Author Topic: Good investment to match with 3.25% mortgage?  (Read 7492 times)

Gone Fishing

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Good investment to match with 3.25% mortgage?
« on: May 13, 2015, 12:06:29 PM »
My dad recently retired and has a 3.25% mortgage with 27 years or so left on it.  He is wanting to pay it off to reduce his market exposure, but with such a low fixed rate I was wondering if there was a good low risk, fixed return investment he could "match" the mortgage with to earn a little margin and achieve his goal of reducing market exposure/volitility.   

MDM

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Re: Good investment to match with 3.25% mortgage?
« Reply #1 on: May 13, 2015, 12:23:54 PM »
Not aware of any "guaranteed" fixed returns above 3.25%.  30 year Treasury Notes are ~3% (see http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield).

Beyond that, it depends on how one defines "low risk".


beltim

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Re: Good investment to match with 3.25% mortgage?
« Reply #2 on: May 13, 2015, 12:34:03 PM »
Long term corporate bonds might fit the bill.  20-year AA rated bonds are yielding 4.25%: http://finance.yahoo.com/bonds/composite_bond_rates

How old is your dad?  A single premium immediate annuity might work too.  A 50-year old male could get about 5% on a single life with 20 years certain policy, or 5.72% on a 25 year fixed policy.  The life rates go up for higher ages.

Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #3 on: May 13, 2015, 12:35:36 PM »
Not aware of any "guaranteed" fixed returns above 3.25%.  30 year Treasury Notes are ~3% (see http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield).

Beyond that, it depends on how one defines "low risk".



Even an annuity would not be out of the question if I could show he would make a profit. 

He is in the 15% tax bracket and itemizes, so even a 3% return would work if it were qualified, so we are not too far off...


Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #4 on: May 13, 2015, 01:07:09 PM »
Long term corporate bonds might fit the bill.  20-year AA rated bonds are yielding 4.25%: http://finance.yahoo.com/bonds/composite_bond_rates

How old is your dad?  A single premium immediate annuity might work too.  A 50-year old male could get about 5% on a single life with 20 years certain policy, or 5.72% on a 25 year fixed policy.  The life rates go up for higher ages.

He is in his early 60's.  I have asked him for the balance and P&I payment so I can run some calculations.  I'm thinking the annuity would have to have a cash refund provision to make it work?

beltim

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Re: Good investment to match with 3.25% mortgage?
« Reply #5 on: May 13, 2015, 01:11:30 PM »
Long term corporate bonds might fit the bill.  20-year AA rated bonds are yielding 4.25%: http://finance.yahoo.com/bonds/composite_bond_rates

How old is your dad?  A single premium immediate annuity might work too.  A 50-year old male could get about 5% on a single life with 20 years certain policy, or 5.72% on a 25 year fixed policy.  The life rates go up for higher ages.

He is in his early 60's.  I have asked him for the balance and P&I payment so I can run some calculations.  I'm thinking the annuity would have to have a cash refund provision to make it work?

It wouldn't have to, but a cash refund provision would lower the risk.  A 62-year old could get 6.14% single life, or 5.64% single life with guaranteed 20 years.

I'm getting quotes from https://www.immediateannuities.com/information/annuity-rates-step-1.html

CorpRaider

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Re: Good investment to match with 3.25% mortgage?
« Reply #6 on: May 13, 2015, 01:13:24 PM »
Hey if thirty years move a little more you might be looking at a true no brainer, after tax.  On that point, maybe you could find some munis you are comfortable with, some of those tax effective yield spreads (compared to treasuries) are a lot smaller than usual.

frugalnacho

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Re: Good investment to match with 3.25% mortgage?
« Reply #7 on: May 13, 2015, 01:35:28 PM »
How is paying it off going to reduce his market exposure?  By selling shares out of the market to pay off the mortgage?

With a 27 year time frame I don't understand why he wouldn't want that money exposed to the market.  He/you don't think he will get a 3.25% non inflation adjusted return over the next 27 years?  That sounds incredibly pessimistic.

forummm

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Re: Good investment to match with 3.25% mortgage?
« Reply #8 on: May 13, 2015, 01:42:01 PM »
You'll get more than 3.25% (minus tax deduction) out of the market over 27 years. An annuity is guaranteed because you lose the equity. If Treasuries were paying more than 3.25%, the banks would go invest in those instead of your dad's loan. Treasuries are much more liquid and not the same default risk.

MDM

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Re: Good investment to match with 3.25% mortgage?
« Reply #9 on: May 13, 2015, 01:56:54 PM »
It wouldn't have to, but a cash refund provision would lower the risk.  A 62-year old could get 6.14% single life, or 5.64% single life with guaranteed 20 years.

I'm getting quotes from https://www.immediateannuities.com/information/annuity-rates-step-1.html
Those percentages (e.g., 5.64%) include return of principal, not just returns above principal.

Comparing a $200K lump sum invested for 20 years vs. $940/mo (the 5.64% amount) for 20 years, they are equal for an interest rate of 1.225%.  Anything higher and the lump sum is better.

forummm

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Re: Good investment to match with 3.25% mortgage?
« Reply #10 on: May 13, 2015, 02:02:00 PM »
It wouldn't have to, but a cash refund provision would lower the risk.  A 62-year old could get 6.14% single life, or 5.64% single life with guaranteed 20 years.

I'm getting quotes from https://www.immediateannuities.com/information/annuity-rates-step-1.html
Those percentages (e.g., 5.64%) include return of principal, not just returns above principal.

Comparing a $200K lump sum invested for 20 years vs. $940/mo (the 5.64% amount) for 20 years, they are equal for an interest rate of 1.225%.  Anything higher and the lump sum is better.

Are you saying that his dad gets 5.64% for life, and then when his dad dies the estate gets the $200k back? With interest rates this low, that seems hard to imagine.

forummm

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Re: Good investment to match with 3.25% mortgage?
« Reply #11 on: May 13, 2015, 02:04:33 PM »
It wouldn't have to, but a cash refund provision would lower the risk.  A 62-year old could get 6.14% single life, or 5.64% single life with guaranteed 20 years.

I'm getting quotes from https://www.immediateannuities.com/information/annuity-rates-step-1.html
Those percentages (e.g., 5.64%) include return of principal, not just returns above principal.

Comparing a $200K lump sum invested for 20 years vs. $940/mo (the 5.64% amount) for 20 years, they are equal for an interest rate of 1.225%.  Anything higher and the lump sum is better.

Are you saying that his dad gets 5.64% for life, and then when his dad dies the estate gets the $200k back? With interest rates this low, that seems hard to imagine.

Ah, you're saying the opposite. The $200k doesn't get paid back. That makes more sense. More from the website:

Quote
You receive this income for your lifetime. After you die, no payments are made to beneficiaries.

MDM

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Re: Good investment to match with 3.25% mortgage?
« Reply #12 on: May 13, 2015, 02:08:16 PM »
Ah, you're saying the opposite. The $200k doesn't get paid back. That makes more sense.
Yes.  The "with guaranteed 20 years" (aka "20 years certain") option means the monthly payments will continue for 20 years or until death, whichever is later.

beltim

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Re: Good investment to match with 3.25% mortgage?
« Reply #13 on: May 13, 2015, 02:22:02 PM »
It wouldn't have to, but a cash refund provision would lower the risk.  A 62-year old could get 6.14% single life, or 5.64% single life with guaranteed 20 years.

I'm getting quotes from https://www.immediateannuities.com/information/annuity-rates-step-1.html
Those percentages (e.g., 5.64%) include return of principal, not just returns above principal.

Comparing a $200K lump sum invested for 20 years vs. $940/mo (the 5.64% amount) for 20 years, they are equal for an interest rate of 1.225%.  Anything higher and the lump sum is better.

Good point.  I get an even lower number than you do when I run the calculation.  I had thought that if the dad lived long enough, the returns would be better, but it looks like the dad would have to live another 37 years for the return to hit 3%.  So annuities probably aren't the way to go here.

beltim

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Re: Good investment to match with 3.25% mortgage?
« Reply #14 on: May 13, 2015, 02:28:40 PM »
Hey if thirty years move a little more you might be looking at a true no brainer, after tax.  On that point, maybe you could find some munis you are comfortable with, some of those tax effective yield spreads (compared to treasuries) are a lot smaller than usual.

I like the munis idea too.  20-year munis rated AA are yielding 3.83% right now, are federal-tax free, and have a cumulative default rate of 0.03%.

http://finance.yahoo.com/bonds/composite_bond_rates
http://www.municipalbonds.com/education/read/77/default-rates-of-municipal-bonds

Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #15 on: May 13, 2015, 03:23:40 PM »
How is paying it off going to reduce his market exposure?  By selling shares out of the market to pay off the mortgage?

With a 27 year time frame I don't understand why he wouldn't want that money exposed to the market.  He/you don't think he will get a 3.25% non inflation adjusted return over the next 27 years?  That sounds incredibly pessimistic.

Correct.

He almost paid cash (by selling securities) for the house, but I got him to take out the mortgage instead. He has been trying to pay it off ever since. I have held him off this long, but not sure I can do it much longer.  I certainly think and hope he can do better than 3.25% in the market (2.6% when you include the tax benefit), but he keeps saying he "would sleep better at night" if the mortgage was paid off.  I also think he is a little confused around applying an appropriate withdrawal rate to the "leveraged" equities and thinks he will have more income by paying the mortgage off.  Here is his thought process (rounded for simplicity and not including pension/ss income):

Current Senario:
Portfolio                       $1mm
4% withdrawal             $40k
Mortgage payment       $12k/yr
Cash available to spend $28k

Payoff Senario
Portfolio                       $760k
4% withdrawal              $30.4k
Cash available to spend  $30.4k

While his long term gain would not be as much, I think I could convince him to keep the mortgage if there was something that could easily be matched to the mortgage vs paying it off.  I think it would have to be cash flow positive in order to convince him.

Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #16 on: May 13, 2015, 03:27:08 PM »
Hey if thirty years move a little more you might be looking at a true no brainer, after tax.  On that point, maybe you could find some munis you are comfortable with, some of those tax effective yield spreads (compared to treasuries) are a lot smaller than usual.

I like the munis idea too.  20-year munis rated AA are yielding 3.83% right now, are federal-tax free, and have a cumulative default rate of 0.03%.

http://finance.yahoo.com/bonds/composite_bond_rates
http://www.municipalbonds.com/education/read/77/default-rates-of-municipal-bonds

Sounds good, now is there a way to match a diversified basket of them with the mortgage that will keep him cash flow positive as the yield alone will not make the mortgage payment (Balance $239k, P&I $1085)

forummm

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Re: Good investment to match with 3.25% mortgage?
« Reply #17 on: May 13, 2015, 04:58:46 PM »
I certainly think and hope he can do better than 3.25% in the market (2.6% when you include the tax benefit), but he keeps saying he "would sleep better at night" if the mortgage was paid off.  I also think he is a little confused around applying an appropriate withdrawal rate to the "leveraged" equities and thinks he will have more income by paying the mortgage off.  Here is his thought process (rounded for simplicity and not including pension/ss income):

Current Senario:
Portfolio                       $1mm
4% withdrawal             $40k
Mortgage payment       $12k/yr
Cash available to spend $28k

Payoff Senario
Portfolio                       $760k
4% withdrawal              $30.4k
Cash available to spend  $30.4k

Peace of mind has a value. Why not let him pay it off? Sure, it's not going to maximize your inheritance/his charity. But the old guy probably worked hard to save it and wants to enjoy his old age without worry. If he buys some bonds with it, it won't make much difference in the final balance of his portfolio. And he's clearly not willing to put it in equities. So why not let him rest easy?

beltim

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Re: Good investment to match with 3.25% mortgage?
« Reply #18 on: May 13, 2015, 05:05:20 PM »
Hey if thirty years move a little more you might be looking at a true no brainer, after tax.  On that point, maybe you could find some munis you are comfortable with, some of those tax effective yield spreads (compared to treasuries) are a lot smaller than usual.

I like the munis idea too.  20-year munis rated AA are yielding 3.83% right now, are federal-tax free, and have a cumulative default rate of 0.03%.

http://finance.yahoo.com/bonds/composite_bond_rates
http://www.municipalbonds.com/education/read/77/default-rates-of-municipal-bonds

Sounds good, now is there a way to match a diversified basket of them with the mortgage that will keep him cash flow positive as the yield alone will not make the mortgage payment (Balance $239k, P&I $1085)

Probably not.  You'd need to get ~5.4% yield to pay out of interest.  Unless maybe I'm misunderstanding you?  You could just sell the excess as you needed.  There are long-term muni ETFs with reasonably low fees.

brooklynguy

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Re: Good investment to match with 3.25% mortgage?
« Reply #19 on: May 13, 2015, 05:40:02 PM »
Here is his thought process (rounded for simplicity and not including pension/ss income):

Current Senario:
Portfolio                       $1mm
4% withdrawal             $40k
Mortgage payment       $12k/yr
Cash available to spend $28k

Payoff Senario
Portfolio                       $760k
4% withdrawal              $30.4k
Cash available to spend  $30.4k

While his long term gain would not be as much, I think I could convince him to keep the mortgage if there was something that could easily be matched to the mortgage vs paying it off.  I think it would have to be cash flow positive in order to convince him.

It sounds like you already recognize this, but this is not the right way to think about this.  The comparison reflects neither (i) that the $12k mortgage expense will, unlike any other expenses, not rise with inflation, nor (ii) that the $12k mortgage expense will go away after 27 years.  By "cash flow positive," do you mean that the mortgage payment will be entirely covered by the investment yield alone?  Because that wouldn't necessarily be the case even with a "riskless" investment (like the Treasury Notes mentioned earlier) that yields a high enough interest rate to be guaranteed to outperform the mortgage (e.g., if it had a 3.26% interest rate).

MDM

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Re: Good investment to match with 3.25% mortgage?
« Reply #20 on: May 13, 2015, 06:13:21 PM »
Payoff Senario
Portfolio                       $760k
4% withdrawal              $30.4k
Cash available to spend  $30.4k
Alternate Payoff Senario
Portfolio       $760k invested "normally" (maybe ~7-8% expected return) +
                    $240k invested "conservatively" (maybe ~5% expected return)
4% withdrawal from normal portfolio                   $30.4k
Cash available to spend from normal portfolio     $30.4k
Mortgage payments from conservative portfolio  $12k

Fast forward until the mortgage is paid off: ~$175k remains in the conservative portfolio.

Or, as has also been suggested, just pay it off now.  What price peace of mind?

Mighty-Dollar

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Re: Good investment to match with 3.25% mortgage?
« Reply #21 on: May 13, 2015, 10:38:10 PM »
I was wondering if there was a good low risk, fixed return investment he could "match" the mortgage with to earn a little margin and achieve his goal of reducing market exposure/volitility.
It's called bonds. Reduce stock risk with bonds like AGG (the total bond market index).

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Re: Good investment to match with 3.25% mortgage?
« Reply #22 on: May 14, 2015, 12:12:24 AM »
I would pay the mortgage off. Historical returns aren't the same as the returns you actually will get. And sleep at night is worth a lot by itself.

Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #23 on: May 14, 2015, 08:42:05 AM »
I think I have him settled for a while longer my points were as follows:

His mortgage interest is deductible.  After taxes his effective rate is 2.6%.

Most of his dividends and capital gains are taxed at 0%.

Confirmed that he is planning on a 3% WR. 

I told him to add his principle portion of the mortgage his 3% WR, as that is effectively doing what he wants even if he dips into his investment principal to pay down the mortgage.

And the winner:  If he doesn't beat 2.6% in the market over the next 20+ years, we are all going to have much bigger problems! 

rmendpara

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Re: Good investment to match with 3.25% mortgage?
« Reply #24 on: May 14, 2015, 08:44:08 AM »
What you must do is convince him to move up his level of risk-tolerance. Simple, but not easy.

It's not a bad situation if he pays off the house today, given current valuations are elevated, but he'll likely do much better by staying invested and paying it off over time.

Another alternative would be for him to always withdraw 4% and pay any extra cash over his living expenses toward the mortgage. Even maintaining the mortgage for 10 years will be huge.

There is a value to having a home paid off, so my opinion as a 20 something is very different than a new retiree when it comes to debt.

Please let him know, and make sure he understands, that he should think about the situation today toward debt the same as if he were 27 years younger. He still needs his portfolio and finances to last for quite some time, so dialing back risk too far is also a risk in itself.

Gone Fishing

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Re: Good investment to match with 3.25% mortgage?
« Reply #25 on: May 14, 2015, 08:56:31 AM »
What you must do is convince him to move up his level of risk-tolerance. Simple, but not easy.

It's not a bad situation if he pays off the house today, given current valuations are elevated, but he'll likely do much better by staying invested and paying it off over time.

Another alternative would be for him to always withdraw 4% and pay any extra cash over his living expenses toward the mortgage. Even maintaining the mortgage for 10 years will be huge.

There is a value to having a home paid off, so my opinion as a 20 something is very different than a new retiree when it comes to debt.

Please let him know, and make sure he understands, that he should think about the situation today toward debt the same as if he were 27 years younger. He still needs his portfolio and finances to last for quite some time, so dialing back risk too far is also a risk in itself.

He has been a pretty aggressive investor over the past 20+ years, but just retired last month so I think he just has a few post retirement jitters.  I'm sure I'll catch some heat when the next correction/bear comes but he should thank me for it eventually, I hope...