Author Topic: Pay off mortgage before investing?  (Read 12060 times)

nnhubbard

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Pay off mortgage before investing?
« on: November 04, 2013, 11:51:21 AM »
I have a dilemma. I am stoked about the idea of starting to invest, but I also have a mortgage payment and student loans.

Would it be smart to put all my financial resources into paying those off first completely, and then start investing?

Currently mortgage is at 3% and student loans are lower than that.

iamlindoro

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Re: Pay off mortgage before investing?
« Reply #1 on: November 04, 2013, 12:18:28 PM »
You need to compare the expected investment returns against the interest rate on the debts.  Since you've mentioned elsewhere that you're investing in a US Total Market fund right now, the average annual return from that is 11% a year.  Never mind some years it will be less (like the crash a few years ago) and sometimes it will be much more (like this year).  The AVERAGE annual gain over the long arc is all we care about, and that's averaged about 11% a year since inception.

Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.
« Last Edit: November 04, 2013, 12:21:46 PM by iamlindoro »

iamlindoro

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Re: Pay off mortgage before investing?
« Reply #2 on: November 04, 2013, 12:20:32 PM »
And the obligatory article on what you can expect from the investment you've made:

http://www.mrmoneymustache.com/2011/06/06/dude-wheres-my-7-investment-return/

bo_knows

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Re: Pay off mortgage before investing?
« Reply #3 on: November 04, 2013, 12:38:04 PM »

grmagne

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Re: Pay off mortgage before investing?
« Reply #4 on: November 04, 2013, 12:46:20 PM »
Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.

In that scenario he can compare a 7-8% real growth rate against a 0% mortgage rate because a 3% mortgage rate in a 3% inflation environment is a wash.  From the bank’s perspective, they’d consider themselves to be making no rate of return off the mortgage.

iamlindoro

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Re: Pay off mortgage before investing?
« Reply #5 on: November 04, 2013, 01:02:16 PM »
Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.

In that scenario he can compare a 7-8% real growth rate against a 0% mortgage rate because a 3% mortgage rate in a 3% inflation environment is a wash.  From the bank’s perspective, they’d consider themselves to be making no rate of return off the mortgage.

Well, the 0% would be the *bank's* adjusted return, right?  All the above numbers need to be from the OP's perspective, so he still has to beat 3% to break even from his perspective.

grmagne

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Re: Pay off mortgage before investing?
« Reply #6 on: November 04, 2013, 05:10:07 PM »
Well, the 0% would be the *bank's* adjusted return, right?  All the above numbers need to be from the OP's perspective, so he still has to beat 3% to break even from his perspective.

It’s two sides to the same coin, though. If inflation = rate of return (both 3% in this case) then it’s effectively a 0% loan from both the bank’s and the borrower’s point of view. It’s more intuitive from the bank’s perspective, which is why I described it that way. But it’s equally valid to say that the borrower is paying 0% real interest because the debt grows at the same rate as inflation.

A more extreme thought experiment would be a 3% loan with 5% annual inflation. In this case the bank loses money every year and the borrower experiences a decrease in real debt even without any debt re-payments whatsoever. Thus if you could earn a 5% investment growth, which is effectively 0% real rate of return, you’d still be better investing than paying off the loan. The bottom line is that you always have to net out inflation from both sides when considering whether to pay down debt or invest.

dadof4

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Re: Pay off mortgage before investing?
« Reply #7 on: November 04, 2013, 10:28:56 PM »
You need to compare the expected investment returns against the interest rate on the debts.  Since you've mentioned elsewhere that you're investing in a US Total Market fund right now, the average annual return from that is 11% a year.  Never mind some years it will be less (like the crash a few years ago) and sometimes it will be much more (like this year).  The AVERAGE annual gain over the long arc is all we care about, and that's averaged about 11% a year since inception.
So far so good.

Disclaimer:past performance does not guarantee future returns, yada yada.
Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.
Inflation does not come in to play here (at least not directly).

Even if return on stock is 4% (instead of 11%), he's still better off (on average) with the stocks. This is true whether inflation is 3%, 0% or 20%.
« Last Edit: November 04, 2013, 10:38:30 PM by dadof4 »

kyleaaa

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Re: Pay off mortgage before investing?
« Reply #8 on: November 05, 2013, 02:10:51 PM »
I wouldn't expect 7% real from the stock market going forward, but you will almost certainly do better than 3% over the long term.

dadof4

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Re: Pay off mortgage before investing?
« Reply #9 on: November 05, 2013, 08:19:50 PM »
Some food for thought - not sure how accurate this is.

There is a school of thought that says you should invest by mirroring the investments of the ultra-rich, eg Warren Buffett. There is some soundness to this approach - the ultra-rich have access to information we don't, and by their very actions they can change the financial landscape.

Let's say I told you that Buffett has a 17 billion dollar mortgage. Because of various business decisions, he is actually increasing that mortgage value every year.
What if I also told that Buffett had a magical power that could lower all mortgages at will. I wouldn't have to tell you that Buffett doesn't like losing money, and would rather use his magic power than paying back the full mortgage. Wouldn't getting a mortgage and enjoying Buffett's magic power when he used it be cool?

As it happens, if you replace "Buffet" with "US Government", replace  "Billion" with "Trillion", replace "mortgage" with "national debt" and replace "magic power" with "the ability to control inflation", you have something pretty close to reality. Nominal debt at low interest (not to mention tax deductible interest) is a good thing if you use it for investing (patience and safety cushion may be required).
« Last Edit: November 05, 2013, 11:34:26 PM by dadof4 »

CopperTex

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Re: Pay off mortgage before investing?
« Reply #10 on: November 05, 2013, 09:33:12 PM »
Paying off your mortgage vs. investing is almost as much a psychological problem as it is mathematical one.

Yes, that is why they call it personal finance.  It's personal and it's finance.  I'm in the group that fully believes paying off the mortgage is a good thing to do. I'm interested in increased cash flow and killing a mortgage does just that.  It seems that anyone interested in retiring early would want to not have a mortgage, but some are ok with the risk and only look at the numbers part of it.

gooki

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Re: Pay off mortgage before investing?
« Reply #11 on: November 06, 2013, 02:22:34 AM »
My primary driver for recommending aggressive repayment of a mortgage is that most people don't invest their excess income. They piss it away on buying stuff.

steveo

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Re: Pay off mortgage before investing?
« Reply #12 on: November 06, 2013, 12:56:28 PM »
I think you need to take everything into perspective.

My mortgage is about 180k at the moment. I live in Australia and there are no tax benefits when it comes to interest payments and the mortgage rate is around 5%. Any income from stocks gets taxed at my marginal tax rate (approx 50%) less credits on the tax already paid via the company. Stocks aren't cheap at the moment and I don't see any other cheap investments.

To me it makes sense to pay off my mortgage. It also lowers my expenses for life. I doubt the numbers would even state that it is better to invest in stocks especially if risk is considered.

dadof4

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Re: Pay off mortgage before investing?
« Reply #13 on: November 06, 2013, 01:32:11 PM »
I think you need to take everything into perspective.

My mortgage is about 180k at the moment. I live in Australia and there are no tax benefits when it comes to interest payments and the mortgage rate is around 5%. Any income from stocks gets taxed at my marginal tax rate (approx 50%) less credits on the tax already paid via the company. Stocks aren't cheap at the moment and I don't see any other cheap investments.

To me it makes sense to pay off my mortgage. It also lowers my expenses for life. I doubt the numbers would even state that it is better to invest in stocks especially if risk is considered.
That's certainly true. We aren't saying paying off a mortgage is universally a bad idea. It depends on your circumstances. At 5% interest, investing and earning 7% will only give you a marginal utility. If you're forced to pay taxes on those, you're losing by not paying off the mortgage.

However, at 3% interest (or 2% when you consider government tax credits), and investing in tax-deferred accounts,earning 7% is a clear win, as long as you are prepared to deal with the volatility. If your investments are in pre-tax accounts, you potentially win even more - since those additional mortgage principle payments are post-tax.

Dezrah

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Re: Pay off mortgage before investing?
« Reply #14 on: November 06, 2013, 03:09:30 PM »
This is going to be weird advice but maybe you'll like it.  While the vanilla advice of "invest expecting a higher return" is probably correct, that kind of thing rarely get me thinking and excited about my money.

Take 100 points and divide them into these three categories based on how important they are to you and your money: cashflow, security, and longevity.  This will then be the percent you put toward your student loan, your mortgage, and investments respectively from your monthly savings.

For example, let’s assume you’re really, really happy where you are now and want lots of stability for that, yet you also have a healthy family history and expect a long, leisurely life.  Your immediate needs are few and tend to be carefully thought out.  Your allocation might look like this:

Cashflow (Student Loans) – 10%
Security (Mortgage) – 60%
Longevity (Investments) – 30%

So if you saved $1,000 per month after all your minimum payments, you’d put $100 toward the student loans, $600 toward your mortgage, and $300 for investing.

Every few months, reevaluate and see if your priorities have changed and adjust accordingly.  (I told you it was weird.)

cdub

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Re: Pay off mortgage before investing?
« Reply #15 on: November 06, 2013, 03:25:39 PM »
For me - the psychological benefits of having no more debt and much lower monthly expenses far outweigh the "math". Math can be wrong and there are no guarentees on ROI. There is a gaurenteed ROI in paying down the mortgage.

Heck - I've even started an entire blog devoted to paying off my mortgage early (http://mortgage-payoff-club.com/) to inspire me to get it done.

Currently I'm investing 20% of my income for retirement and throwing everything else at the mortgage.

I'm currently sending $1k extra per month but once the wife goes back to work that should go up to $4k extra as we'er doing just fine on my income alone.


Bruised_Pepper

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Re: Pay off mortgage before investing?
« Reply #16 on: November 06, 2013, 05:00:50 PM »
It's all about risk.  It sounds like you stands to increase his net worth more quickly by investing and paying the debt off slowly, but keeping a liability around is inherently risky.  Consider how losing your job/income would affect your ability to pay these liabilities.  If you have enough money to cover yourself through a (worst-case scenario) long and bitter unemployment/loss of income, then you might as well invest and make the extra cash. 

NearlyThere

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Re: Pay off mortgage before investing?
« Reply #17 on: November 08, 2013, 01:44:53 AM »
I paid off my mortgage in 4 years and before investing. With hindsight, I'd have made 1.5% greater return with investments over that period, but coming home each night knowing the house was mine (or the money was offset the mortgage in the bank) was a great comfort.

My dad made a very valid point to me last night: Money is not a problem when you have it. The same goes for your mortgage. When it's paid, its not an issue, ever again.

I've made three memorable decisions in my life and paying off the mortgage was one of them.

Moomingirl

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Re: Pay off mortgage before investing?
« Reply #18 on: November 09, 2013, 09:06:12 PM »
I've been thinking about getting a second rental property (currently have around $200,00Nz in equity in our first). But with interest rates currently at 4.95% and increasing, I just don't like the risk of borrowing more, then having to pay the mortgage if the place is empty. So we are concentrating on paying down the mortgage that we have. We have managed $55,000 over the last couple of years, and only have $165,000 to go.  :D

fmzip

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Re: Pay off mortgage before investing?
« Reply #19 on: November 20, 2013, 06:15:02 PM »
My primary driver for recommending aggressive repayment of a mortgage is that most people don't invest their excess income. They piss it away on buying stuff.

Very good point! I have my extra principal payment on autopay, 47 payments to go.

I hope that the day the mortgage is paid off I then can send the extra principal payment of $650 plus the mortgage principal of $490 to the investment account instead......

Time will tell. I certainly have been more diligent with paying it down than I have been with curbing my spending to save more.

Pylortes

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Re: Pay off mortgage before investing?
« Reply #20 on: November 20, 2013, 08:38:11 PM »
I am squarly in the investment camp, but i do recognize the choice is not for everyone and for some paying down the mortgage is a better option.  To me, this is a simple math problem and there is a very high probability you will come out ahead in the long run by investing.  But this assumes you have the self discipline to actually invest the extra money every month and not spend it.   I also personally believe that inflation will eventually go higher.  If so, your monthly mortgage payment will look like a greater and greater bargain, meanwhile your stocks/mutual funds are likely to keep pace with inflation and give you a stronger return.

Bottom line, math says to invest but psychology is a factor and if you value the thought of owning a home free and clear you may want to do otherwise.  From a math perspective just ask yourself why apple etc have been issuing debt lately even though they have no need for it?  Cheap leverage can really juice returns.  Your mortgage is cheap leverage.

jrhampt

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Re: Pay off mortgage before investing?
« Reply #21 on: November 25, 2013, 11:50:11 AM »
This is not necessarily an either/or decision if you have grown your income high enough to do both.  I am paying off my mortgage early, but only after maxing out contributions to tax-deferred accounts. 

JessieImproved

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Re: Pay off mortgage before investing?
« Reply #22 on: December 11, 2013, 12:55:03 PM »
I have a second mortgage at 9% (fixed).  With incredibly focused investing, I could probably make better returns than that, but it's too close for my comfort.  Therefore my current strategy is max out our IRAs and then throw every additional penny at the second until it's gone, at which point we will evaluate the situation.  But if the mortgage was at 3%, I wouldn't hesitate to put my money elsewhere.

matchewed

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Re: Pay off mortgage before investing?
« Reply #23 on: December 11, 2013, 03:07:16 PM »
I have a second mortgage at 9% (fixed).  With incredibly focused investing, I could probably make better returns than that, but it's too close for my comfort.  Therefore my current strategy is max out our IRAs and then throw every additional penny at the second until it's gone, at which point we will evaluate the situation.  But if the mortgage was at 3%, I wouldn't hesitate to put my money elsewhere.

Have you looked into a refinance? 9% is pretty bad in the current market.

k9

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Re: Pay off mortgage before investing?
« Reply #24 on: December 17, 2013, 08:32:11 AM »
You need to compare the expected investment returns against the interest rate on the debts.  Since you've mentioned elsewhere that you're investing in a US Total Market fund right now, the average annual return from that is 11% a year.  Never mind some years it will be less (like the crash a few years ago) and sometimes it will be much more (like this year).  The AVERAGE annual gain over the long arc is all we care about, and that's averaged about 11% a year since inception.

Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.

I guess the bank who sold the mortgage will soon get out of business. Why lend anyone money at 3% since they can generate a guaranteed 11% on the stock market with a no-brainer vanguard index ? They must be out of their mind.

matchewed

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Re: Pay off mortgage before investing?
« Reply #25 on: December 17, 2013, 09:14:52 AM »
You need to compare the expected investment returns against the interest rate on the debts.  Since you've mentioned elsewhere that you're investing in a US Total Market fund right now, the average annual return from that is 11% a year.  Never mind some years it will be less (like the crash a few years ago) and sometimes it will be much more (like this year).  The AVERAGE annual gain over the long arc is all we care about, and that's averaged about 11% a year since inception.

Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.

I guess the bank who sold the mortgage will soon get out of business. Why lend anyone money at 3% since they can generate a guaranteed 11% on the stock market with a no-brainer vanguard index ? They must be out of their mind.

You do know what banks do and what they're in the business of doing right? And guaranteed is rather wrong.

arebelspy

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Re: Pay off mortgage before investing?
« Reply #26 on: December 17, 2013, 09:17:09 AM »
You do know what banks do and what they're in the business of doing right? And guaranteed is rather wrong.

WOOSH!

matchewed, I expect better of you. ;)

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aj_yooper

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Re: Pay off mortgage before investing?
« Reply #27 on: December 17, 2013, 09:43:39 AM »
You need to compare the expected investment returns against the interest rate on the debts.  Since you've mentioned elsewhere that you're investing in a US Total Market fund right now, the average annual return from that is 11% a year.  Never mind some years it will be less (like the crash a few years ago) and sometimes it will be much more (like this year).  The AVERAGE annual gain over the long arc is all we care about, and that's averaged about 11% a year since inception.

Now, remove your inflation figure from that.  The standard amount most people use is about 3% inflation per year.  So now, adjusted for inflation, you can expect to make 7-8% "real money" on a total US stock market investment.  Since 7-8% is greater than the 3% mortgage, it makes more sense to put your money towards the investment than towards the mortgage.

I guess the bank who sold the mortgage will soon get out of business. Why lend anyone money at 3% since they can generate a guaranteed 11% on the stock market with a no-brainer vanguard index ? They must be out of their mind.

You do know what banks do and what they're in the business of doing right? And guaranteed is rather wrong.

Oh, wait a moment.  That's what the guys and gals at the big banks did and it worked great until it didn't.

matchewed

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Re: Pay off mortgage before investing?
« Reply #28 on: December 17, 2013, 09:56:41 AM »
You do know what banks do and what they're in the business of doing right? And guaranteed is rather wrong.

WOOSH!

matchewed, I expect better of you. ;)



Parents never did tell me I was the bright one. :D

k9

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Re: Pay off mortgage before investing?
« Reply #29 on: December 17, 2013, 02:54:27 PM »
Haha yes I was a bit sarcastic here. What I mean obviously is that there is no mathematically right answer to that question (unless your mortgage rate is insanely high). It all boils down to "how much of your money are you ready to bet for a potentially higher return ?"

I faced the mortgage vs investment question too. The answer for me was 50% payoff 50% investment (yes, I'm a coward). Your mileage may vary.

wakkowarner

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Re: Pay off mortgage before investing?
« Reply #30 on: December 20, 2013, 12:24:27 PM »
The ROI portion has already been tackled but there are other factors too.  One major one would be liquidity.  The investments that you make in your home are locked into your home.  Money invested in the stock market is in stocks/indexes.  If you need to access the money (emergency, opportunity, whatever) in one case you would need to sell your house.  In the other case you would need to sell some stocks.  The selling of stocks is much easier, much faster, and can be done in smaller amounts if needed. 

Some would ask"what if the stock market dips?"  Well, the same can be asked of the value of your home.  Effectively paying off your house early with investment dollars is investing in your home instead.  Some people say it gives "peace of mind" for them but I have more peace of mind knowing I have easier access to my invested money.  I can take the exact same money and pay it off in full just like they already did, but instead I'll be earning 7% on hundreds of thousands of dollars.  Sure I still have payments to make that they don't have, but my investment can cover that so it is no longer an out-of-pocket expense for me just like it isn't for them (my investment pays for the debt while they no longer have the debt).  On top of that I am way ahead on the size of my higher % yielding stocks and so it grows much quicker than theirs since they are just getting started.