Author Topic: Mortgage vs Investing - Risk Mitigation Early in the mortgage  (Read 8653 times)

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I have been reading over the mortgage payoff vs investing debates at an OCD level, and with mixed emotions trying to find a decent middle ground. 

Here is my dilemma, we bought a house in HCOL area (we are above $417k) on a 15 year fixed rate mortgage at 3.5%. I have always wanted to be completely debt free, so currently I am dropping half of my extra cash onto the house, and the other half into a taxable account (simplifying my position despite discussions I have  had with other folks on increasing ER fund and maxing tax deferred accounts - so this is where I will be after some additional housekeeping). 

My question is this. From a risk mitigation perspective, and since we are early in the process of the mortgage, should we consider dumping everything into investments accounts until I feel like we are in a good spot on the investing side with a decent sized stache, and then return back to doing a 50/50 split.

My thinking is that once I reach a decent size stache, I have reduced my life emergency risk (i.e. plenty of investments to pay the monthly mortgage - maybe like a year's worth of mortgage payments), thereby mitigating risk, and in a great position to accelerate mortgage pay down and continue to invest heavily.

I guess what I am asking is for folks who paid off their mortgage, did they think through developing a big stache on the front end? Seems like  MMM sort of did this with his investing to eventually  pay off the home.     

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #1 on: March 14, 2016, 03:46:36 PM »
I kept 12 mortgage payments plus 6 months expenses in cash.  When I paid off the house, I invested the emergency fund.  YMMV

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #2 on: March 15, 2016, 08:12:50 AM »
Thanks that is helpful. I guess at the end of the day its how active your security gland is when it comes to a buffer.  I did some math and maybe just bumping up my cash fund and then going back to the plan is the way to go.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #3 on: March 15, 2016, 08:58:27 AM »
We lived pay check to pay check pretty much, but paid off $260k mortgage (and three cars) in 13 years, whilst saving ~6% to tax deferred RSP.  Kept a few thousand backup, but three times in that period had a severance due to job loss that acted as the emergency fund while we quickly found new jobs in less time than employment insurance kicked in (we've never been on the dole, even though have been let go three times).   Never felt the need to have an emergency fund more than a month of rolling cash.

Now that we are mortgage free, our big city townhouse has more than doubled in value (paid $273, current assessment $580, and likely sellable for $650). I believe it was a good call, as now we are used to ~60% of our income not being in the bank, so have no problem investing heavily for the long term. 

Now our EF is closer to 4 months spending, but I keep borrowing from it to invest sooner!  I will build it back up to 4 months in the next two weeks (I just borrowed $2500 last week, and will repay $3400 to the EF when our tax return shows up)   It's amazing your saving power when the mortco isn't taking a huge bite every two weeks.

Treating money from your EF as a zero percent loan you must pay back ASAP is great. 
« Last Edit: March 15, 2016, 09:07:35 AM by Heckler »

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #4 on: March 15, 2016, 09:12:08 AM »
If your job is not very secure, for a piece of mind, you can build up your emergency stash first.

Looks like you are pulling in good money so it might take a year or so to fill that up.

Say you need $3000 per month for mortgage and essentials, so that's a $36000 stash for 12months.

You can keep $10k-16k cash in a money market/savings acct, and the rest in a taxable account with something like 30/70 stock/bond allocation.

Have in mind that this is a lot of cash to sit around.

What I have done is have no less than $3k cash reserve in my every day checking acct, $5k in Betterment "Safety Fund" with a 40/60 stock/bond allocation, and about 15k in stocks (6 stocks, form my pre mustache days). In case of emergency I am ok with liquidating $15k stocks at any movement.

Also at 3.5% mortgage and 15yr mortgage, you are doing very good compared to rest of us with 30yr mortgages. It depends in how many years you want to retire, investing would bring more $ in your pocket in the long run (10-20yrs), than you would save from paying off your house early. But than your cost of living is high because of your mortgage... dilemma.

Good luck!


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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #5 on: March 16, 2016, 09:06:27 AM »
I intend to hit the mortgage when I get 50k in my taxable stache. That's not really a strategic number, but provides a couple years of spending cushion and (hopefully) will grow.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #6 on: March 16, 2016, 11:06:29 AM »
I'm in the same boat, mortgage balance 318K and home value 800K. Have cash to pay off; but keep discussing with my wife why pay off a 15yr mortgage @ 2.875% when we can make more investing in dividend paying stocks. But she likes the nest being paid off. For further discussion.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #7 on: March 16, 2016, 11:06:46 AM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #8 on: March 16, 2016, 12:50:12 PM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

For me its risk mitigation. That's the lens I view it through.  I want to reduce my risk as much as possible.  By diversifying my risk mitigation - 50-50 on pay down and investing seems to be where I land most comfortably. My head says invest it all, but my heart says a paid for house has very limited risk in case long term disaster strikes, therefore I will do both.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #9 on: March 16, 2016, 12:59:21 PM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

For me its risk mitigation. That's the lens I view it through.  I want to reduce my risk as much as possible.  By diversifying my risk mitigation - 50-50 on pay down and investing seems to be where I land most comfortably. My head says invest it all, but my heart says a paid for house has very limited risk in case long term disaster strikes, therefore I will do both.

I agree, a paid off house does mitigate some risk. But what does a half paid off house get you? Nothing, the mortgage payment is still the same. Your risk is still the same (i.e. high) until year 15 when you pay it off. If you invest your risk is gradually going down. Even putting a lot into bonds you could remain liquid and get a return same or greater than the mortgage.

IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #10 on: March 16, 2016, 02:26:48 PM »
I see what you are saying, but its not quite as cut and dry in my mind. When you pay down your mortgage you reduce the balance quicker and shorten the loan's time horizon. Sure you may still have the payment, but if disaster strikes and you have to dump the property you have less of a chance of having limited equity or worse be under water. 

I also think for the demographic that visits MMM and that pays off their mortgage early, they are usually paying it off in much less time than 15 years.  My guess would be 7 years or less.

For me, 70% of my monthly outlay is mortgage and daycare.  Getting rid of either of those would change my whole world dramatically. Can't wait for both.     

Midwest

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #11 on: March 16, 2016, 02:33:28 PM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

For me its risk mitigation. That's the lens I view it through.  I want to reduce my risk as much as possible.  By diversifying my risk mitigation - 50-50 on pay down and investing seems to be where I land most comfortably. My head says invest it all, but my heart says a paid for house has very limited risk in case long term disaster strikes, therefore I will do both.

I agree, a paid off house does mitigate some risk. But what does a half paid off house get you? Nothing, the mortgage payment is still the same. Your risk is still the same (i.e. high) until year 15 when you pay it off. If you invest your risk is gradually going down. Even putting a lot into bonds you could remain liquid and get a return same or greater than the mortgage.

IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

Mortgage paydown is much less illiquid if you get a HELOC.  I'm 100% stocks viewing my mortgage paydown as the bond portfolio.  You can get a HELOC for 80% of the loan value. 

With the risk of rising interest rates, you could lose principle on the bonds if you cash out prior to maturity.  Not so on a mortgage.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #12 on: March 16, 2016, 02:52:58 PM »
Mortgage paydown is much less illiquid if you get a HELOC.  I'm 100% stocks viewing my mortgage paydown as the bond portfolio.  You can get a HELOC for 80% of the loan value. 

I would get the HELOC whether or not you pay down your mortgage faster. Even if you put the extra money towards your investments having the HELOC available [with a smaller credit limit] is still a useful tool in the toolbox of options.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #13 on: March 16, 2016, 03:04:22 PM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

For me its risk mitigation. That's the lens I view it through.  I want to reduce my risk as much as possible.  By diversifying my risk mitigation - 50-50 on pay down and investing seems to be where I land most comfortably. My head says invest it all, but my heart says a paid for house has very limited risk in case long term disaster strikes, therefore I will do both.

I agree, a paid off house does mitigate some risk. But what does a half paid off house get you? Nothing, the mortgage payment is still the same. Your risk is still the same (i.e. high) until year 15 when you pay it off. If you invest your risk is gradually going down. Even putting a lot into bonds you could remain liquid and get a return same or greater than the mortgage.

IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

Mortgage paydown is much less illiquid if you get a HELOC.  I'm 100% stocks viewing my mortgage paydown as the bond portfolio.  You can get a HELOC for 80% of the loan value. 

With the risk of rising interest rates, you could lose principle on the bonds if you cash out prior to maturity.  Not so on a mortgage.
Yes, if I have a crisis what I really want to do is borrow tons more money.. Yeah no thanks.

The bond value drop is overblown with any reasonable time frame and intermediate term bond funds.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #14 on: March 16, 2016, 03:11:11 PM »
What's the advantage of paying of the mortgage over time rather than investing it and paying off the house once you're good and ready?

For me its risk mitigation. That's the lens I view it through.  I want to reduce my risk as much as possible.  By diversifying my risk mitigation - 50-50 on pay down and investing seems to be where I land most comfortably. My head says invest it all, but my heart says a paid for house has very limited risk in case long term disaster strikes, therefore I will do both.

I agree, a paid off house does mitigate some risk. But what does a half paid off house get you? Nothing, the mortgage payment is still the same. Your risk is still the same (i.e. high) until year 15 when you pay it off. If you invest your risk is gradually going down. Even putting a lot into bonds you could remain liquid and get a return same or greater than the mortgage.

IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

Mortgage paydown is much less illiquid if you get a HELOC.  I'm 100% stocks viewing my mortgage paydown as the bond portfolio.  You can get a HELOC for 80% of the loan value. 

With the risk of rising interest rates, you could lose principle on the bonds if you cash out prior to maturity.  Not so on a mortgage.
Yes, if I have a crisis what I really want to do is borrow tons more money.. Yeah no thanks.

The bond value drop is overblown with any reasonable time frame and intermediate term bond funds.

If you have a $200k mortgage, 200k bonds and a crisis, you have $200k of debt and $0 net worth.

If you have $0 bonds, $0 mortgage, a crisis and draw $200k on the Heloc, you have $200k of debt and $0 net worth.

Other than the potential interest rate differential, both result in $200k of debt in this theoretical crisis.  My only concern in a crisis would be the bank pulling the Heloc.  I can say, my bank didn't pull mine between 2008 - 2011.

Due to the bank risk, I woudn't advocate relying entirely on debt for the emergency fund.

« Last Edit: March 16, 2016, 03:40:52 PM by Midwest »

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #15 on: March 16, 2016, 03:12:39 PM »
Yes, if I have a crisis what I really want to do is borrow tons more money.. Yeah no thanks.

The bond value drop is overblown with any reasonable time frame and intermediate term bond funds.

Im with you Scandium.  Try my patent pending Heckler Maneuver.

http://forum.mrmoneymustache.com/investor-alley/(canada)-invest-vs-mortgage-discussion-and-spreadsheet/msg634563/#msg634563

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #16 on: March 16, 2016, 04:53:45 PM »
One of the funny things I notice about personal finance, is that people always think they are right, and take ridiculously entrenched positions and are super defensive about their strategies. I often wonder if its fear and insecurity that they might not be on the right path. 

The funny thing is, is even in these debates, all of us are way ahead of the average Joe, and the basic concept of not spending all your cash, de-leveraging, and investing as much cash as possible will put us into FIRE, so arguing on the internet over relatively trivial things when you look at the macro perspective is sort of ridiculous. 

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #17 on: March 16, 2016, 06:07:47 PM »
our (New Zealand's) mortgage market is a bit different to the US. Long term stock market gains are around 7%, while long term mortgage rates around 6.5% though foretasted to keep dropping. The cost of property ownership is lower, but purchase price is higher. For us this environment makes paying the mortgage a pretty good bet. It basically gives you a guaranteed >7% return, and in a bad situation, the ability to switch a mortgage to interest only (a long fix in nz is 5 years) and just pay your tax and insurance (2-3k per year) gives you a lot of flexibility. For us, once the leverage is down we will save outside of the mortgage as well but for now it is all about debt crushing. Plus it feels super satisfying. Every week our cost of living goes down. Mwahahahaha! (fully aware that this is just perspective, and investing would have the same net result) 

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #18 on: March 16, 2016, 07:00:29 PM »
I see what you are saying, but its not quite as cut and dry in my mind. When you pay down your mortgage you reduce the balance quicker and shorten the loan's time horizon. Sure you may still have the payment, but if disaster strikes and you have to dump the property you have less of a chance of having limited equity or worse be under water. 
I agree with Scandium.  What risk are you mitigating by having a smaller mortgage that isn't mitigated by having a bigger investment portfolio?  If the economy goes down and you need cash, you can slowly sell your investments to cover it.  You may have to sell them at a loss, but that is a lot better than having to sell your house when the economy is down.  You could even invest some of your portfolio in bonds if you wanted to be conservative and have an asset that was more stable and capable of being drawn upon in an emergency.

From a risk mitigation standpoint, I'd argue that the safest thing to do is invest all your excess cash into bonds (or some similar low-yield, low-risk investment) until you had enough funds to pay off the mortgage.  With such a low mortgage rate, there are plenty of investments that can provide a similar or better return than your mortgage rate with very little risk in the time horizon you are talking (5-7 years).

If you go this route, you then have the flexibility to adjust your risk as you see fit by choosing your asset allocation between stocks and bonds (or other non-traditional assets).

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #19 on: March 16, 2016, 07:31:21 PM »
Cool, but I don't agree. Paying off a mortgage is less risky than investing in the market. They literally put a disclaimer on investing advertisements. Is it smarter? Maybe not. Less risky. Absolutely.

Heckler

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #20 on: March 16, 2016, 10:08:30 PM »
Its not arguing.  Its confirmation bias.

https://en.m.wikipedia.org/wiki/Confirmation_bias


The Consequences section even has a paragraph on finances.

I see it all rhe time in another forum.   "What bike is the best?"  - well, the same one I own, of course!
« Last Edit: March 16, 2016, 10:12:13 PM by Heckler »

Heckler

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #21 on: March 16, 2016, 10:13:25 PM »
Quote
Confirmation bias, also called confirmatory bias or myside bias, is the tendency to search for, interpret, favor, and recall information in a way that confirms one's beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities.[Note 1][1] It is a type of cognitive bias and a systematic error of inductive reasoning. People display this bias when they gather or remember information selectively, or when they interpret it in a biased way. The effect is stronger for emotionally charged issues and for deeply entrenched beliefs.


Quote
Confirmation bias can lead investors to be overconfident, ignoring evidence that their strategies will lose money.[6][99] In studies of political stock markets, investors made more profit when they resisted bias. For example, participants who interpreted a candidate's debate performance in a neutral rather than partisan way were more likely to profit.[100] To combat the effect of confirmation bias, investors can try to adopt a contrary viewpoint "for the sake of argument".[101] In one technique, they imagine that their investments have collapsed and ask themselves why this might happen.

From the wiki
« Last Edit: March 16, 2016, 10:15:20 PM by Heckler »

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #22 on: March 17, 2016, 03:47:28 AM »
Its not arguing.  Its confirmation bias.

https://en.m.wikipedia.org/wiki/Confirmation_bias


The Consequences section even has a paragraph on finances.

I see it all rhe time in another forum.   "What bike is the best?"  - well, the same one I own, of course!

Fascinating. Good pull.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #23 on: March 17, 2016, 05:33:57 AM »
Cool, but I don't agree. Paying off a mortgage is less risky than investing in the market. They literally put a disclaimer on investing advertisements. Is it smarter? Maybe not. Less risky. Absolutely.

I guess it depends what risks you want to mitigate. For me, that means having a backup plan in case I lose my income stream. Since I'm 2 years into a 30 year loan with a ltv of ~75%, I am more able to cover our bills in case of job loss by investing extra money than by paying extra principal on our house. So to me, yeah I would say investing it is less risky.

If it were me, I would agree with the posters that suggest investing all of the extra in a taxable account. You can nickname it mortgage payoff fund and once value equals mortgage = Boom! I would just invest it according to my overall AA from my IPS and wouldn't mess with more bonds, but that's just me.

At risk of being accused of confirmation basis, when we first bought the house, we were paying it down extra, but after doing some research on this site and others... We decided to invest instead.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #24 on: March 17, 2016, 07:43:19 AM »
Wait a second.  After taxes, these are your effective rates on the mortgage interest rate you pay:

15% bracket = 2.975%
25%bracket = 2.625%
28% bracket = 2.52%
33% bracket = 2.35%
39.6% bracket = 2.275%

If you cannot invest and earn a higher compound return than this over 15 years, you need to start over with this website.


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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #26 on: March 17, 2016, 08:45:20 AM »
IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

Another option is to invest a portion in a sinking fund until the time that you want to pay some or all of the mortgage in a lump sum.  That's what I did and am still doing.  I put aside a monthly amount into a separate investment account and then last August, I felt that I was too heavily invested in equities so I re-allocated by selling off the (long-term portion of the) sinking fund, and putting that amount toward my mortgage.  The intent was to recast (re-amortize) the mortgage for free, but I haven't done that yet because I want to put another large lump sum in before doing so. 

Recasting the mortgage does indeed reduce risk because it makes your minimum payments smaller. And most banks offer one recast for free or very minimal expenses. 

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #27 on: March 17, 2016, 08:53:06 AM »
Its not arguing.  Its confirmation bias.

https://en.m.wikipedia.org/wiki/Confirmation_bias


The Consequences section even has a paragraph on finances.

I see it all rhe time in another forum.   "What bike is the best?"  - well, the same one I own, of course!
While it's definitely a thing, it might not be logical fallacy every time. If i researched all bikes and bought the one I found to be the best, well then yes that is the best one.

What I do or buy is the best (IMO) otherwise why would I do it? If I found that option A is best and I do B then I'm an idiot!

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #28 on: March 17, 2016, 09:09:51 AM »
Wait a second.  After taxes, these are your effective rates on the mortgage interest rate you pay:

15% bracket = 2.975%
25%bracket = 2.625%
28% bracket = 2.52%
33% bracket = 2.35%
39.6% bracket = 2.275%

If you cannot invest and earn a higher compound return than this over 15 years, you need to start over with this website.

^^^ THIS
Risk mitigation: it is lower risk to let the bank own the house. Owning the house makes your total portfolio overweight in one non-liquid real estate investment. Why would you do this?

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #29 on: March 17, 2016, 09:24:20 AM »
IMO these discussions always use a false choice: invest vs a paid off home. That's not what it is, you don't pay it off day one. You do so over time and have near-zero liquidity while doing it. Too risky for me! But if that's what you're comfortable with obviously stick with it.

Another option is to invest a portion in a sinking fund until the time that you want to pay some or all of the mortgage in a lump sum.  That's what I did and am still doing.  I put aside a monthly amount into a separate investment account and then last August, I felt that I was too heavily invested in equities so I re-allocated by selling off the (long-term portion of the) sinking fund, and putting that amount toward my mortgage.  The intent was to recast (re-amortize) the mortgage for free, but I haven't done that yet because I want to put another large lump sum in before doing so. 

Recasting the mortgage does indeed reduce risk because it makes your minimum payments smaller. And most banks offer one recast for free or very minimal expenses.

Recasting is definitely a tool I am thinking about employing, while still maintaining the same payment. As you said, it reduces risk.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #30 on: March 17, 2016, 10:47:34 AM »
Cool, but I don't agree. Paying off a mortgage is less risky than investing in the market. They literally put a disclaimer on investing advertisements. Is it smarter? Maybe not. Less risky. Absolutely.
I guess it depends what risks you want to mitigate.
I think that is the exact question that needs to be asked.  Paying off the mortgage vs. investing in the STOCK market is a less risky RETURN ON YOUR MONEY, but that doesn't mean it's reducing your overall risk of financial failure.  It's also far from the only option you have to invest your money outside of your mortgage.  There's bonds, REIT, CDs, high yield bank accounts, etc.

Just yesterday there was a post on getting guaranteed 5% return on up to $5000, but it's not limited to one account.  The linked blog poster has opened up 6 of them for a total of $30,000 in savings.  In the thread, someone else referenced a checking account that gets 3% return.  There are other options out there like that if you look for them.  They would all be superior to paying down your mortgage: guaranteed return and full liquidity.

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #31 on: March 17, 2016, 12:03:28 PM »
Cool, but I don't agree. Paying off a mortgage is less risky than investing in the market. They literally put a disclaimer on investing advertisements. Is it smarter? Maybe not. Less risky. Absolutely.

Paying off a mortgage is vastly more risky than investing in the market.  No question.   Let's do a thought experiment.  Let's say Person A is aggressively paying down the mortgage, and Person B is aggressively investing.  We get out to year 10 or whatever and some emergency happens.  You get sick and can't work, divorce, or there is a family emergency or whatever else might happen in life.   Person A is stuck.   They don't have liquid funds to deal with the emergency, and they can't make the mortgage payment.  At this point the bank forecloses, not caring one whit about all those extra payments you made.   Person B, on the other hand deals with the emergency and has liquid funds he could use to make the mortgage payments, probably for years if it came down to it.

At this point mortgage payoff fans will typically suggest various work around for the above problem, all of which involve walking right up to the brink of admitting paying down the mortgage is risky without actually saying it.     For example, they will say they plan recast the mortgage, which keeps the money out of the house for long periods of time and thereby mitigates the risk.   Fair enough, but if it is smart to keep the money out of the house for long periods of time, then why isn't it smarter to keep the money out of the house all of the time?   

Or they'll say I'll just have a really big e-fund.  Again fair enough, that should probably work.  But if you need to reserve a big pot of money just in case your strategy goes south, isn't that the same as saying your strategy is really risky?   Yes it is.




Midwest

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #32 on: March 17, 2016, 12:16:30 PM »
Cool, but I don't agree. Paying off a mortgage is less risky than investing in the market. They literally put a disclaimer on investing advertisements. Is it smarter? Maybe not. Less risky. Absolutely.

Paying off a mortgage is vastly more risky than investing in the market.  No question.   Let's do a thought experiment.  Let's say Person A is aggressively paying down the mortgage, and Person B is aggressively investing.  We get out to year 10 or whatever and some emergency happens.  You get sick and can't work, divorce, or there is a family emergency or whatever else might happen in life.   Person A is stuck.   They don't have liquid funds to deal with the emergency, and they can't make the mortgage payment.  At this point the bank forecloses, not caring one whit about all those extra payments you made.   Person B, on the other hand deals with the emergency and has liquid funds he could use to make the mortgage payments, probably for years if it came down to it.

7 years ago, we decided to pay off our mortgage ASAP and began paying it down aggressively.  Upped the Heloc immediately for exactly the reasons you described (liquidity issues).  As the balance went down, I upped the HELOC (3x).  If things went sideways, I could have always drawn off the HELOC.

I'm person A with an option to become person B should the need arise.  During 2008/2009, I considered completely drawing out my HELOC (only $60k at the time) to make myself person B.

Periodically, we have used our Heloc to make real estate investments.  Couldn't do that if it were tied up in bonds.  My ROI on those investments has been much better than the market.

To those advocating investing over mortgage payoff, I agree it's possible to beat the roi of mortgage paydown over the long term. I do think you're underestimating market risk of a 3-5% yield in today's environment.  Depending on your tax situation, you may also be over estimating the value of the mortgage deduction.

If the 5% savings account idea is real, maybe I'll draw off my HELOC and do it.  Alternatively, I could finance another flip with a higher yield.

If you are doing the investing method (person B), some brokers will loan against your account (liquidity without selling).  Haven't done it so I don't have all the details.
« Last Edit: March 17, 2016, 12:29:17 PM by Midwest »

GregO

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #33 on: March 17, 2016, 12:55:53 PM »
7 years ago, we decided to pay off our mortgage ASAP and began paying it down aggressively.  Upped the Heloc immediately for exactly the reasons you described (liquidity issues).  As the balance went down, I upped the HELOC (3x).  If things went sideways, I could have always drawn off the HELOC.

I'm person A with an option to become person B should the need arise.  During 2008/2009, I considered completely drawing out my HELOC (only $60k at the time) to make myself person B.

Periodically, we have used our Heloc to make real estate investments.  Couldn't do that if it were tied up in bonds.  My ROI on those investments has been much better than the market.

To those advocating investing over mortgage payoff, I agree it's possible to beat the roi of mortgage paydown over the long term. I do think you're underestimating market risk of a 3-5% yield in today's environment.  Depending on your tax situation, you may also be over estimating the value of the mortgage deduction.

If the 5% savings account idea is real, maybe I'll draw off my HELOC and do it.  Alternatively, I could finance another flip with a higher yield.

If you are doing the investing method (person B), some brokers will loan against your account (liquidity without selling).  Haven't done it so I don't have all the details.
I don't have a problem with people choosing to pay down their mortgage, but I still think it leaves you in a much riskier position financially until the mortgage is paid off.  A HELOC would alleviate a lot of those risks, but you are depending on debt and a bank, which is inherently more risky.  The bank could choose to cancel your HELOC at any time, raise interest rates dramatically, change the terms, etc.  All of those things are out of your control and add risk.

If you did go the route of Person A, you could have chose to sell your bond funds and invest in real estate also.  There is very little difference there between a HELOC and owning bond funds or a bond ladder.

I do agree there is market risk in investing in bond funds, but we're almost always talking very long time frames with mortgages.  The research I have read says that you should plan on holding bond funds 2-3 years to mitigate the short term volatility risk, which is usually easily achieved in mortgage paydown scenarios.

But the market risk in stocks, bonds, etc vs the guaranteed return of mortgage paydown is all risk on your ROI.  The risk of having less liquidity in your home is a cash flow risk (unable to pay your bills if you lose your job or other financial issue).  It's the balance of those two risks that has to be weighed.  And IMO, the long timeframe that we are talking about reduces the return risk significantly and makes it the superior choice.  But no one knows the future, so I could be wrong there.

tooqk4u22

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #34 on: March 17, 2016, 01:20:39 PM »
I love my way is better than your way views.  I personally took a hybrid approach where I maxed out retirement accounts, had meaningful emergency fund, made extra payments to the mortgage, had a HELOC, and invested additional amounts along the way - and it worked for me but might not for others, I liked that my stash was growing, debt was reducing, and I had funds to whether storms. 

There is no right or wrong answer because the answer is based on the individuals personal risk tolerance - which may or may not be consistent with common views on the subject.  The historical math suggests that one will do better by investing vs. paying off the mortgage, but two things that are typically ignored are the difference isn't always that great at the end, people don't generally adjust or know how to quantify for the additional risk (ie risk adjusted return). Plus the mortgage deduction is largely a myth for most people as the standard deduction (especially for families) typically exceeds the mortgage and other deductions or AMT starts coming into play to wipe out some of the benefits. 

Anyway, take a $200,000 mortgage at 3.5% rate for 15 years and compare out comes for extra $1000/months at end of 15 years.

Inv Return           Invest         Payoff Mort then Inv           Diff
7%                   $317,000           $262,000                       $55,000
5%                   $267,000           $243,000                       $24,000

Leverage is what makes it better, and leverage adds risk.  Plus paying down the mortgage is a guaranteed (risk-free) return. So by investing with leverage you would be compounding the risk, which is fine but that's how the decision should be made because the 5-7% or even higher are not guaranteed.  Leveraged returns just as easily go the other way too.

S&P 500 has a current PE of 22 and a forward PE of 16, said otherwise expected current return is 4.5% or 6.3% the difference being attributed to inflation/operating leverage/efficiencies.  Yield to maturity on Vanguards BND is 2.23%.  With a 80/20 split that would result in an expected return of 5.49% using the forward PE - increase the bonds it goes down, go all equities and it goes up the range is 2.23% to 6.3%.

For me, to realize an expected return of $24-30k in total over 15 years with the added leverage and market risk I don't think is worth it.  That is just this point in time though when comparing expected returns to the 3.5% mortgage rate.




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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #35 on: March 18, 2016, 01:59:23 AM »
This is exactly what I am doing. Thanks for confirmation that it worked well for you.

Spitfire

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Re: Mortgage vs Investing - Risk Mitigation Early in the mortgage
« Reply #36 on: March 22, 2016, 02:22:57 PM »
I agree, a paid off house does mitigate some risk. But what does a half paid off house get you? Nothing, the mortgage payment is still the same.

This is a great point and has me rethinking my earlier post. It may actually be less risky to invest until I can pay it off all at once. Thanks for the thread OP.