Should I pay down my mortgage?

[mariettapeashoot]

Hello! I have been poking around the blog for about 6 months now, this is my first post. I was raised with a 'save alot, spend a little' money strategy, but am just starting to think about the 'strategy' of what to do with the savings. My question is: when I have enough money in my taxed investments, should I use them to pay off my mortgage in full?

Background:
Family: me (42y), husband (39y), and two daughters (7y, 5y). When our daughters were younger our income was temporarily down (eg, we both took the max unpaid FMLA time after each girl was born) and our expenses were up (nanny then private preschool for each girl). But now that they are in public school and we know we aren't having more kids, our financial situation feels different.

Income: we bring home about $9k a month, combined
Savings/strategy: we both max out our 401k and Roth IRA accounts annually (now, though we haven't always)
 -We have about $395k in our 401ks
-We have about $150k in Roth IRAs
 -We have about $215k in (taxed) investments (70%stock/30%bond)
-we have about $60k in our checking/savings bank accounts
-we don't have dedicated savings for our daughter's college expenses, but that is a conscious choice, not an oversight


Debt: we have no credit card, car loan or student loan debt. just the mortgage--we owe about $280k, 4.2% (we're about 5 years into a 30y mortgage). When you add in our insurance/etc, we pay about $2000/mo.

Question: When the balance in our taxed investments matches our mortgage balance, should we pay the whole thing off?

In general, the advice seems to be that if you have a low enough interest rate, you should keep the mortgage. But it seems to me that I can get a guaranteed return on my investment by paying off the mortgage and then can use that $2000/mo (that I would have spent on house payments). I know it will mean some years of not having that $200+k in tax/bonds--but we have a fair amount invested in tax advantaged accounts, so its not like we wouldn't have any investments getting market returns.

I guess I like the idea of such a large amount of my investments getting a *guaranteed* ROI, more flexibility in terms of monthly cash flow (maybe I'm still stinging from the years when we had lots in the bank but a hard time covering our monthly childcare expenses?) and simplification of my portfolio.

Thoughts?

[tralfamadorian]

You will come out either a little or a lot ahead by investing instead of paying down a low interest fixed rate mortgage early.  Here's a chart of what the funds would return in the stock market average year over a 30 year period. At worst you would make ~8%-4.2%=3.8%/yr avg. At best you would make 15%-4.2%=10.8%/yr avg.



Note this is over a 30 yr period. The shorter the period, the more variable the returns can be.

[reeshau]

Background:
Family: me (42y), husband (39y), and two daughters (7y, 5y)

...

Debt: we have no credit card, car loan or student loan debt. just the mortgage--we owe about $280k, 4.2% (we're about 5 years into a 30y mortgage). When you add in our insurance/etc, we pay about $2000/mo.

You seem to have a handle on the balance sheet aspects of paying off the mortgage early.  But I would ask some questions around your future cash flow:

As is, you will have the mortgage paid off when you are 67, and your husband is 64.  Do you want to work this long?  Or, does your retirement budget include this amount?

Perhaps more importantly, your daughters will be through college before your mortgage is paid off.  I don't see any 529 plans listed for them.  What is your philosophy and plan for higher education?  If you targeted paying off the mortgage within 15 years, then you would have this amount to cash flow college.  Of course, That's probably not enough to cover all of it--even for just one child, and you will have two in school at the same time.  Are you actually propsing spending money that had been earmarked for education on paying down the mortgage?

Perhaps your philosophy is quite strongly in the "they can fend for themselves" camp, or "I don't buy into the group delusion that college is a necessity" camp, but it seems odd to leave out these plans when making this big decision.

[Morning Glory]

I would wait until you have enough to completely pay it in full, and then only do it if you plan to stay in that house for a long time. If you use your $215k right now and pay it down, your balance will only be $75k. The problem is that if you lose a job your payment will still be $2000/month, even though your balance is lower, and you won't have that $215k to draw from. I think it is also a bad time to pull money out of the market, although it is not possible to predict the top or the bottom.

 Also why are you in 30% bonds in a taxable account? I am not an expert but I remember Collins saying that your bond allocation belongs in a tax advantaged account, and also your allocation is too high for someone still in the accumulation phase.

 Your cash allocation is quite high too. This should be 3-6 months of expenses unless you have rentals or unpredictable income.

[maizefolk]

Unless there is information or motivation not mentioned in your original post, no you should not.

With 4.2% and 25 years to go, you are quite likely to come out significantly ahead financially by leaving your taxable investments in the market and paying down the mortgage on schedule (tralfamadorian already made this point before I did.)

In addition, since you owe $280k and only have $215k you want to throw at the mortgage at the moment, making a big lump sum payment puts you in a more fragile situation as you're not improving your cash flow (which you would if you paid the mortgage off entirely), and are substantially depleting the money you could use to weather unexpected events (major home repairs, job loss, medical emergencies, etc), even though the $60k in cash is still a well more than respectable cushion. (MrsWolfeRN already made this point before I did.)

But perhaps you could talk a little bit more about what your motivation/goal here is?

[mariettapeashoot]

Thanks, everyone! I'm grateful for and impressed by the detailed responses so far. They have been helpful to refine my thinking and clarify my question. I have edited my original post so that all the information is in one place. Any follow-up replies are appreciated!

[freya]

If you are itemizing deductions, absolutely don't pre-pay the mortgage at least until you are financially independent with respect to non-mortgage expenses.  And agree with above posters who advised against selling assets at a loss and wiping out your liquidity.  You would very likely regret that!

If you are not itemizing and you are really itching to bring down the mortgage balance, try splitting your savings between taxable investments and mortgage prepayment.  You're right that the market will not guarantee you the 4.2% (+/- taxes) return you'll get from mortgage prepayment - the figures quoted above are an average over at least 2-3 decades of staying in the stock market, assuming you don't panic and sell in a downturn (like now).

Also just as a reality check on college costs...tuition at most private colleges is now up around $60K/year, plus living expenses.  What are your plans for dealing with those costs for your daughters?  They can't and shouldn't borrow that amount.

[Brother Esau]

You'll find tons of debates on this topic here if you poke around enough. I'll just add that after following MMM for 2 years now I absolutely won't pay off my mortgage early until I'm close to RE. I would much rather put my green soldiers to work in diversified investments than to pay off low interest (historically low at this point) debt.

[MDM]

-We have about $215k in (taxed) investments (70%stock/30%bond)

Debt: just the mortgage--we owe about $280k, 4.2% (we're about 5 years into a 30y mortgage). When you add in our insurance/etc, we pay about $2000/mo.

Question: When the balance in our taxed investments matches our mortgage balance, should we pay the whole thing off?

In general, the advice seems to be that if you have a low enough interest rate, you should keep the mortgage. But it seems to me that I can get a guaranteed return on my investment by paying off the mortgage and then can use that $2000/mo (that I would have spent on house payments). I know it will mean some years of not having that $200+k in tax/bonds....

What is the expected after-tax return on the 30% in bonds, and how does that compare with the after-tax cost of your mortgage?

The mortgage payment on a 30 year $300K loan at 4.2% is a little under $1500.  You'll still have to pay the other $500/mo for insurance, etc.

[brooklynmoney]

I have the exact same mortage balance and am just about at the same point in the loan as you are. My interest rate is lower at 3.625%. I used to pre pay $500 a month. No more. I’m keeping it forever. It’s cheap money and it seems risky to tie up all my cash in one asset.

[Brother Esau]

My interest rate is lower at 3.625%. I used to pre pay $500 a month. No more. I’m keeping it forever. It’s cheap money and it seems risky to tie up all my cash in one asset.

Word! Mine is 3.25%. Cheap $ indeed!

[Ben Kurtz]

I tend to think about paying off the mortgage more in terms of any potential FI/RE timeline. If you are going to RE or downshift earnings at some point it's very good to have the house paid off at around that point, to minimize your long-term fixed monthly obligations when you are living off investments or a much reduced salary. But from an investment theory point of view there is no sense in prepaying the mortgage overly soon if you think you are both fully in the workforce for another 5+ years.

The one thing to keep in mind is that you will want to glide-path a dedicated pot of investments into more conservative assets earlier than your main stash so you can be sure the payoff money isn't caught in a bear market, and/or plan a gradual payoff schedule that spreads out the big mortgage payoff over something like a year to take the edge off that risk. You can really get creative and make half the big payoff gradually over the last six months or so of your working career, refinance the much lower balance into a new 30 year mortgage, quit work a few weeks later, and then spread the next half of the payoff over the next 6-12 months. That will lock you into much lower fixed monthly obligations while preserving a good chunk of easily accessible cash, all as a hedge against things not working out as planned when you start any early retirement.

I see your note in your main post about your decisions regarding college savings, but that piques my curiosity more: what are these philosophical reasons for not opening a college savings plan? I know there are alternatives to paying full freight at a fancy private school for 4 years and taking out huge loans, but even state schools are not particularly cheap and there are some good arguments for having the flexibility to help your kids through some more expensive educational options.

[maizefolk]

mariettapeashoot can certainly answer for herself, but I just want to say that I read the point about a lack of dedicated college savings as meaning just that, a lack of dedicated savings.

Since money in fungible, it doesn't really matter if you save in separate buckets for college/major home repairs/FIRE or just one big pile of money that you're usually shoving more money into and with drawing money from as it is needed.

[Ben Kurtz]

Money is indeed fungible, but there are significant federal tax advantages in 529 plans, and in quite a number states there are further benefits.

If the parents think there is a decent chance they will contribute anything to a kid's further education -- which for most middle class families is a common aspiration -- then contributing to such a plan is a fairly obvious move. So I am curious what the analysis is in this case, because between the lines it sounds like it will be somewhat unconventional.

[Boofinator]

A couple things to add to the generally good advice given (though showing a 30-year equities cagr chart is overly simplistic for making the comparison):

Have you considered the tax implications of selling your taxable equities? You'll probably be paying at least 15% on all of the capital gains for that amount, which could be substantial.

As others have noted, a mortgage is a bit like a fixed rate bond. I therefore have a hard time investing in bonds when their yield is lower than your mortgage interest rate. Not sure I have any big suggestion except you may consider lowering your allocation to bond. (And bonds in taxable versus tax deferred versus Roth is a bit of a contentious debate with no settled answer.)

My biggest suggestion would be to get out of cash, unless you are expecting to need that money in the very near future. Bonds act as a very good store of money, and you are likely to come out way ahead. If an emergency occurs, just sell some investments. If you kept only $10k in cash and invested the rest in bonds, you'd be making something like an extra $1000 per year.

[Dicey]

Good for you for asking before acting! Feel free to join the conversation on this thread. Costs you nothing to learn as much as you can before you make your decision.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

[vand]

Stock market history and maths says that you should invest your money rather than pay off the mortgage to take of the superior long term returns of the stock market, but there is far more to this question that just maths and past-performance. The biggest issue is that stocks are undeniably expensive at this point in time. They will means-revert over time (perhaps horribly so) which will mean a significant period of underperformance, so there is no guarantee at all that future performance will come close to past performance.. some valuation methods like CAPE & the Buffett indicator suggest stocks will do well to return any positive real term growth in the next decade.

I always like to point people to this brilliant article that I think fairly weighs up the arguments for/against:

https://financialmentor.com/investment-advice/pay-off-mortgage-early-or-invest/7478

[Dicey]

Stock market history and maths says that you should invest your money rather than pay off the mortgage to take of the superior long term returns of the stock market, but there is far more to this question that just maths and past-performance. The biggest issue is that stocks are undeniably expensive at this point in time. They will means-revert over time (perhaps horribly so) which will mean a significant period of underperformance, so there is no guarantee at all that future performance will come close to past performance.. some valuation methods like CAPE & the Buffett indicator suggest stocks will do well to return any positive real term growth in the next decade.

I always like to point people to this brilliant article that I think fairly weighs up the arguments for/against:

https://financialmentor.com/investment-advice/pay-off-mortgage-early-or-invest/7478

Brilliant, indeed. Thanks for sharing this, @vand!

[BlueHouse]

While I generally agree that paying down a mortgage with a very low rate doesn't favor the best financial return, there are situations where people will want to do it anyway.  If this is the case, please explore a mortgage recast.  This involves paying down some significant part of your mortgage and then having the bank re-amortize (often for free) the loan.  All the terms stay the same (same term, same rate, etc.), but the monthly cost decreases.   This angle was very helpful to me when I had a mortgage payment that made me very uncomfortable due to job insecurity. 

It answers all the objections about paying down the mortgage but still being responsible for meeting a big monthly number. 

It's not for everyone, but if your needs are similar to mine, then this is worth looking into. 

[minimalistgamer]

I can answer this based on experience.

I would only pay it off once you have the full amount to clear the mortgage and 3 months of emergency fund.

I do not recommend liquidating your assets and paying down your mortgage because if an emergency arises (god forbid), then you will still need to make mortgage payments. The bank will not give you any brownie points for paying extra.

So, save up enough to pay the whole thing off. The sense of relief is not something that I can describe :)

[Dicey]

I can answer this based on experience.

I would only pay it off once you have the full amount to clear the mortgage and 3 months of emergency fund.

I do not recommend liquidating your assets and paying down your mortgage because if an emergency arises (god forbid), then you will still need to make mortgage payments. The bank will not give you any brownie points for paying extra.

So, save up enough to pay the whole thing off. The sense of relief is not something that I can describe :)

Excellent advice!

[harvestbook]

My personal experience was aggressively paying off my mortgage back in 2011/2012. Our rate was relatively low (bought in 2004, refinanced to below 4% on a 15-year at some point, can't recall exactly) but I saw owning my house outright as a quicker route to financial independence. Part of it was circumstance--a small business taking off and not having adequate tax-deferred spaces to put the money. Today the math would favor having invested that money instead, but who knew that at the time? (Historic averages won't necessarily be the averages that YOU personally would get).

So yes, a psychological motive, but there were math effects: much lower emergency fund, much lower annual budget, less risk of financial catastrophe due to job loss, more room to invest aggressively. It doesn't seem to be the most popular position, but owning a home outright has been the most financially freeing action of my life.

[Dicey]

My personal experience was aggressively paying off my mortgage back in 2011/2012. Our rate was relatively low (bought in 2004, refinanced to below 4% on a 15-year at some point, can't recall exactly) but I saw owning my house outright as a quicker route to financial independence. Part of it was circumstance--a small business taking off and not having adequate tax-deferred spaces to put the money. Today the math would favor having invested that money instead, but who knew that at the time? (Historic averages won't necessarily be the averages that YOU personally would get).

So yes, a psychological motive, but there were math effects: much lower emergency fund, much lower annual budget, less risk of financial catastrophe due to job loss, more room to invest aggressively. It doesn't seem to be the most popular position, but owning a home outright has been the most financially freeing action of my life.

You understand that cash in your direct control is the best protection against "financial catastrophe", right? Sure, a paid-odd house feels financially freeing. Until you discover the exponentially greater feeling that is FI. No comparison. Very best strategy: save and invest everything until you hit FI, then pay the mortgage off in one lump sum, if you still really want to. All the usual caveats apply, blah x3. Please keep in mind that this is the place where we learn how to reach FIRE most efficiently. It's not about what feels best now, it's about what's going to feel the very best for the rest of your life.

Do you want one marshmallow now, or two later? The mustachian answer is two, as soon as possible, please.