgage by the time the 1st is starting schooling to allow extra funds to pay for school and while getting to contribute to buckets.
If we stop paying extra mortgage, we'll most likely see contributions to the 457b decrease as each kid starts schools/activities.

That's great on the 457!  Then use it like it's going out of style!

As for your question, here's an explanation: houses cost a lot.  They cost more over time.  For instance, houses in my zip code cost almost 100% more than they did a few years ago. 

Once you buy, you own the house and cannot be forced to pay more for it, ever.  If you rent, your rent can go up and up - in proportion to the costs.  If real estate costs go up, your rent goes up.

In addition, you will typically have a mortgage with a house.  You can use it to hedge against high rates.  You get an OK rate up front, but then you typically have the option to refinance whenever rates drop enough - below your rate - and then you have an even lower rate. 

For instance, we started with a 4.5 or 4.25% rate on this house, but we refinanced during the low-rate explosion (at no cost) and now have a 2.5% mortgage rate.  That's below the average inflation rate (which runs between 2.5-3.0%), which is both incredible and a historical anomaly: whoever bought my mortgage has lost a ton of money and real value.  (Our government bought it - no surprise there.  Only governments are typically that dumb.) 

So, to your question: you get to lock in the cost of the house, while everyone who doesn't own has to pay whatever the house costs whenever they buy it, in the future.  They can generally expect costs to go up by a few percent every year (this year is an outlier, though, after the huge run-up in prices lately that's now calming down and even dropping back down a little), while your cost for the same house will stay the same.  You've prevented yourself from being priced out if houses go up dramatically wherever you are at (see also: my neighborhood). 

I'll give you an example: we bought our house for under $400k.  Four years later, the average house on this street was over $1m+.  Yet our house payment went down, as we refinanced into a 2.5% mortgage, and are now using i-bonds and other things to pay us more than our mortgage costs, so that we're effectively getting it paid off even faster.  At any rate, we wouldn't have wanted to buy a house here at >$1m, so we're very happy we bought when we did.  (Note: Usually, that process takes years, but we've seen a crazy run-up in house prices the past several years - ever since covid - that is highly unusual.)  You could buy our same house today, but you'd have to pay a payment roughly 4x as much or so (maybe more, depending).  We don't, though, since we bought it before things jumped this last time. 

Finally, your last question, as to finances: That's a really ambitious goal to have the mortgage paid before kids are in school.  I don't talk much about our finances here, but we're in a very similar situation, except that there was no reasonable plan that would have had us have the mortgage paid that quickly, so we have not attempted it.  I would try to find a plan that accommodates your mortgage, and, if anything, look for better-paying employment as needed because schooling is expensive. 

Two things that may help, in case you haven't considered them:
1.  You might have a dependent-care FSA which can give you up to $5,000/year tax-free to pay for care (which may include schooling, you'd have to check, but I would think so). 
2.  You can do a 529 plan for your kid and drop up to $10k/year into it, then spend that on private school and get that tax-free as a result.  (Granted, they won't have a big, fat, tax-free college fund if you do that, but I prefer the immediate tax break.) 

So you can at least save on the taxes for the schooling, which makes it a little less painful. 

Laura33

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Question:
Could someone "explain it like I'm five" how having a mortgage is a hedge against inflation? Especially, if my salary historically hasn't/wont increase unless a job change happens. Is it only a hedge if income also increases?

It is a hedge against inflation in housing costs; pay raises aren't necessary to benefit.  You are locking in both today's home prices and today's interest rates.  If home prices and/or interest rates go up, your mortgage stays the same, meaning that you are paying less than someone who buys today.  And like @Finances_With_Purpose said, if interest rates go down, you can refinance -- it's one of the few areas where normal people "win" whether rates rise or fall. 

It's a little easier to see the differences if you compare it to renting.  If rental prices go up a few percent every year, you're stuck paying more and more -- and if your salary doesn't increase accordingly, you're paying more and more of your income toward housing every year.  A mortgage is the equivalent of locking in a rental rate for 30 years (and then getting free rentals after that point!).  It's just that the changes aren't as obvious when you're talking about a mortgage, because you don't "see" the annual changes in home prices as much; it's more noticeable over 10+ years than it is over 1-2. 

Example:  I bought my house for around $600K and have a 15-year mortgage for under 3%.  My mortgage payment, IIRC, is around $2400/mo.  My house is probably now worth at least $850K, based on comparable sales.  So if I bought now and put 20% down ($170K vs. $120K I paid, so there's an extra $50K off the bat), I need a mortgage of $680K (vs. $480K, so there's another $200K).  At today's rates for a 15-year mortgage (6%+), that gives me a monthly payment of around $5800.  WTF?!?!?!?!  (I am having heart palpitations just looking at that number!)

IOW, I am paying less than half as much as I would if I bought today -- for the same house!  Part of that is because the house costs more, and part of it is because interest rates went up, but the two combine for a really massive wallop to the budget. 

Pay raises can help improve the numbers even more.  Again, that's not something that's really noticeable year-to-year, but compound it over 10-20 years, and it's significant.  If you get a 4% pay raise every year, your pay will double in 18 years.  Now, that may or may not keep up with inflation; doubling your pay over time doesn't mean doubling your buying power, because inflation will chip away at that.  But remember, over this same timeframe, your mortgage payment has not increased with inflation - it is exactly the same as it was 18 years before!  So that means if your mortgage was previously 20% of your pay, now it's only 10%.  So even with small pay raises, every year those raises help make your housing costs a smaller and smaller percentage of your income.

firestarter2018

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The reason we are aiming for a 16 year mark for FIRE is my current employer pays 75% health benefits then. So we get a 100% coverage plan for in-network and prescriptions for ~$730 instead of ~$2400 a month.


Just saw this thread and wanted to comment on this piece - OP, you may want to run the math on a subsidized ACA plan and what the premiums would be when you retire. At your income level and family size, your coverage would be heavily subsidized, to the point where it may not even make sense to keep working extra years for that subsidized employer coverage, unless you just really like working. A very quick estimate using the KFF calculator (https://www.kff.org/interactive/subsidy-calculator/) using the $81,000 income you cited, 2 adults 2 kids, putting your ages at 6 years in the future, show a premium for a silver plan at $383 (this is an average across all U.S. states).  So you could probably get a gold or platinum plan for about the same as that subsidized employer coverage.  Use your state's specific Exchange site to get a more accurate estimate and compare local plans.

Just a thought -- there can be many reasons to keep working, but if you can get very heavily-subsidized ACA coverage, then working extra for the employer coverage may not be one of them.

alittlelife

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Iím going to disagree with the statement that a mortgage is a hedge against inflation in housing. Buying a house (vs. renting) is the hedge against housing inflation. The mortgage is the loan that allows you to buy your house. The important distinction here is that paying off the loan does not negate the fact that you own your house and are in that way protected from inflation in the housing market. A mortgage is a hedge against inflation because it is a long term low interest loan. You have borrowed money at 4.375% with a 30 year term. You are paying this loan back in nominal dollars, plus that 4.375% interest. But if inflation were to be 6% annually over the life of the loan, then in real (inflation-adjusted dollars) youíd be paying that loan back with a negative interest rate, -1.625%. As in you'd be earning 1.625% (in inflation-adjusted terms) by keeping the loan and not paying it off early.

As others have pointed out, you can currently buy government bonds that pay more in interest than you are paying in interest for your mortgage. There would even be more security if you went that route, since extra mortgage payments that are used to purchase bonds would then be available in case of an emergency. The bank is not going to care that you previously made extra payments if you canít make this monthís payment.
« Last Edit: March 19, 2023, 03:09:14 PM by alittlelife »

rockeTree

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OP here again adding some clarifications and coming in with a question and scenario:

By the third child, the 1st is starting school which if private is a ~$7000 or if homeschooled "free". Public school really isn't an option as the state (which will remain anonymous) is ranked 48th in schooling...


Just a note that you specify the state above when talking about car insurance, might want to edit if you are worried about sharing that.

Dicey

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Iím going to disagree with the statement that a mortgage is a hedge against inflation in housing. Buying a house (vs. renting) is the hedge against housing inflation. The mortgage is the loan that allows you to buy your house. The important distinction here is that paying off the loan does not negate the fact that you own your house and are in that way protected from inflation in the housing market. A mortgage is a hedge against inflation because it is a long term low interest loan. You have borrowed money at 4.375% with a 30 year term. You are paying this loan back in nominal dollars, plus that 4.375% interest. But if inflation were to be 6% annually over the life of the loan, then in real (inflation-adjusted dollars) youíd be paying that loan back with a negative interest rate, -1.625%. As in you'd be earning 1.625% (in inflation-adjusted terms) by keeping the loan and not paying it off early.

As others have pointed out, you can currently buy government bonds that pay more in interest than you are paying in interest for your mortgage. There would even be more security if you went that route, since extra mortgage payments that are used to purchase bonds would then be available in case of an emergency. The bank is not going to care that you previously made extra payments if you canít make this monthís payment.
Can you please point to a single time in modern history where inflation has exceeded 6% for 30 years straight?

engineerjourney

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SNIP

Two things that may help, in case you haven't considered them:
1.  You might have a dependent-care FSA which can give you up to $5,000/year tax-free to pay for care (which may include schooling, you'd have to check, but I would think so). 

SNIP


Wanted to mention that dependent care FSA and childcare tax credits (which can do similar tax savings) can not be used if there is a stay at home parent.  You can look up the specific rules but its related to earned income from both parents so side gigs could change that but depends on the hours of childcare vs working and such.

Also, OP, based on your first post you are not maxing your family HSA? You are missing out on a lot of tax savings if its done through payroll (gets you the extra $$ savings on FICA taxes).  I'd change that to being maxed out before even looking at any other savings options personally. 

 

Wow, a phone plan for fifteen bucks!