Author Topic: 2.875% 30 year Mortgage - Maintain vs. Payoff  (Read 1579 times)

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
2.875% 30 year Mortgage - Maintain vs. Payoff
« on: July 09, 2020, 09:50:08 AM »
Hi All,

It's been awhile since I've posted here, however I always respected the thought process put in by Mustachians, and will later hope to provide a new link to my financial diary as life has changed for me over the last few years.  Indeed, one person who reads this blog indicated I was close to "GLIDE FIRE", however I was not aware of that term's meaning...in the days when I was reading this blog regularly the term did not come up.

So here's my question:

I have a 670,000 USD mortgage at 2.875% and have 1,270,000 USD in cash after a recent property sale.  I've been very busy with buying and selling a home during COVID-19, moving, home schooling, transitioning to a virtual environment at work that I feel very disconnected from where the market is today and what the prevailing sentiment is for further market decline.

That being said, I can now pay off the 670,000 mortgage in full or in part, but am struggling with the decision.

A quick contextual snapshot:

Assets:

- 600k in 401k
- Home value is 1.15 million
- 1.27 million in cash
_______________
3.02 Million

Liabilities:

- 670k mortgage at 2.875%


Let me know your thoughts?  If you suggest to keep the mortgage, and invest the 1.27 million, please kindly provide rationale.  Also, any info re: how to slowly invest the 1.27 million over the next 12-24 months would be appreciated.

Thanks!


talltexan

  • Magnum Stache
  • ******
  • Posts: 3770
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #1 on: July 09, 2020, 09:59:45 AM »
I don't see any info about other sources of income, including those that were used to qualify you for a $670,000 loan.

I also don't see anything about an age or risk tolerance. I'm assuming the payments on your loan are about $2,300/monthly. If your goal is to put your sale proceeds into an investment product that gives you a rock solid income purely to make the payments on your property, I'd choose something simple like Vanguard Wellington...there's an ample bond stake to reduce risk, and getting $30K /year out of it should be reliable.

PDXTabs

  • Handlebar Stache
  • *****
  • Posts: 1976
  • Age: 37
  • Location: Portland, OR, USA
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #2 on: July 09, 2020, 10:01:21 AM »
Let me know your thoughts?  If you suggest to keep the mortgage, and invest the 1.27 million, please kindly provide rationale.

Because the stock market will typically return more than 2.875%, and the mortgage interest is tax deductible. A good equities portfolio is also more diverse than one house.

Also, any info re: how to slowly invest the 1.27 million over the next 12-24 months would be appreciated.

As quickly as you can stomach. I personally would probably DCA over the next 12-18 months.

MDM

  • Senior Mustachian
  • ********
  • Posts: 10262
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #3 on: July 09, 2020, 10:16:19 AM »
If all the interest is deductible, you would "earn" 2.875% by the payoff.  If none of the interest is deductible, you would "earn" 2.875% / (1 - marginal_tax_rate) by the payoff.  If some is deductible, take the weighted average.

If instead of the payoff you would invest, compare the applicable number above with what you expect to earn on the portion of your investment in bonds.  If you would invest 100% in stocks, use that number for comparison.

What numbers do you get for all the above?

LoanShark

  • 5 O'Clock Shadow
  • *
  • Posts: 83
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #4 on: July 09, 2020, 12:41:03 PM »
Totally a personal, subjective question. Will you sleep better by having no debt and the house paid off, or sleep better knowing you have a potential arbitrage situation (historical returns of the market being ~8% vs the 2.875% cost of the market)?

I sleep better with no debt, but that's me. I know it's not "optimal".

As far as what to do with the money from the recent RE sale - I'd evaluate your risk tolerance, age and invest accordingly. Keep 6-12 months of living expenses in cash and throw the rest in the market. I'm sitting at around 15% cash right now ($200K) in case I see any opportunistic purchases come up...I'm also 34 so it makes sense for me to have the vast majority of my portfolio in equities, because I have a longer time horizon for when I'll need that money, and time for the market to recover when there's another significant dip.

That's a lot of cash that can be devalued via inflation to have sitting around.

bthewalls

  • Bristles
  • ***
  • Posts: 261
  • Location: ireland/northern ireland
  • gods own prototype....
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #5 on: July 09, 2020, 05:11:31 PM »
I paid my mortgage off with a sale and now free to invest all income

Itís great to be mortgage free

1st world problem?

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #6 on: July 09, 2020, 05:15:44 PM »
I don't see any info about other sources of income, including those that were used to qualify you for a $670,000 loan.

I also don't see anything about an age or risk tolerance. I'm assuming the payments on your loan are about $2,300/monthly. If your goal is to put your sale proceeds into an investment product that gives you a rock solid income purely to make the payments on your property, I'd choose something simple like Vanguard Wellington...there's an ample bond stake to reduce risk, and getting $30K /year out of it should be reliable.

Thanks Tall Texan.  I have an annual average salary plus bonus of about 350k per year.  I'm 45 years old with two kids under six.  I've made almost all of my money on salary and real estate investments, so I'm conservative when it comes to the stock market.  Strike that - very conservative. 

Payments on loan are $4223 per month (Principal and interest is $2782 of which 1,606 is interest) and taxes, insurance is $1441).


Thanks for the Vanguard suggestion.

A follow-up question.  Isn' there some frictional cost (tax) towards taking money out of Vanguard Wellington and then paying the mortgage.

For instance, if I was aiming to pay $4223 per month or $50,676 per year (with 1.27 million dollars invested), considering my tax bracket, what percentage return would I need to cover the $50,676?  If you estimated my effective tax rate as about 28%, would I need to make $50,676X128% = $64865.   $64865/1270000 = 5.1%.  Or is there a way to avoid the effective tax rate of 28%? 

Thanks!

Dicey

  • Senior Mustachian
  • ********
  • Posts: 13712
  • Age: 62
  • Location: NorCal
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #7 on: July 09, 2020, 05:44:14 PM »
With your income, that payment's a blip. I'd keep it.

MDM

  • Senior Mustachian
  • ********
  • Posts: 10262
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #8 on: July 09, 2020, 05:47:16 PM »
I have an annual average salary plus bonus of about 350k per year.  ...I'm conservative when it comes to the stock market.  Strike that - very conservative. 

Payments on loan are $4223 per month (Principal and interest is $2782 of which 1,606 is interest) and taxes, insurance is $1441).

A follow-up question.  Isn' there some frictional cost (tax) towards taking money out of Vanguard Wellington and then paying the mortgage.
Yes, but why wouldn't you be paying out of cash flow from your salary instead of withdrawing from investments?

If your investments are very conservative...how do their expected after-tax returns compare with your after-tax mortgage interest rate?

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #9 on: July 09, 2020, 06:27:06 PM »
I have an annual average salary plus bonus of about 350k per year.  ...I'm conservative when it comes to the stock market.  Strike that - very conservative. 

Payments on loan are $4223 per month (Principal and interest is $2782 of which 1,606 is interest) and taxes, insurance is $1441).

A follow-up question.  Isn' there some frictional cost (tax) towards taking money out of Vanguard Wellington and then paying the mortgage.
Yes, but why wouldn't you be paying out of cash flow from your salary instead of withdrawing from investments?

If your investments are very conservative...how do their expected after-tax returns compare with your after-tax mortgage interest rate?

That's a fair point re:  paying out of salary/bonus vs. withdrawing from investments.  I guess I was organizing the investment return vs. mortgage payment in one neat but unnecessary "box" of trade-offs.

With re: to investments, I tend to make my investment income on property sales with some of these properties having rental income.  This is all occurred between 2010 and 2020.

I guess now is as good a time as any to figure that out.  Without accounting for rental monies and payments on the mortgages and down payments (which I realize is substantial):

First property:  2010-2020:  Bought for 480k, sold for 740k  (after broker's fee)  = 110k profit over 10 years with initial downpayment of 20k and 150k invested.  So it would seem I paid in 170k, and came out with 110k in profit over a 10 yr investment.   Not sure about this calculation but 110/170 = 65%, but over 10 years.  So one could argue I received 6.5% per year over 10 yrs on this RE investment (probably oversimplification).

Second Property - 2012 - Bought for 310k,  Sold for 595k (after broker fee)  in 2014, put down 30k, put in 15k in improvements,  285k/45k - 600% profit, so 300% profit every year over 2 years.

Third Property - 2011-2015, bought for 220k, Sold for 325k (after broker fee) in 2014, put down 30k, 10k in improvements,  so 40k invested, 105k return - 105k/40k - 263% profit, over 4 years, 65% profit every year over 4 years.

All in all, over a 10 year period I invested 170K+45k+40k = 255k.  Equity profit total =110+285k+105k = 500k.

It's about 200% divided by 10 years - 20% per year gains.

After doing this calculation, I always thought I made more in real estate (there were some great exits).


I guess even if I was half as successful as I was in the past with real estate, I'd do far better than 2.875%.  (Acknowledging past performance is no guarantee of future returns).  There were periods of time that I did not invest, whereas in the stock market it's more of a time in the market analysis. 

I guess I somewhat believe that over the last 10 years "a rising tide lifts all ships".  I guess for me though, I stuck with RE vs. stocks, so making the transition to stocks at this time is a bit harder for me.



« Last Edit: July 09, 2020, 06:29:55 PM by boston swiss »

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #10 on: July 09, 2020, 07:35:47 PM »
I paid my mortgage off with a sale and now free to invest all income

Itís great to be mortgage free

1st world problem?

Agree!

waltworks

  • Magnum Stache
  • ******
  • Posts: 4190
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #11 on: July 09, 2020, 09:45:06 PM »
Why are you even asking? It makes zero difference in your situation either way.

I'd decide based on whether it's more annoying to pay the mortgage monthly (probably not too annoying, assuming it's just an autopay from a bank account) or to pay property taxes and insurance and such on your own instead of through escrow. Because really, at 43, with $3 million sitting around, you should be making decisions based on quality of life, not money. You've arguably already worked much too long, unless you have super expensive habits/hobbies.

-W

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #12 on: July 10, 2020, 06:04:44 PM »
Why are you even asking? It makes zero difference in your situation either way.

I'd decide based on whether it's more annoying to pay the mortgage monthly (probably not too annoying, assuming it's just an autopay from a bank account) or to pay property taxes and insurance and such on your own instead of through escrow. Because really, at 43, with $3 million sitting around, you should be making decisions based on quality of life, not money. You've arguably already worked much too long, unless you have super expensive habits/hobbies.

-W


Thanks W.  I love that perspective.  Sometimes it helps to see the analysis from an outside party.  Much appreciated.

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #13 on: July 10, 2020, 06:07:05 PM »
If all the interest is deductible, you would "earn" 2.875% by the payoff.  If none of the interest is deductible, you would "earn" 2.875% / (1 - marginal_tax_rate) by the payoff.  If some is deductible, take the weighted average.

If instead of the payoff you would invest, compare the applicable number above with what you expect to earn on the portion of your investment in bonds.  If you would invest 100% in stocks, use that number for comparison.

What numbers do you get for all the above?

Thanks - I think this is a very nice way to summarize the process.  I'll likely walk through this and talk with my accountant to make sure I did it correctly.

Taran Wanderer

  • Pencil Stache
  • ****
  • Posts: 690
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #14 on: July 10, 2020, 07:51:10 PM »
The math says you should invest the $1.27 million. I like the suggestion of DCAing over 12 months or so.

If it was me, I would pay the house off worth half and invest the other half. The less debt I have, the less anxiety I have. Itís purely emotional. Rationally, you should invest all the cash. But Iíd pay off the house.

The_Big_H

  • Stubble
  • **
  • Posts: 154
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #15 on: July 10, 2020, 09:48:38 PM »
If I was in your shoes I would pay off that mortage by the end of the year, then proceed to max out every retirement vehicle available (max 401k, max mega backdoor if possible, max Roth, max any spouses accounts) even if it meant nearly $0 paycheck (live off some cash).  $15-40k into an emergency fund, the rest into a brokerage account invested in tax efficient stuff (muni bonds, VTSAX), save the tax inefficient stuff for your retirement accounts.

In my mind you could retire tomorrow with your current assets.  Working is ultimately voluntary for you unless you have some very large expenses  or expensive tastes we don't know about.  Whether you want to work or not is dependent on you, but every year I worked if I was you I would be sure to max every retirement account I could.  The goal is to get as much of that money in your taxable brokerage account into something tax advantaged ($19.5k each 401k, $6k each rothIRA, $3-7k HSA, $~30k mega backdoor if allowed).

That mega backdoor is so sweet in your shoes I might CHOOSE my employer based on who allows mega backdoor roths (boy would that get a look from the interviewer / HR)

Buffaloski Boris

  • Handlebar Stache
  • *****
  • Posts: 2055
  • Religion isn't the opiate, politics is.
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #16 on: July 11, 2020, 05:25:48 AM »
The advice on this thread is really exceptional. I enjoyed seeing the thought process so thanks all.

I personally believe the OP is going to do fine either way; my personal preference which may or may not be shared by the is to pay off debt. But with a mortgage at 2.875, gosh Iíd be tempted to just keep it. I donít think there is an obvious answer on that. Itís going to boil down to personal preference.

I wanted to approach this from a different angle: diversification. The OP noted that he was very conservative on stocks and a lot of NW looks to be from or in real estate. So Iím wondering how much of the 600k in the retirement asset is in stocks, how well diversified that is across markets, countries, and other asset classes?

DK

  • Stubble
  • **
  • Posts: 222
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #17 on: July 13, 2020, 06:26:40 PM »
open a new bank account, put 50k of the cash into it. thats where the mtg pmts will come out of. open a brokerage account and invest the rest in a total market stock fund. setup so the dividends go into your new bank account. in 53wks, sell 40k to put in that account. it will be long term capital gains tax rate at that point and will pay for the next yr of mtg pmts, along with the dividends that have been getting put in there.
you won't have to worry about the mtg anymore, and you'll likely end up with more in your investment account after the mtg is paid off. lower tax rate than earned income (and only gains would be at that lower tax rate).

MustacheAndaHalf

  • Magnum Stache
  • ******
  • Posts: 2942
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #18 on: July 13, 2020, 07:07:10 PM »
First property:  2010-2020:  Bought for 480k, sold for 740k  (after broker's fee)  = 110k profit over 10 years with initial downpayment of 20k and 150k invested.  So it would seem I paid in 170k, and came out with 110k in profit over a 10 yr investment.   Not sure about this calculation but 110/170 = 65%, but over 10 years.  So one could argue I received 6.5% per year over 10 yrs on this RE investment (probably oversimplification).

Second Property - 2012 - Bought for 310k,  Sold for 595k (after broker fee)  in 2014, put down 30k, put in 15k in improvements,  285k/45k - 600% profit, so 300% profit every year over 2 years.

Third Property - 2011-2015, bought for 220k, Sold for 325k (after broker fee) in 2014, put down 30k, 10k in improvements,  so 40k invested, 105k return - 105k/40k - 263% profit, over 4 years, 65% profit every year over 4 years.
Was the 150k on the 1st property invested over a 10 year period?   Meaning at year 1, did you only put $15k more into the investment, and another $15k in year two?  That looks more like $75k over 10 years, when you average the later payments and the earlier payments together.  So I would treat that as:
$110k profit / (20k + 75k) = 110/95 = 111% profit.  Turning $95k into $205k in 10 years is like multiplying your initial investment by 2.158.  Another way to view that is investing $95k compounding at 8% per year gives you $205k after 10 years.  So your 1st property earned about an 8% return per year.

2nd property, you put $45k into the property, and got $285k out.  But the sales proceeds need to pay for your costs, so isn't the profit $285k - $45k = $240k?  That still gives a 240/45 = 533% profit.  Over 2 years, you multiplied 45k by 6.333, which is roughly +150%/year for two years: 45k x 2.5 x 2.5 = $281k

3rd property you listed a down payment and improvements, but no mortgage payments.  The 105k needs to pay for your $40k expenses, so the profit is actually $65k/$40k = 144%.  That's like multiplying a $40k investment (no mortgage?) by 2.625 to make it $105k in 4 years.  I get a 27.3% annual return for 4 years, or 40*(1.273^^4) = 105.

So what I see are annual returns of +150%/yr, +27.3%/yr and +8%/yr.  By comparison, Vanguard Total Stock Market's performance was +10% over 5 years and +13.7% over 10 years, both above average.

I don't see much value in paying off the mortgage while you have a high paying job (that's secure?), and are still accumulating assets for retirement.  If you decide you want to take less risk, and might retire from your job, maybe take another look at the mortgage then.  Doesn't it make more sense to keep investing in properties, and maybe some in the stock market, than in the mortgage right now?
« Last Edit: July 13, 2020, 07:12:44 PM by MustacheAndaHalf »

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #19 on: July 14, 2020, 07:53:24 PM »
open a new bank account, put 50k of the cash into it. thats where the mtg pmts will come out of. open a brokerage account and invest the rest in a total market stock fund. setup so the dividends go into your new bank account. in 53wks, sell 40k to put in that account. it will be long term capital gains tax rate at that point and will pay for the next yr of mtg pmts, along with the dividends that have been getting put in there.
you won't have to worry about the mtg anymore, and you'll likely end up with more in your investment account after the mtg is paid off. lower tax rate than earned income (and only gains would be at that lower tax rate).

I like this idea...it was something I was thinking about with Betterment helping me out to do this...nice to see it written out so clearly.  Much appreciated.

boston swiss

  • 5 O'Clock Shadow
  • *
  • Posts: 36
  • Age: 45
  • Location: Boston
Re: 2.875% 30 year Mortgage - Maintain vs. Payoff
« Reply #20 on: July 14, 2020, 08:03:42 PM »
First property:  2010-2020:  Bought for 480k, sold for 740k  (after broker's fee)  = 110k profit over 10 years with initial downpayment of 20k and 150k invested.  So it would seem I paid in 170k, and came out with 110k in profit over a 10 yr investment.   Not sure about this calculation but 110/170 = 65%, but over 10 years.  So one could argue I received 6.5% per year over 10 yrs on this RE investment (probably oversimplification).

Second Property - 2012 - Bought for 310k,  Sold for 595k (after broker fee)  in 2014, put down 30k, put in 15k in improvements,  285k/45k - 600% profit, so 300% profit every year over 2 years.

Third Property - 2011-2015, bought for 220k, Sold for 325k (after broker fee) in 2014, put down 30k, 10k in improvements,  so 40k invested, 105k return - 105k/40k - 263% profit, over 4 years, 65% profit every year over 4 years.
Was the 150k on the 1st property invested over a 10 year period?   Meaning at year 1, did you only put $15k more into the investment, and another $15k in year two?  That looks more like $75k over 10 years, when you average the later payments and the earlier payments together.  So I would treat that as:
$110k profit / (20k + 75k) = 110/95 = 111% profit.  Turning $95k into $205k in 10 years is like multiplying your initial investment by 2.158.  Another way to view that is investing $95k compounding at 8% per year gives you $205k after 10 years.  So your 1st property earned about an 8% return per year.

2nd property, you put $45k into the property, and got $285k out.  But the sales proceeds need to pay for your costs, so isn't the profit $285k - $45k = $240k?  That still gives a 240/45 = 533% profit.  Over 2 years, you multiplied 45k by 6.333, which is roughly +150%/year for two years: 45k x 2.5 x 2.5 = $281k

3rd property you listed a down payment and improvements, but no mortgage payments.  The 105k needs to pay for your $40k expenses, so the profit is actually $65k/$40k = 144%.  That's like multiplying a $40k investment (no mortgage?) by 2.625 to make it $105k in 4 years.  I get a 27.3% annual return for 4 years, or 40*(1.273^^4) = 105.

So what I see are annual returns of +150%/yr, +27.3%/yr and +8%/yr.  By comparison, Vanguard Total Stock Market's performance was +10% over 5 years and +13.7% over 10 years, both above average.

I don't see much value in paying off the mortgage while you have a high paying job (that's secure?), and are still accumulating assets for retirement.  If you decide you want to take less risk, and might retire from your job, maybe take another look at the mortgage then.  Doesn't it make more sense to keep investing in properties, and maybe some in the stock market, than in the mortgage right now?

I think your calculations sound correct.  I think I was lazily trying to figure out how my RE investments did in the past vs. the mortgage rate.  I also thank you for the Vanguard TSM performance.  It puts things in perspective.  My wife is changing careers and by June/July of 2021 will be a nurse and I can start to think about leaving my big paying salary job at that point.  Our  monthly spend is closer to 7k per month and I'd like to put 400-500k away for kids education.

My guess is my wife will take home somewhere between 4-5k per month (could be higher in the future as she was a CFO prior to going into nursing).  So I'm probably putting in more time at the high paying job  to make up the difference (3-4k per month)  and getting the kids education fund well funded.  I'll probably start a separate thread to work that one out.  Thanks!