Author Topic: Paying down mortgage in accumulation (after tax advant) to cashout refi on FIRE?  (Read 593 times)

ender

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I want to have a dedicated conversation on this topic.

One of the interesting things in the FIRE world is sequence of returns, both for accumulation as well as retirement.

Bonds/cash are far more stable in accumulation (aka less likely to be worth less when you want to FIRE) but obviously have lower upside too. @vand was sharing some interesting graphs which got me thinking on this subject.

Stocks have a decent chance of being worth less at the end of a given short term period than the start. As the time horizon expands, this risk goes away.

In the long run you want stocks as part of your allocation but what about the time right around your retirement?

A lot of people seem to use a bond tent or something similar.

The way I'm personally planning on reconciling this is to take as much advantage of tax advantaged accounts (401k, IRAs, HSA) and then dump extra cash into my mortgage. This defacto results in a larger bond portion of my portfolio during my accumulation years.

It would be really interesting to see some analysis on whether this benefits your FIRE date - paying down a mortgage throughout accumulation - and right before you FIRE, doing a cash out refinance to then invest all that money.

I'm curious if anyone has run math on doing something like this. Assuming you:

  • Already max tax advantaged accounts
  • Have leftover money to invest/save

Would it be reasonable to pay extra on a mortgage, simulating a bond fund, with the plan to do a cashout refinance shortly before FIRE? This would allow you to:

  • Leave investments untouched for a good percentage of your early FIRE years (depending on equity). You could have enough cash as a buffer immediately to setup a Roth conversion pipeline too (again depending on equity)
  • Hold a mortgage in FIRE, mitigating inflation risk

You would of course be adding some risk if your home value went down.

I don't think I've seen this sort of approach discussed much. I am curious if other folks have thought around ideas like this to try to further mitigate sequence of returns risk.

vand

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Urgh.. this hurts my head a little, @ender. Maybe it's that I'm not that familiar with the US terminology.. anyway, I don't think that you can get away from the lost opportunity cost of investing for 30yrs vs paying off your mortgage, investing will almost certainly win out and leave you in a better overall position.

Forgive me if I haven't understood you quite right, bit from your post you seem to be suggesting that paying down the mortgage has about the same effect as buying bonds..? That's not the case because - at least when you buy bonds on the secondary market as 99.9% of us do - the value goes up and down, and it is the long term downward trend in yields that has seen such impressive returns for bondholders over the last 40 years way above just the (yield*years-to-maturity).

We currently have a fully paid off home, but are actually looking to trade up some time soon. Normally I am in the "pay off your debts" camp, but none of these decisions exist in a vacuum, and with long term rates so low (here I can fix for 10 yrs at 2.4% or 5yrs at 1.4%) I have to say that I'm more inclined to leverage up to the eyeballs with an interest-only mortgage and invest heavily. Bringing us back round nicely to asset allocation and portfolio construction, if I use a predictable multi-asset strategy like the permanent portfolio there is almost no chance that over the full term of the mortgage I will not substantially outperform the loan rate.

ender

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Urgh.. this hurts my head a little, @ender. Maybe it's that I'm not that familiar with the US terminology.. anyway, I don't think that you can get away from the lost opportunity cost of investing for 30yrs vs paying off your mortgage, investing will almost certainly win out and leave you in a better overall position.

Forgive me if I haven't understood you quite right, bit from your post you seem to be suggesting that paying down the mortgage has about the same effect as buying bonds..? That's not the case because - at least when you buy bonds on the secondary market as 99.9% of us do - the value goes up and down, and it is the long term downward trend in yields that has seen such impressive returns for bondholders over the last 40 years way above just the (yield*years-to-maturity).

We currently have a fully paid off home, but are actually looking to trade up some time soon. Normally I am in the "pay off your debts" camp, but none of these decisions exist in a vacuum, and with long term rates so low (here I can fix for 10 yrs at 2.4% or 5yrs at 1.4%) I have to say that I'm more inclined to leverage up to the eyeballs with an interest-only mortgage and invest heavily. Bringing us back round nicely to asset allocation and portfolio construction, if I use a predictable multi-asset strategy like the permanent portfolio there is almost no chance that over the full term of the mortgage I will not substantially outperform the loan rate.

Let me clarify.

Let's say your Mustachian working career is 10 more years. During those 10 years, you prioritize extra savings into paying down your low rate mortgage (additional to tax advantaged accounts).

The return difference matters less in the working years because the interval is so short that the absolute savings amount matters disproportionately much compared to the return difference (over the short term only). It effectively represents a larger bond portion for your AA.

When you are close to retiring, you do a cash out refinance to reclaim as much of the cash you put against the mortgage as possible. Risk here is real estate drops meaningfully.

You use this cash as your bridge money as needed or invest it longer term into stocks, depending on your access to retirement accounts.

The reason this seems reasonable to me is it lowers sequences of return risk while accumulating. From a purely numerical perspective, you'd always want to prefer investing the extra money into the market (vs mortgage principal) but this means a down market doubly hits you.

It's unclear to me if this stability is worth it, or how often it ends up being a good play historically. It certainly feels like you could reduce the likelihood of market impact pushing your FIRE date out in the future and also give yourself a cash cushion to start Roth conversions, etc, once you do FIRE. Depending on your home equity vs spending you may even be able to set aside 5 years expenses and also still dump more into the market for long term investments. The flip side is it likely will extend your FIRE date, at least based on historical market returns in the average case.

But this wouldn't be optimizing for the average but rather trying to mitigate the risks where over the short term of the 10 remaining working career years results in the market performing below bonds.

And over a short (10 years or less) remaining working career, you should nearly always prioritize tax advantaged accounts if you can, particularly pretax. The tax savings alone even if you put it all into a safe investment takes a long time to catch up to current mortgage rate compounding.

vand

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I thought about this bit, but still having trouble wrapping my head around the concept. My conclusion was that whatever you do greatly depends on individual circumstances and attitude (as ever).  How you feel about your portfolio depends greatly on so many things, such as:

- Do you have multiple income streams in retirement? eg, rental income, defined benefit pension
- How long has it taken you to get to where you are?
- How quickly are you able to replace a portfolio drawdown from your income?
- How would you feel about having to work a bit longer if you took too much risk and it didn't work out?
- How would you feel about having to work a bit longer if you took too little risk and your portfolio didn't grow very quickly?
- What's your attitude to debt and leverage?

So imo individual personal circumstances general dictate the sort of investment risks that it is sensible to take. In general it makes sense to swap higher risk for more certainty as you approach the your goal of being able to live off the wealth of the assets you have accumulated. If you can figure out a way to leverage your home equity into your financial plan then great, but just be aware that the reverse mortgage is already a thing, and with good reason few people think they're a great idea.

maizefolk

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I think the argument with the bond tent is that you move money into it in the last few years before FIRE (when your assets are large enough that a 20-30% drop in the stock market might delay hitting your FIRE number by years), and then slowly move money back out of it once you are FIREd as your total assets (including the money you've kept in stocks) grow past the point where you are vulnerable to sequence of return risk.

What you're describing is more of a shallow mortgage lean-to where you start putting extra money into your mortgage from the start of your accumulation phase and then transfer it all into potentially volatile stocks right around the date you FIRE.

So the big downsides I would see, relative to a bond tent strategy, are that 1) you'd be putting much more money into low return assets many years before it is necessary to avoid the risk of FIRE date slippage which means either FIREing later, or FIREing at the same time, but with a higher withdrawal rate than you otherwise would 2) because cash-out refinances are less granular than bonds and it is also substantially harder to do a cash-out refinance post-FIRE, this strategy doesn't provide the same protection against sequence of return risk in the early years AFTER you FIRE as a bond tent strategy would.

Are there big upsides from your perspective to this strategy vs a conventional bond tend or simply opening a taxable investment account and having a higher allocation to bonds across your total set of investments?*

*Phrased in this awkward way instead of "buy bonds with a taxable investment account" because the tax optimal solution would be to buy extra stocks in your taxable account and reallocate some of the stocks in your retirement accounts to bonds.

ender

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Are there big upsides from your perspective to this strategy vs a conventional bond tend or simply opening a taxable investment account and having a higher allocation to bonds across your total set of investments?*

I'm not sure.

I've wondered about this as well, is there any advantage to doing this vs a separate taxable account and similar questions.

I'm sort of settling on "no" as while you get guaranteed returns with the mortgage payoff, you do incur some risk based on ability to refinance. It's basically a comparison of that risk vs the risk of a sizable bond fund dropping in value.

joe189man

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why not pay the mortgage normally and invest in index funds with any extra, then pre fire do a refinance on the mortgage to a smaller payment/term. Then do a HELOC as your buffer in case of bad times, poor market returns.

This way you have a smaller mortgage payment in retirement by refinancing, have the ability to pull money out with the HELOC if necessary, and you put more money into the market sooner giving it time to grow

Depending on home value this should work ok, but i havent run numbers

i have seen many on here say they have issues buying a car or property once they FIRE as they dont have income, a heloc pre-FIRE may negate some of those issues early on?

maizefolk

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If you go into FIRE with a mortgage, refinancing into a new 30-year term right before you pull the trigger really does appear to increase success rates significantly.

TomTX

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When you are close to retiring, you do a cash out refinance to reclaim as much of the cash you put against the mortgage as possible. Risk here is real estate drops meaningfully.

Well, the other big risk is that today's low refi rates may not be available in 10 years. I'm seeing numerous people report after hunting/negotiating they scored a 30 year refi at 2.75% with no points and low fees.