Author Topic: Paying off Mortgage Early How bad is it for your FI Date?  (Read 218371 times)

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #100 on: August 21, 2013, 08:24:31 AM »
Bo_knows can your new calculator take into account a mortgage? 

bo_knows

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #101 on: August 21, 2013, 08:42:02 AM »
Bo_knows can your new calculator take into account a mortgage?

Other than compensating for reduced expenses due to paying off a mortgage... no.  I'm not sure how it could work any differently.  Thoughts?

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #102 on: August 21, 2013, 10:25:09 AM »
Bo_knows can your new calculator take into account a mortgage?

Other than compensating for reduced expenses due to paying off a mortgage... no.  I'm not sure how it could work any differently.  Thoughts?

Thanks for the KISS (Keep It Simple Stupid) answer.  I was getting all hung up on the principal increasing networth and being the equivalent of buying a bond that pays out at the interest rate, which I believe is more complicated than just reducing the expense of the P&I once it is paid off.  I track Net Worth, so it did not seem correct to basically call the mortgage payment an expense, when a portion is increaing your net worth.  Now that my eyes are open, I understant that this program is a portfolio program not a net worth program, so I think your solution would work well.

If the program can have expenses that do not increase with inflation then I think we have our solution.  The Principal and Interest should not change over the term, but the taxes and insurance should increase with inflation. I think on Firecalc, it was showing the expense increasing over time based on inflation vs. being locked for 30 year or term of the loan. Maybe Firecalc did this, but I did not understand it thoroughly. I need to spend some time on your program as it appears to be very robust. It does not appear to work with my Ipad, so that slows me down.   

So if the program can lock the mortgage payment P&I for the term of the loan and if it can eliminate the P&I in the year that the loan is paid off in today's dollars then I think it would capture the true reduction in expenses.

If you don't lock down the P&I, then it would always show that it is better to rent vs. buy a house.

Thanks for your response,

Tom

   

bo_knows

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #103 on: August 21, 2013, 10:37:55 AM »

If the program can have expenses that do not increase with inflation then I think we have our solution.  The Principal and Interest should not change over the term, but the taxes and insurance should increase with inflation. I think on Firecalc, it was showing the expense increasing over time based on inflation vs. being locked for 30 year or term of the loan. Maybe Firecalc did this, but I did not understand it thoroughly. I need to spend some time on your program as it appears to be very robust. It does not appear to work with my Ipad, so that slows me down.   

Yup, in my example above ($30k spending plus $10k mortgage), you could instead just set your default spending to $30k, and add an input in the "Spending Inputs" section equal to $10k/yr, for X years, and set it to "Not Inflation Adjusted".

Quote
So if the program can lock the mortgage payment P&I for the term of the loan and if it can eliminate the P&I in the year that the loan is paid off in today's dollars then I think it would capture the true reduction in expenses.

If you don't lock down the P&I, then it would always show that it is better to rent vs. buy a house.

Thanks for your response,

Tom

I believe that it does what you say, but the example above.

annod

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #104 on: August 22, 2013, 09:30:14 AM »
Seems like most would agree that with a fixed 30 yr 3.x% mortgage, it is not wise to prepay mortgage. Today's rate is around 4.625-4.75%. It is more than what many treasury bond's return or TIPS.
Does it make sense that if I were planning to have a 10% of my savings allocated to bonds, and as long as the bond's return rate is lower than the mortgage interest rate, to put that 10% into mortgage prepayment instead? 

What are your thoughts?

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #105 on: August 27, 2013, 01:05:47 PM »
Seems like most would agree that with a fixed 30 yr 3.x% mortgage, it is not wise to prepay mortgage. Today's rate is around 4.625-4.75%. It is more than what many treasury bond's return or TIPS.
Does it make sense that if I were planning to have a 10% of my savings allocated to bonds, and as long as the bond's return rate is lower than the mortgage interest rate, to put that 10% into mortgage prepayment instead? 

What are your thoughts?

Sub 5% mortgage, you should be able to acquire equities that beat that rate over 20+ years.  By having money in taxable investments that provides you with the ability to have an emergency fund that is earning an equity level return vs. a savings account earning .5%.  If you have your money tied up in your house, then if you lose your job, have a medical emergency, etc. you won't have the cash to get through these events.  If inflation is chugging along at 2-3%, then your true cost to borrow is fairly low.  Some are predicting inflation to increase in the future, which would be good if you have a longterm fixed rate mortgage.   

tomsang

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #106 on: September 05, 2013, 09:28:29 AM »
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

US Mortgage Interest rates had the largest increase in 38 years last week.

http://www.fool.com/investing/general/2013/06/27/weekly-mortgage-rates-rise-most-in-38-years.aspx

Those that have a 30 year fixed rate mortgage in the 3.xx increased their networth on the value of their mortgage.  The value of your locked in cheap loan is an asset as long as you keep it to term.  You can calculate the NPV of the loan with your interest rate and the market's interest rate to determine how much you have made.

To calculate the value of your gain,
1)  Calculate or obtain the Principal and Interest on your current mortgage payment
2)  Figure out what the current interest rate a similar loan at current rates.
3)  Go to this website or your favorite NPV website    http://www.pine-grove.com/online-calculators/present-value-annuity-calculator.htm
4)  Enter your monthly P&I payment as calculated or known in step 1:
5)  Enter today's mortgage interest rate as indicated in step two as the annaul discount rate.
6)  Fill out the term and other information and calculate.
7)  Take Present Value as calculated and subtract your current loan balance
8)  The difference is the NPV gain or loss on your loan vs. the current rates. 

IE:  $450,000 30 year fixed at 3.5% locked where interest rates are now at 4.5%, I left it with no payments made for simplicity sakes even though the 3.5% rates were easier to obtain a few months ago.  The value of your cheap loan is :

$450,000 Loan Balance
($397,086) Present value of the the monthly mortgage payments at 4.5%
$52,914 gain

If your PP, stocks or others are down.  Maybe your interest rate hedge(30 year fixed Rate Mortgage) kicked off a gain this week.  This works in reverse as well if interest rates drop, but they have been at historical lows so the downside risk is probably on the lower end of the spectrum.

Don't prepay your mortgage if you have a low 30 year fixed mortgage.  Enjoy the interest rate hedge.

Tom


mr. T

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #107 on: September 10, 2013, 08:04:04 AM »
I live in the Netherlands. Our situation is as follows:
Mortgage interest is 4.8%. I can deduct this against 42% income tax. So I pay 0.58 * 4.8 = 2.784% myself.

But it doesn't end there. Holland has a capital tax of 1.2%, of which the first own house is exempted. Paying off the mortgage (instead of investing) saves this tax. So the effective rate of the mortgage becomes 2.784 + 1.2 = 3.984%.

But that's still not the end. Holland also has a tax on imputed rent (eigenwoningforfait). You have to add a percentage of the estimated value of your house (for a decent house this is 0.6%) to taxable income. So, for a 200k house this is 1200. Assume this is taxed by the marginal tariff of 42%. This will be 504 per year.

But of course it's not as simple as that. If your mortgage is very low, there is an exeption to the rule (wet Hillen). The imputed rent tax can't be higher then the deduction on the mortgage interest. So, as soon as you can deduct less then 504, this will decrease. In these situations, repaying the remainder will be beneficial.

Conclusion: the situation tends to be highly complex and very dependent on the fiscal regime and the interest rate that can realistically be achieved. Making sweeping statements is perilous.

If you ignore the imputed rent thing, not repaying is theoretically better when you can invest with a yield of more than 3.984%. But this implies some big assumptions:
1- that the fiscal regime stays unchanged. Here in Holland the rules change all the time. Mortgage interest deduction is under debate at the moment. No-one knows how the situation will be in 5 years time. The government can choose to index threshold numbers or not. The government can choose to change the boundaries of tax brackets. Or the tariffs of the tax brackets. Or the percentage of imputed rent tax. And the house is reappraised every year. Assuming a stable environment is skating on very thin ice.
2- here in Holland most mortgages are fixed-interest for about 10 years. Refinancing during this period is often not a good deal since the bank will levy a penalty that's close to the difference in interest. But waiting for renewal is a gamble too: no-one knows the interest rates in e.g. 5 years time. On top of that, 2 of the biggest banks here are nationalised, and a third is still on state aid. Competition on the mortgage market is virtually non-existent at this moment. So it's impossible to predict what kind of offer you will get in the future.
3- you don't know the interest rates of the future. If interest rates turn out to be in the double digits when renewal is due, you'll be very happy with a mortgage-free house.

My personal opinion is that's best to make hay while the sun shines. A low interest rate provides the cashflow that can be used to decrease gearing. When interest rates go up, free cashflow will dry up and repaying will become a lot more difficult. Call me emotional if you want.

About a mortgage as inflation-hedge. This is of course true, in theory. Because it assumes that your income will follow inflation while mortgage payments stay fixed. But for people on a salary this tends not to be the case: in situations with high inflation, salaries tend to stay behind. So, theoretically, your mortgage payments will decrease measured in purchasing power, but the purchasing power of your income will decrease too.  And you will still have to buy food. In this kind of environment, fixed costs can still be a millstone, even when in theory they are shrinking. Of course, if you have the slack to survive until salaries catch up, you're laughing. But a large amount of people will be crushed in the process. Ask the Germans.

Freeyourchains2

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #108 on: September 10, 2013, 08:57:10 AM »
How many people do you know leverage to the hilt @4.5% for 30 years fixed to gain profits?

$500,000 saved could leverage $2,500,000 which could make a profit of $153,000/ year depending on tenants vacancies and repairs. Just get a Jumbo Mortgage, or another option is a Non-recourse Loan and have the bank back your apartment complex as collateral.

Detail assumptions: Full vacancy. $25,000/month summed rents, 2% of Apartment complex for property tax and insurance estimated ($50,000/year). Mortgage @ $112,500/year. Fully runned by you the plumber, owner, manager; Or hire management team for $50,000/year.

mr. T

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #109 on: September 11, 2013, 02:06:08 AM »
You ask me? Here in Holland it's normal to borrow 100% plus financing costs. So, in practice this will be about 110%. In the past it was even crazier: it was common to also borrow for remodelling. Mortgages could go up to 120-130% of the value of the property. In this country, about 1 million houses are underwater. That's an awful lot for a country of 17 million people. Repaying mortgages is a hot topic over here.

I understand that in the US there has been a window of opportunity to lock in an incredibly low interest rate for a very long period. I understand the reasoning behind getting that almost free money and investing it. It's like credit card stoozing. But that's a local and a temporal phenomenon that might not reappear for a very long time. And in many countries it hasn't appeared at all. I think some people here are a bit too easily making statements that will not apply to many readers.

lithy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #110 on: September 11, 2013, 07:18:58 AM »
In this country, about 1 million houses are underwater.

Only now they also owe more on their house than it's worth!

Zing ;)

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #111 on: September 11, 2013, 07:31:10 AM »
In this country, about 1 million houses are underwater.

Only now they also owe more on their house than it's worth!

Zing ;)

I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
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jian

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #112 on: September 21, 2013, 02:56:56 PM »
I suspect the equity market has been overvalued for a while now, in the US at least. So buying more US stocks now might be buying high. I know I know, this is tantamount to market timing, but I can't help it! :D

With that in mind, I wonder if it's safer to make extra mortgage payments? It's a bit complicated, as mine is a rental property with many tax benefits/deductions and I'm too lazy to do the math there. Also, I'm not talking about paying off the mortgage, just making extra payments while stock market seems too high and I hate buying high.

matchewed

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #113 on: September 21, 2013, 03:57:25 PM »
I suspect the equity market has been overvalued for a while now, in the US at least. So buying more US stocks now might be buying high. I know I know, this is tantamount to market timing, but I can't help it! :D

With that in mind, I wonder if it's safer to make extra mortgage payments? It's a bit complicated, as mine is a rental property with many tax benefits/deductions and I'm too lazy to do the math there. Also, I'm not talking about paying off the mortgage, just making extra payments while stock market seems too high and I hate buying high.

If you are not doing long term investing I guess it's something that is valid. But for most FIRE people we're investing for 60+ year periods. Buying stocks now whether it is high or not won't matter in that time frame.

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footenote

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #115 on: November 10, 2013, 01:37:10 PM »
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point. 

OptimusFrugal

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #116 on: November 10, 2013, 02:24:43 PM »
When I finally paid my house off an incredible amount of stress that I did not even know existed was lifted from my life.  There is nothing like being debt free.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #117 on: November 10, 2013, 02:43:06 PM »
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point.

It's not true for most of us here, but it certainly is true of most people.

I bought a motorcycle from a guy who just finished paying off the loan on it, so he upgraded and got a new loan and sold his "old" one to me.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?

At sub 5%?  Absolutely.  At sub 4% it's a no-brainer.  If you expect a 4% SWR to hold, you should be extremely happy at the FREE MONEY (after inflation).
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.

footenote

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #118 on: November 10, 2013, 03:51:33 PM »
"In reality, there is a psychology to debt. Everyone has an "acceptable debt threshold," so paying off debt is a never-ending battle. The moment it's paid off, most consumers with no debt will soon take on new debt within their threshold. So focus on savings and simply keep debt under control."

I stopped reading at that point.

It's not true for most of us here, but it certainly is true of most people.

I bought a motorcycle from a guy who just finished paying off the loan on it, so he upgraded and got a new loan and sold his "old" one to me.

If your house was paid off,  would you go get a mortgage and take the money and invest it in stocks?

At sub 5%?  Absolutely.  At sub 4% it's a no-brainer.  If you expect a 4% SWR to hold, you should be extremely happy at the FREE MONEY (after inflation).
I wasn't saying it might not apply to most people. I was saying it doesn't apply to me.

fmzip

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #119 on: November 19, 2013, 07:13:18 AM »
I had my mortgage down to $35K many many years ago.

My financial adviser at the time suggested refinancing and getting equity out since money was so cheap (4.98%) and my income was high. The plan, invest the money in the market......

Well the market ultimately crashes and 10 years later my mortgage is back down to $45K as I diligently try to pay it off. Do I feel silly for making extra principle payments for the past several years of riding the bull market???

Certainly I'd prefer a larger portfolio but you really have no idea what the stock/housing market will do.

I am eagerly looking forward to having the house paid off in 47 months, much shorter term than some peoples car payments!

I think the other consideration is your age. At 47/49, we have less time to recover. Was this a good gamble 10-12 years ago? Sounded like a smart move.....


okiedoke

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #120 on: November 20, 2013, 11:29:11 AM »
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

US Mortgage Interest rates had the largest increase in 38 years last week.

http://www.fool.com/investing/general/2013/06/27/weekly-mortgage-rates-rise-most-in-38-years.aspx

Those that have a 30 year fixed rate mortgage in the 3.xx increased their networth on the value of their mortgage.  The value of your locked in cheap loan is an asset as long as you keep it to term.  You can calculate the NPV of the loan with your interest rate and the market's interest rate to determine how much you have made.

To calculate the value of your gain,
1)  Calculate or obtain the Principal and Interest on your current mortgage payment
2)  Figure out what the current interest rate a similar loan at current rates.
3)  Go to this website or your favorite NPV website    http://www.pine-grove.com/online-calculators/present-value-annuity-calculator.htm
4)  Enter your monthly P&I payment as calculated or known in step 1:
5)  Enter today's mortgage interest rate as indicated in step two as the annaul discount rate.
6)  Fill out the term and other information and calculate.
7)  Take Present Value as calculated and subtract your current loan balance
8)  The difference is the NPV gain or loss on your loan vs. the current rates. 

IE:  $450,000 30 year fixed at 3.5% locked where interest rates are now at 4.5%, I left it with no payments made for simplicity sakes even though the 3.5% rates were easier to obtain a few months ago.  The value of your cheap loan is :

$450,000 Loan Balance
($397,086) Present value of the the monthly mortgage payments at 4.5%
$52,914 gain

If your PP, stocks or others are down.  Maybe your interest rate hedge(30 year fixed Rate Mortgage) kicked off a gain this week.  This works in reverse as well if interest rates drop, but they have been at historical lows so the downside risk is probably on the lower end of the spectrum.

Don't prepay your mortgage if you have a low 30 year fixed mortgage.  Enjoy the interest rate hedge.

Tom


This is not the full story.  When interest rates rise, people can afford less house (or, more accurately, less house payments).  House prices reflect that fact, if imperfectly.  So, to be theoretically honest and consistent, if you're counting a rise in interest rates as a "gain" because you have a locked-in lower rate, you need to offset that increase by calculating some measure of deduction in the value of  your house. 

There is no free lunch.

matchewed

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #121 on: November 20, 2013, 01:38:13 PM »
Has anyone calculated the value of their mortgage?  Current mortgage rates in the US are reaching a 2 year high. http://www.bloomberg.com/news/2013-09-05/u-s-mortgage-rates-increase-with-30-year-fixed-at-4-57-.html?cmpid=yhoo

Here is how to calculate the value of your 30 year fixed rate mortgage! My 30 year fixed rate interest rate hedge is kicking off some great gains over the past three months. 

/snip for brevity

This is not the full story.  When interest rates rise, people can afford less house (or, more accurately, less house payments).  House prices reflect that fact, if imperfectly.  So, to be theoretically honest and consistent, if you're counting a rise in interest rates as a "gain" because you have a locked-in lower rate, you need to offset that increase by calculating some measure of deduction in the value of  your house. 

There is no free lunch.

You're presuming a correlation between housing prices and interest rates. You don't need to offset that increase if that doesn't actually hold that the value of your house has reduced. More on the lack of correlation here. And here.

okiedoke

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #122 on: November 21, 2013, 04:09:30 PM »

Matchewed:  that's helpful, puzzling, and interesting.  Thanks. 

If Shiller says there's not a tight fit between rates and prices, I pretty much have to defer to him -- nobody would know better.   I have all sorts of thoughts about whether the explanation of "rising interest rates = good economy and higher wages that compensate for the decrease in purchasing power" would still hold true.  E.g., we're operating in an historically unprecedented rate suppression, with what seem like serious, titanic shifts in the labor market, etc.  But I confess that those are just grasping attempts to justify my position (well, a perfectly standard economic theory).  Since I have no data better than Shiller's, so I'll concede the point.   

How's that for a weird internet message board post?   

jrhampt

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #123 on: November 21, 2013, 07:07:07 PM »
I had my mortgage down to $35K many many years ago.

My financial adviser at the time suggested refinancing and getting equity out since money was so cheap (4.98%) and my income was high. The plan, invest the money in the market......

Well the market ultimately crashes and 10 years later my mortgage is back down to $45K as I diligently try to pay it off. Do I feel silly for making extra principle payments for the past several years of riding the bull market???

Certainly I'd prefer a larger portfolio but you really have no idea what the stock/housing market will do.

I am eagerly looking forward to having the house paid off in 47 months, much shorter term than some peoples car payments!

I think the other consideration is your age. At 47/49, we have less time to recover. Was this a good gamble 10-12 years ago? Sounded like a smart move.....

Great story!  This is exactly why I am paying down my mortgage ahead of schedule. 

willn

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #124 on: November 22, 2013, 10:23:38 AM »
Math optimizing nerds calculating returns sometimes (often?) don't consider all risks-oh sure, they calculate the SWR based on long term market trend, and the lost opportunity of investment.

But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

But there are not insignificant risks to consider besides the lost opportunity of investment gains when considering whether to pay it off.

Accepting risk is a personal decision--no one can make if for you, so be sure you consider as many imaginable scenarios as you can.  Layoffs, illness, and bad economies happen pretty often, and sometimes they do overlap. Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.







fiveoclockshadow

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #125 on: November 22, 2013, 12:09:42 PM »
Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.

Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #126 on: November 22, 2013, 12:22:48 PM »
Your calculations should consider not just the sunny continuing accumulations of assets but also the probability of the worst case scenario and how you would weather it.

Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.
+1
I often wince when reading advice here delivered as shibboleth regardless of your age or other circumstances. There are immense differences in the best decisions regarding investment / work / paying off a mortgage for a 25 YO vs a 45 YO vs a 65 YO. We shouldn't act or advise otherwise.

The "no/lo" insurance strategies also make me shake my head....

blanch1118

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #127 on: November 22, 2013, 12:53:01 PM »
But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

I would counter by saying, what if you lose your job and have your assets tied up by prepaying your mortgage? You can always sell shares (even devalued ones) to pay bills, but it is harder to sell your house to get your equity back.  Investments are much more liquid and leave the investor with more flexibility.

I am not necessarily advocating that, but just pointing out the other side.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #128 on: November 22, 2013, 01:39:08 PM »
But, if you aren't FI yet and depend on your income for housing and investing, what happens if you lose your job while you have that mortgage that you could have paid off?  And the money you invested by not paying off the mortgage, has now dropped in half?  Throw in a major illness of your spouse.  Now your house is underwater, your investments are say 60% of what they were, and you can't wait 7 years for the market to bounce up to start pulling money out.  How much is it in a tax deferred, possibly penalized account?   I'm not seeing many math calculations addressing that scenario.  Hey, sometimes it may still be favorable to keep the mortgage, even so.

I would counter by saying, what if you lose your job and have your assets tied up by prepaying your mortgage? You can always sell shares (even devalued ones) to pay bills, but it is harder to sell your house to get your equity back.  Investments are much more liquid and leave the investor with more flexibility.

I am not necessarily advocating that, but just pointing out the other side.

Yep, that's the choice we all have to make.

For me, a paid for house, since its the single largest payment we (wouldn't) have, a 10 or 20k cash emergency fund could last a very, very long time, which to me is very valuable.  Faced with a series of crises, that peace of mind is a financial asset that will have returns.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #129 on: November 22, 2013, 09:33:17 PM »
Actually the only thing you should really consider in retirement planning is the worst case scenario and how you would weather it.

The one problem with this forum is it often seems dominated by the 100% stocks and then leverage some more crowd.  Which is strange since there seems to be a high density of those capable at math here.  Unfortunately many seem to know just enough math to get themselves in trouble, it is as if they've never heard of the pain of "sequence of returns" and follow the blind fallacy of SWR.

Two mitigating factors to being too conservative though.  One, if you are really living the Mustachian life then the mortgage is probably not huge to begin with (control your housing costs) so the amount of leverage may not be that high if you defer paying off.  Second, the Mustachian way of life says you are always ready to re-enter the workforce if necessary and so "weather it" means something different than for an 85 year old. 

While those are both important things to remember I frequently read posts here that make me think the authors don't really understand the risks in the market or have a glib perception of their tolerance for taking risk.  As you say a personal decision, but making that decision requires a fair bit of understanding of the market and a fair bit of careful introspection .  I often wonder if those with 100% equity positions, 80% LTV mortgages, no insurance and a $1000 emergency fund have really considered their decisions.

+1
I often wince when reading advice here delivered as shibboleth regardless of your age or other circumstances. There are immense differences in the best decisions regarding investment / work / paying off a mortgage for a 25 YO vs a 45 YO vs a 65 YO. We shouldn't act or advise otherwise.

The "no/lo" insurance strategies also make me shake my head....

To me, this attitudes much more likely to lead to portfolio failure.  Maybe not you two in particular, but those with the super conservative mindset.

People advocating for the aove almost always confuse risk with volatility.  Stocks are more volatile.  They aren't more risky.

Historically investing in "safer" assets is much more likely to lead to portfolio failure.  The worst years in history that lead to portfolio failure are due to inflation, not low or negative returns.  With us Mustachians especially, having super long retirements, inflation is the killer that will ruin you.

Volatility you see happening and can reduce expenses.  Slow erosion of your buying power though (while wages move to match pace, but your conservative investments don't) you can't come back from.

I'd much rather be in stocks and last for the long run than something "safe" in the short run (I.e. protects my principal with low/no volititlity) but guaranteed to fail in the long run.  I think you agree, which is why your portfolio isn't 100% cash, you just haven't played that tune to the end.

To each his own, and best of luck with your ER portfolio.
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #130 on: November 23, 2013, 05:13:47 AM »
ARebelSpy - No where did fiveoclockshadow or I advocate for anything nearly as conservative as 100% cash. I personally have relatively little cash in my portfolio.

I'm all for a balanced portfolio (including more equities than have been commonly recommended during retirement than was recommended in years past) at any stage of life. Both fiveoclockshadow and I were simply observing that 100% stocks is not always wisest for every stage in life. I don't understand what "you just haven't played that tune to the end" means - can you say more?

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #131 on: November 23, 2013, 05:43:32 AM »


People advocating for the aove almost always confuse risk with volatility.  Stocks are more volatile.  They aren't more risky.

Historically investing in "safer" assets is much more likely to lead to portfolio failure.  The worst years in history that lead to portfolio failure are due to inflation, not low or negative returns.  With us Mustachians especially, having super long retirements, inflation is the killer that will ruin you.

Volatility you see happening and can reduce expenses.  Slow erosion of your buying power though (while wages move to match pace, but your conservative investments don't) you can't come back from.

I'd much rather be in stocks and last for the long run than something "safe" in the short run (I.e. protects my principal with low/no volititlity) but guaranteed to fail in the long run.  I think you agree, which is why your portfolio isn't 100% cash, you just haven't played that tune to the end.

To each his own, and best of luck with your ER portfolio.

As you know, equities have higher standard deviations (volatility) than bonds and, usually, higher returns.  Yes, you can see volatility happen, but you can't control it, aside from lowering expenses or using human capital, if you don't have non-volatile assets to draw down until the storm ends or benefit from it, by re-balancing.  If the variance is a deep long sink, then what? 

BTW, I don't think anyone is planning on a portfolio of T-bills.  Bernsetin talks about stages to investing, but YMMV. 

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #132 on: March 03, 2014, 10:34:38 AM »
http://vmichelangeli.com/Michelangeli_PayoffMortgInvest_Nov1_2011.pdf

Interesting Phd paper that I must claim that I don't fully track, but if I read it correctly it says you will be financially better off to not pay off the mortgage. If I read it correctly it also says that the probability that you will live to 80-100 increases if you pay off the mortgage. So you will live longer with no debt:)  I might need a true scientist to tell me what the paper says as it is pretty complex.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #133 on: March 03, 2014, 11:20:34 AM »
Seems fairly straightforward.

Quote
I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

Quote
Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.
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foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #134 on: March 03, 2014, 12:18:19 PM »
The question then is does what makes sense for a 20 year time frame (the paper) make sense for a 40 year one? The odds are not paying off the mortgage is the go up as your time frame expands (from 10 years to 30) AND as the rates go down (I have a lot of confidences I can bet <3%. The 6.75 of like 8 years ago is a lot tougher).


Seems fairly straightforward.

Quote
I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

Quote
Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.

PeteD01

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #135 on: March 03, 2014, 03:03:50 PM »
Seems fairly straightforward.

Quote
I find that, on average, retirees with less than $300,000 in non-housing financial wealth are better off keeping the mortgage and investing.

Quote
Households with more than $300,000 in financial wealth can benefit from prepaying when the years to termination are less than eleven. Having enough liquidity in their portfolio, they save on interest payments and benefit from the elimination of the inflationary risk. However, when the years to loan termination increase, those households experience welfare losses, which result from the opportunity cost of not investing large sums in financial assets with higher expected returns.

Fortunately, the calculations do not have to be performed by the individual - only common sense is required.

If you don't plan for FIRE and 65 is a long ways off - don't pay off your low rate mortgage. All you need to do is to invest and at 55 you look if you got about $300k and if yes start paying off your mortgage. Not very smart but not too dumb either as a strategy.

If you do plan for FIRE you need to monitor your market investments and begin paying off the mortgage when you have enough invested to fund FIRE by the time the mortgage is payed off - that will likely be a shifting target for a while.
In other words, the decision to pay off your mortgage becomes dependent on the time to FIRE which in turn depends on the size of the stache. Your saving rate and market returns thus determine not only the timing of FIRE but also the timing of mortgage payoff - pretty straightforward, I think.

Peter
« Last Edit: March 03, 2014, 03:06:52 PM by PeteD01 »

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #136 on: March 04, 2014, 09:36:15 AM »
There is a practical consideration that always seems to be overlooked in these "to pay off mortgage early or not" discussions.  Yes, it is true that paying off a mortgage early is "suboptimal from a math standpoint" if the interest rate on the investments that otherwise would have been made in lieu of the early principal payments exceeds the interest rate on the mortgage.  However, for cash flow purposes, the interest rate on the alternative investment needs to not only exceed the interest rate on the mortgage, but exceed it by enough of a margin that the investment income covers the ENTIRE mortgage payment (principal and interest).

Let's use the clear and concise example from earlier in this thread, except instead of assuming a 7% rate of return on the cash on hand, let's assume a 4.5% rate of return (which still exceeds the 4% interest rate on the mortgage).

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 4.5%: $4500 annually = $375 monthly
Monthly expenses not covered by passive income: $2102

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000
-----------------------------------------------------------

Now, even though the cash on hand is earning an interest rate higher than the interest rate charged on the mortgage, our hypothetical homeowner has $102 of monthly payments that is NOT covered by the passive investment income.  He/she would need additional income to make up the shortfall.  Which means he/she needs to wait until he/she has amassed additional assets to generate that income in order to retire.  Which means the decision not to pay off the mortgage has indeed DELAYED financial independence.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #137 on: March 04, 2014, 10:17:34 AM »
Brooklynguy-  The major risk that you may want to consider is that paying off your mortgage early is creating liquidity risk. You are not improving networth per se, as you should be able to invest in assets that out perform a 4% or less mortgage.  In your scenario with a mortgage you have $100k of liquidity if it all hits the fan. Even if we have a huge recession and your investments lose 50% of their value you have $50k to get you through the rough patch.  This amounts to 20 months of protection or safety.  Under the paid off mortgage scenario you have no cushion or safety.  Even if you come back with "I have a 6 month emergency fund", you are still much riskier than if you had the investments in the bank.  The person with a mortgage would have an emergency fund and 20+ months of investments (40+ if the world didn't crash and you still have $100k+ in investments). 

The other major issue when you are paying off your mortgage early is you are not off the hook for your monthly payment.  Until you have paid off your mortgage, you still owe the payment each month.  So if you prepay $50k, then it all hits the fan you still owe the $477 per month payment.  If you can't make the payment because everything hits the fan, you can't call the bank and say I prepaid $50k.  They will say thank-you, please make your payment of $477 by this date or we will begin foreclosing procedures.  At this point you don't have the investment fund to get you through this rough patch.  So under the prepaying each month scenario you are in the riskiest scenario as you are illiquid, still owe a set amount each month, and you have your assets tied up in an asset that probably lost value and the assets can not be extracted. 

The only benefit of paying off your mortgage early is that it is a way to lock up your assets so you don't buy stupid stuff.  If you need that then you will be better off. By setting up this system, you are taking on a lot of liquidity risk and you don't have a diversified asset allocation.

Again paying off the mortgage isn't as "evil" as buying an SUV, but it may not be optimal for investment returns or as safe as people believe.  Having debt for assets is not evil and it can be safer than having no debt.  Debt is a business transaction.  If it used in a Mustachian manner it may push up your FI date, especially for those that have sub 4% fixed rate mortgages.

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #138 on: March 04, 2014, 10:41:57 AM »
Tomsang - my example referred to paying off the mortgage in full, in which case you are off the hook for the monthly payments.  You are right that liquidity risk is an issue, but with a paid off mortgage you remove the mortgage payment from the monthly expenses.  In my personal situation, unlike the hypothetical example, my mortgage payment represents over half of my monthly expenses.

And there are other factors to consider as well, which I didn't want to complicate my first post with.  For example, in my situation (with my very large NYC-area mortgage), if I keep my mortgage outstanding and invest that money instead of using it to pay off my mortgage, the investment earnings will have a substantial effect on the tax credits I would receive under the Affordable Care Act.

So I'm just trying to point out that the calculus isn't as simple as "if I can earn a better rate of return than my mortgage interest rate, I should not pay off my mortgage."

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #139 on: March 04, 2014, 10:58:55 AM »
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #140 on: March 04, 2014, 12:07:21 PM »
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.
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brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #141 on: March 04, 2014, 12:34:02 PM »
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.

Good point.  So that takes care of the compounding of the cash flow problem, but not the original cash flow problem itself.  In my situation, I have a mortgage interest rate of 3.875% but would need to earn 6.3% on the outstanding principal balance (assuming I had that amount saved) in order to generate income to cover my total mortgage payment (I refinanced in April 2013 and have been paying down pretty aggressively since then -- if I had not made any additional principal prepayments, the rate I would need to earn would be 5.64%).

In these discussions, people generally say if the mortgage rate is less than 4% you should keep it outstanding, but doesn't that implicitly assume that your stash will earn at least 5.64% (rather than the standard 4% generally assumed for SWR purposes)?  Is the discrepancy that the 4% SWR already accounts for inflation, while inflation can be disregarded (and therefore a higher rate of return can be assumed) for purposes of the mortgage determination since mortgage payments are fixed over time?

foobar

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #142 on: March 04, 2014, 12:48:20 PM »
Why on earth would payment need to be made using the passive return of the investment? In your example, you are losing 23k by paying off the mortgage early. Put in 7% and you gave up on 200k in order to sleep better at night. And if you follow Dave Ramsey and are getting your 12% you passed up 1.9 million:)

By paying off the mortgage you avoid market risk but by doing the lower return/lower risk option, you bring longevity risks into the equation. When you need to write 20k/yr property tax checks in 30 years would you rather have a paid off mortgage or a payed of mortgage and 200k in cash?

There is a practical consideration that always seems to be overlooked in these "to pay off mortgage early or not" discussions.  Yes, it is true that paying off a mortgage early is "suboptimal from a math standpoint" if the interest rate on the investments that otherwise would have been made in lieu of the early principal payments exceeds the interest rate on the mortgage.  However, for cash flow purposes, the interest rate on the alternative investment needs to not only exceed the interest rate on the mortgage, but exceed it by enough of a margin that the investment income covers the ENTIRE mortgage payment (principal and interest).

Let's use the clear and concise example from earlier in this thread, except instead of assuming a 7% rate of return on the cash on hand, let's assume a 4.5% rate of return (which still exceeds the 4% interest rate on the mortgage).

With a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $100,000
Monthly mortgage payment (at loan interest rate of 4%): $477
Total monthly expenses: $2477

Cash on hand: $100,000 (invested instead of paying off the house)
Passive income from cash on hand at 4.5%: $4500 annually = $375 monthly
Monthly expenses not covered by passive income: $2102

Without a mortgage
-------------------------------------------------------
Monthly non-housing expenses: $2000
Current mortgage on house: $0
Monthly mortgage payment: $0
Total monthly expenses: $2000

Cash on hand: $0
Passive income from cash on hand: $0
Monthly expenses not covered by passive income: $2000
-----------------------------------------------------------

Now, even though the cash on hand is earning an interest rate higher than the interest rate charged on the mortgage, our hypothetical homeowner has $102 of monthly payments that is NOT covered by the passive investment income.  He/she would need additional income to make up the shortfall.  Which means he/she needs to wait until he/she has amassed additional assets to generate that income in order to retire.  Which means the decision not to pay off the mortgage has indeed DELAYED financial independence.

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #143 on: March 04, 2014, 01:06:22 PM »
Also, the cash flow problem reflected in my example is compounded if the homeowner (like myself) has already started down the road of prepaying their mortgage.  In that situation, your monthly mortgage payment is disproportionately large compared to the outstanding principal (because it was based on the original principal amount), so if you decide to change course and start diverting principal prepayments to other investments, then those investments need to earn an even higher rate of return to cover the principal + interest than if you would've taken the approach of not paying down the mortgage to begin with.

Refi.

Good point.  So that takes care of the compounding of the cash flow problem, but not the original cash flow problem itself.  In my situation, I have a mortgage interest rate of 3.875% but would need to earn 6.3% on the outstanding principal balance (assuming I had that amount saved) in order to generate income to cover my total mortgage payment (I refinanced in April 2013 and have been paying down pretty aggressively since then -- if I had not made any additional principal prepayments, the rate I would need to earn would be 5.64%).

In these discussions, people generally say if the mortgage rate is less than 4% you should keep it outstanding, but doesn't that implicitly assume that your stash will earn at least 5.64% (rather than the standard 4% generally assumed for SWR purposes)?  Is the discrepancy that the 4% SWR already accounts for inflation, while inflation can be disregarded (and therefore a higher rate of return can be assumed) for purposes of the mortgage determination since mortgage payments are fixed over time?

So draw down on the principal a little to cover the whole payment.  You'll still come out ahead, as long as the amount you earn is higher than the mortgage interest, it doesn't have to be high enough to cover the whole thing merely with interest, if you have to draw down some of your liquid principal to turn it into equity (i.e. the principal part of your mortgage payment), that's fine.

You're assuming the amount generated has to cover the interest and principal, when that isn't the case, your original premise is faulty.

:)
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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #144 on: March 04, 2014, 01:12:47 PM »
If you do not have enough (potentially liquid) investments to be able to make your mortgage payments when you lose your job, you do not have enough investments to do an early mortgage payoff and you will need to keep investing as much as you can. That is simple and straightforward.

If you do have enough investments to be able to weather a temporary job loss AND have enough investments for FIRE (at the time of loan termination) without the mortgage payment, then paying off the mortgage (deleveraging your investments) is an excellent way to reduce overall volatility (you can express that as the volatility of time to FIRE).

What you are engaging in is liability matching and, by using the mortgage payoff route, you need less than by trying to match the liability with investment returns which means less time to FIRE.

There is only one way that market investments will put you ahead in time to FIRE in this scenario and that is unusually high market returns.

Now, if you do not have enough (potentially liquid) investments to weather job loss and to be FIRE without the mortgage payments, the opposite is true - well, not quite: The odds of less time to FIRE are lower with paying off your mortgage earlier because volatility has a much lesser effect on time to FIRE because of the extended time in the market. In other words, the closer you are to FIRE, the more susceptible your date of FIRE is to market volatility.

None of this makes any sense though if one assumes any sort of constant return from the market - but that is just not how the market works.

Peter

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #145 on: March 04, 2014, 01:14:11 PM »
Why on earth would payment need to be made using the passive return of the investment?

Because once I am retired that will be the only source of cash flow to make the payment.  That was my point -- I understand that if you have the capability to make the mortgage payments, it is optimal to keep the mortgage outstanding as long as you can invest in assets that outperform the mortgage rate.  But for an early retiree with no income other than investment returns, the investment really needs to earn enough to cover the entire mortgage payment (not just the interest portion) or you simply won't have the cash to make the mortgage payment (and that's when you start to run the risk of needing to sell assets in down years to make the mortgage payments).

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #146 on: March 04, 2014, 01:24:58 PM »
Why on earth would payment need to be made using the passive return of the investment?

Because once I am retired that will be the only source of cash flow to make the payment.  That was my point -- I understand that if you have the capability to make the mortgage payments, it is optimal to keep the mortgage outstanding as long as you can invest in assets that outperform the mortgage rate.  But for an early retiree with no income other than investment returns, the investment really needs to earn enough to cover the entire mortgage payment (not just the interest portion) or you simply won't have the cash to make the mortgage payment (and that's when you start to run the risk of needing to sell assets in down years to make the mortgage payments).

No, this is not true.

Did you read what I said?  You can draw down on the principal (of the amount that you'd have used to pay the mortgage off, not your other stache).

Let say you have 1MM portfolio and 300k mortgage (scenario A)

Or you can pay that mortgage off and have 700K portfolio, no mortgage (scenario B).

And we'll say that you need 700k portfolio to live on.  You're saying option B is the only viable one if the interest earned on the 300k doesn't cover the full mortgage payment (principal + interest).  I'm saying you can use the interest earned from the 300k, and withdraw some of the 300k, to make that payment.  Then you're transferring that extra in your stache to extra equity (via the principal part of your payment) in the house.

You were already willing to draw down the whole 300k in scenario B, in scenario A you will draw it down slowly as well (and either way you're living on the income from the 700k, that doesn't change, and doesn't get drawn down in either scenario), but as long as that 300k is earning more interest in your portfolio than you are paying on your mortgage, then the longer you keep it as part of that portfolio, instead of equity not earning anything (or rather, earning the rate of the mortgage interest), the more you'll have in the end.  In scenario A you'll end up with more money overall.

Do you understand now why your premise that it has to cover the full payment isn't valid (because you can use those funds you would have used to pay it all off to instead draw down on slowly)?  :)
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brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #147 on: March 04, 2014, 01:39:11 PM »
Thanks, arebelspy.  Our posts crossed.  You are right, my original premise was faulty.  But in your scenario A, there is the risk that principal will have to be drawn down after a huge market crash in the early years, which could severely impair the ability to catch back up later.  But I suppose that risk could be mitigated by holding a cash cushion.  I also need to weigh factors like the other one I mentioned, eligibility for ACA subsidies.  But you have given me a lot think about -- thanks very much!

arebelspy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #148 on: March 04, 2014, 01:47:03 PM »
Thanks, arebelspy.  Our posts crossed.  You are right, my original premise was faulty.  But in your scenario A, there is the risk that principal will have to be drawn down after a huge market crash in the early years, which could severely impair the ability to catch back up later.  But I suppose that risk could be mitigated by holding a cash cushion.  I also need to weigh factors like the other one I mentioned, eligibility for ACA subsidies.  But you have given me a lot think about -- thanks very much!

Yes, that is a risk.  But on a long enough timeline (i.e. a 30 year mortgage), you'll come out ahead the vast majority of the time (maybe every time, historically, depending on the rate of your mortgage).

There is always some slight risks/tradeoffs.  No one is saying that investing is the right decision 100% of the time.  Just that mathematically, you'll nearly always have more money in retirement if you don't pay it down, and if you want to play the odds, they're vastly in favor of not paying off your mortgage, paying it down early is costing you money from the opportunity cost of those funds.

Thanks for the fun discussion.  :)
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
If you want to know more about me, this Business Insider profile tells the story pretty well.
I (rarely) blog at AdventuringAlong.com. Check out the Now page to see what I'm up to currently.

brooklynguy

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Re: Paying off Mortgage Early How bad is it for your FI Date?
« Reply #149 on: March 04, 2014, 03:00:08 PM »
Keeping my mortgage outstanding post ER also makes it more complicated for me to determine how much I need to retire.  I had been using a number equal to 25x my annual expenses excluding my mortgage payments (on the assumption that my mortgage would be fully paid off at the time I declare FIRE), plus a cushion.  Any thoughts on the best way to calculate the number needed if the mortgage will remain outstanding?  One way to think about it would be to use the same number I used previously, plus additional investments in an amount equal to the remaining balance of the mortgage.