Author Topic: Paying off Mortgage Early – How bad is it for your FI Date?  (Read 212117 times)

texxan1

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #550 on: April 11, 2018, 04:51:38 PM »
I had a simple and logical choice to pay off my mortgage.. Simply did the calculations to see how much I would save by paying it off... Saved me 125k in interest payments.. However, I could have made more than that by putting it in the market for the long term... BUT,   The mindset of having a mortgage free house and the freedom to choose is what set it apart.. I would do it again anytime....

It only saved me $1200 a month, which all gets invested now, but the FEELING of freedom outweighed the loss of potential income...

YMMV

tomsang

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #551 on: April 12, 2018, 01:02:44 AM »
I had a simple and logical choice to pay off my mortgage.. Simply did the calculations to see how much I would save by paying it off... Saved me 125k in interest payments.. However, I could have made more than that by putting it in the market for the long term... BUT,   The mindset of having a mortgage free house and the freedom to choose is what set it apart.. I would do it again anytime....

It only saved me $1200 a month, which all gets invested now, but the FEELING of freedom outweighed the loss of potential income...

YMMV

I think you understand the concept. Mathematically and logically everyone knows that paying off a 30 year fixed rate low interest rate is dumb, yet people still do it. It is like buying a Hummer. Everyone know it is a bad investment, but emotionally people make stupid choices. When emotions take over math, logic and knowledge you get society. When people base their decisions on math, logic and knowledge you get Mustachian behavior.

Scandium

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #552 on: April 12, 2018, 08:36:43 AM »
I’ve read most of this thread and I hope I am not rehashing something that I missed.

 I have run the cFIREsim scenarios for myself and see how keeping the mortgage is the better option. However, I found this article gave me things to think about I hadn’t considered before. https://earlyretirementnow.com/2017/10/11/the-ultimate-guide-to-safe-withdrawal-rates-part-21-mortgage-in-retirement/

“The lesson from this exercise: If you are risk-averse and like to hedge out the tail risk it’s best to have no mortgage and a moderate bond allocation. If you are a risk-taker (degenerate gambler?) then you might as well go all-in: Have a mortgage and 100% equities in the portfolio as well. Having both a mortgage and a bond portfolio doesn’t make any sense.”

In short, on average keeping the mortgage is best, but if you are concerned about limiting risk for sequence-of-returns failures and protect against the low probability worst-case scenarios it is better to not have a mortgage.

The bolded makes no sense. A bond allocation is a diversified liquid asset you can use to re-balance (or pay of the mortgage), a mortgage is not liquid and highly concentrated. In 500+ posts I'm sure it's been said here many times, but a mortgage is not the same as bonds.

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #553 on: April 12, 2018, 09:27:38 AM »
I had a simple and logical choice to pay off my mortgage.. Simply did the calculations to see how much I would save by paying it off... Saved me 125k in interest payments.. However, I could have made more than that by putting it in the market for the long term... BUT,   The mindset of having a mortgage free house and the freedom to choose is what set it apart.. I would do it again anytime....

It only saved me $1200 a month, which all gets invested now, but the FEELING of freedom outweighed the loss of potential income...

YMMV

I think you understand the concept. Mathematically and logically everyone knows that paying off a 30 year fixed rate low interest rate is dumb, yet people still do it. It is like buying a Hummer. Everyone know it is a bad investment, but emotionally people make stupid choices. When emotions take over math, logic and knowledge you get society. When people base their decisions on math, logic and knowledge you get Mustachian behavior.
It's an exaggeration to call it dumb, mathematically wrong, or stupid.  Superior market returns is an assumption about the future based on a model relying on historical data.  Calling that math is distorting and missleading in my opinion because it is important to distinguish certain outcomes that rely solely on a stream of payments (payoff) from uncertain probability based models (typical firecal sims) and from the even more uncertain reality: our plans rely on an assumption-based predictive model dependent on the continuation of historic economic and behavioral patterns  for market returns.  Continued market returns rely on several assumptions, including: 1) sustained economic growth, 2) consistent behavior patterns around asset valuations via equity intruments.  The predictive power of data is both likely and useful, but not certain.  The predictions can change or be flat out wrong.
8
Anyway, holding a morgage during the accumulation phase has been a hisorically good bet.   Its just that.  Calling a certain outcome with lower returns a stupid decision is exaggerating the predictive power of our models of past results, IMHO. If your logic was correct, no long debt instrument would exist.  No investor would buy T-bills, 30 year munis, or preferred stock.

over 95% of forum users rely on the assumption that the equity returns we've seen in the past will continue and support them in retirement for many many years.  So to completely throw out that assumption and just say it may not happen b/c we dont know the future and say that its not math is incorrect.  Its Hummer level stupid to believe equities can support you in FIRE and at the same time pay down a low fixed rate mortgage faster than the term in lieu of investing. 

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #554 on: April 12, 2018, 07:22:15 PM »
So you're a top tier upper management person who retired in their late 50s early 60s that's not FIRE that's retirement. And most would not consider that to have equated to a frugal lifestyle. But you are retired.  I don't know that id trust your keys to a FIREd life though.

LWYRUP

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #555 on: April 12, 2018, 07:49:07 PM »

I'm sure this has been said somewhere in the thread, but comparing a risk free mortgage payoff with a risky stock investment is comparing apples to oranges.

Paying down a mortgage is more like buying bonds.

I purposefully have kept my bond allocation very low but also prepaid my mortgage a bit.

Knowing that I am getting a guaranteed return with some of my money makes me feel better about having 90% of the rest in the stock market at continual all-time highs.

Mortgage prepayment can be one part of an overall investment and liquidity strategy that includes stocks, bonds, commercial real estate, savings accounts, etc.

You should go read the thread

I did.  It is a good thread although complex with lots of arguments and made my head hurt.  Someone could probably make money on their blog by dumbing it down for people.  :)

I get that if you are assuming 7% portfolio growth and a 4% mortgage then it makes sense to contribute to the portfolio rather than the mortgage.  I am still a bit confused about how mortgages work with bond allocations though.

Let's assume someone with a $1 million portfolio that is 75% stock and 25% bonds and a mortgage of 250k at 4%.  One day that person says "bonds really suck, but I take a lot of risk already and I don't want to just dump all that money in the stock market."  Then they decide to dump their bond holdings and pay off their mortgage.

Now they are at $750k, all stock with a paid off house and no mortgage.  Are they in better or worse shape than before?

Basically, is it a bad idea to prepay your mortgage if the funds for the prepayment come from the bond pot rather than the stock pot?
« Last Edit: April 12, 2018, 07:54:04 PM by blinx7 »

ACyclist

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #556 on: April 12, 2018, 07:55:24 PM »
Following Boarder's advice, I stopped paying the mortgage off.  Well, mostly. I only make an extra $25 payment.  This is a big step for me, considering that I was doubling my payment for quite a while.  The interest rate isn't super low though.  It is 4.75.  Not great.  We took the loan in 09 and we have about 14 payments left.  We've been dumping the extra payment in index funds.  We bought some, and the market pulled way back early in the year.  That did not feel good at all. 

Staying the course despite wanting to just pay it off and be done.  Like I said, only $25 extra a month to round up the payment to an even $400. 

I admit that it will feel good to be debt free.  A goal that many don't accomplish.  Debt makes me stress.

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #557 on: April 13, 2018, 04:52:58 AM »

I'm sure this has been said somewhere in the thread, but comparing a risk free mortgage payoff with a risky stock investment is comparing apples to oranges.

Paying down a mortgage is more like buying bonds.

I purposefully have kept my bond allocation very low but also prepaid my mortgage a bit.

Knowing that I am getting a guaranteed return with some of my money makes me feel better about having 90% of the rest in the stock market at continual all-time highs.

Mortgage prepayment can be one part of an overall investment and liquidity strategy that includes stocks, bonds, commercial real estate, savings accounts, etc.

You should go read the thread

I did.  It is a good thread although complex with lots of arguments and made my head hurt.  Someone could probably make money on their blog by dumbing it down for people.  :)

I get that if you are assuming 7% portfolio growth and a 4% mortgage then it makes sense to contribute to the portfolio rather than the mortgage.  I am still a bit confused about how mortgages work with bond allocations though.

Let's assume someone with a $1 million portfolio that is 75% stock and 25% bonds and a mortgage of 250k at 4%.  One day that person says "bonds really suck, but I take a lot of risk already and I don't want to just dump all that money in the stock market."  Then they decide to dump their bond holdings and pay off their mortgage.

Now they are at $750k, all stock with a paid off house and no mortgage.  Are they in better or worse shape than before?

Basically, is it a bad idea to prepay your mortgage if the funds for the prepayment come from the bond pot rather than the stock pot?

I'd say worse. Bonds can be rebalanced and have historically avg a higher return than 4%. Comparing mortgages to bonds is apples to oranges. But does come up alot.

For a lower income mustachian mortgage leveraged real estate investment is a great path to a quick FIRE.

Limiting spending only does so much. And often when we're discussing larger fixed mortgages 200k or more. Not paying a notmortgage down is more efficient than most cost cutting efforts that are extremely glorified here like making your lunches and biking to work.

Also it's important to note we should be comparing a4% mortgage to 10-11% returns since 7% is removing inflation. Mortgages are fixed and don't index to inflation so if you want to use 7% for stock returns you should be using 1% for your 4% mortgage.

ChpBstrd

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #558 on: April 13, 2018, 02:51:30 PM »
I think a paid-off house can be somewhat risky, particularly in a HCOL area. Now that housing prices are back to or beyond 2007 levels, what if it drops in value 50% again? If your equity is only 20-25% you exercise your foreclosure option and walk away, having lost only your down payment plus a few payments. If your equity is 100%, you just lost almost 4X as much. A mortgage is both a put option and an inflation hedge.

Now think of location-specific risks. What happens to Vegas when lots of states legalize gambling? What happens to Miami or New Orleans as sea levels rise? What happens to Silicon Valley when remote working technologies mature? What happens to West Texas when electric cars become the dominant technology? What happens to your property value when the neighborhood goes downhill? Lots of reasons to have a put option.

Seems like concentrating one's wealth in one piece of real estate is risky. Would you put it all in one bond?

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #559 on: April 15, 2018, 09:02:16 AM »
homes dont track inflation homes track wage growth. common misconception.  they are similar but not the same.

Radagast

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #560 on: April 16, 2018, 07:31:54 PM »
Interesting about house prices and inflation versus incomes. I hadn't thought of that before. I also liked the discussion of a mortgage as an expense, not an investment.

My take on this long thread:
Obviously it is a bad idea to make early payments if you do not have the cash to pay a mortgage in one lump sum. That is increasing risk and lowering returns. Paying it off in one lump sum near FIRE is a different case when you have more than sufficient investments to do so though.

Risks to KEEPING a mortgage:
Increased sequence of returns risk.
Increased deflation risk.

Risks to PAYING OFF the mortgage:
Increased long-term shortfall risk.
Increased inflation risk.

There are risks either way, it is not an obvious answer without knowing the future. Personally, I lean slightly on the side of keeping a mortgage. There is a millennia-long history of governments inflating their currencies to oblivion whenever they get into a tight spot. Bill Bernstein thought inflation was the mostly likely "deep risk" in his book "Deep Risk." Therefore, I think keeping a mortgage might be a good way to hedge against deep risk while also increasing expected returns. But it is not an obvious answer, more like a 4:3 split.

ChpBstrd

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #561 on: April 16, 2018, 09:16:04 PM »
Everybody should know that paying down a mortgage is equivalent to making an investment at the mortgage's interest rate - assuming either (a) the mortgage interest is deductible and the investment would be in a taxable account, or (b) the mortgage interest will not be deducted and the investment will be in an IRA. If you have a 5% mortgage and you are considering a 5% treasury bond, it's the same thing. I'd probably go with the treasury to enhance my liquidity and hedge inflation with my mortgage.

Most of us have higher ROI (and higher risk) investment options than paying off our mortgages. My mortgage is 3.625%, and I could grab some bonds, preferred shares, REITs, or MLPs yielding about 6%. This is the arbitrage a lot of people advocate, and that I am in fact practicing. However, the portfolio I would use has some significant risk. To pay off the mortgage is riskless. A similar risk free investment would be the 30 year treasury bond yielding 3% right now! I'll take my chances over the long term.

In terms of which strategy gets you to 25x expenses faster, mortgage payoff is it. A $100k mortgage at 4% interest requires a $477 monthly payment, or $5724 per year. If we multiply that expense by 25, we get $143,100 in invested savings required to support the $100,000 mortgage. Of course, you could save up $100k and pay off the mortgage faster than you can save up $143,100, so mortgage payoff gets you to having a NW of 25x expenses faster. This effect increases with the interest rate. At 6%, you'd need $180k in savings to cover the payments on that $100k loan!

The catch is the 4% rule describes an amount projected to last for life, whereas a mortgage is only 30 years. To be perfectly apples-to-apples, you'd need a complicated model/plan like a 5% rule for 30 years dropping to a 3% rule thereafter. But note how that plan magnifies sequence of returns risk. It gets complicated quickly.

So this comes down to a choice between (a) the higher ROI option, which is mortgage + investments, or (b) hitting 25x as soon as possible. Option A will make you wealthier long-term, but option B gets you over the 25x hurdle faster. The person pursuing option B can FIRE at a lower net worth than the person pursuing A, but at the same time the person pursuing option A probably has a higher net worth that is growing slightly faster and is much better hedged against inflation.

This is a case where optimizing will increase your time to FIRE.

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #562 on: April 17, 2018, 06:23:08 AM »
I'm sorry but @ChpBstrd  you are way off base with your comparisons here. 

The mortgage interest being deductible and comparing to a taxable account vs non deductible and an IRA account are entirely incorrect. 
- The interest deduction just lowers the effective rate of the mortgage based on your marginal bracket - and this doesnt really apply to many anymore under new tax law since most will now be taking the standard deduction but if you have a state and fed marginal rate of 28% combined it would lower your mortgage rate by 28% or a 5% mortgage would actually cost you - 3.6%

Which brings me to the problem with the second statement. assuming that if i can buy a bond today at 3.6% or 5% or whatever my effective mortgage rate is that putting that money in my mortgage is the same as putting it into the bond.  Bonds do not equal mortgages bonds are much more easily rebalanced than a mortgage.  Most people wont be buying individual treasury bonds here but VBTLX or some equivlent.  To look at today's bond rate in a vacuum is also wrong. - bond rates fluctate and if one were to choose to invest in bonds in lieu of a mortgage at a sub 4% rate it would still likely make sense as VBTLX has over 30 year periods expected to outperform that 4% based on historical norms. 

Leaving IRA money on the table to pump money into your house maybe one of the worst possible decisions one can make.  When this 'debate' is brought up the only realy debate is taxable investing vs paying down a mortgage. 

also your point about how much you need in savings to cover the loan ignores inflation - mortgages are fixed and not indexed to inflation - so historically holding a mortgage even in FIRE with just the amount of the money owed on the loan is safer and increases chances of success dramatically - 5% give or take depending on mortgage size - they do make you fail faster in years where they do fail but you still fail in both cases.  this can all be plugged into cFIREsim its not that complicated to historically back test.

SnackDog

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #563 on: April 17, 2018, 01:18:59 PM »
homes dont track inflation homes track wage growth. common misconception.  they are similar but not the same.

It doesn't matter which it tracks (or what other influences matter locally) because after costs for interest, taxes, insurance, repairs, maintenance and discretionary spending (like new drapes or some rose bushes), the total net investment is probably negative.

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #564 on: April 17, 2018, 01:50:35 PM »
homes dont track inflation homes track wage growth. common misconception.  they are similar but not the same.

It doesn't matter which it tracks (or what other influences matter locally) because after costs for interest, taxes, insurance, repairs, maintenance and discretionary spending (like new drapes or some rose bushes), the total net investment is probably negative.

quite incorrect.  very market dependent.

Grande

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #565 on: May 03, 2018, 08:44:59 PM »
I just did this. But I live in Australia, so my calculations won't help you! We have interest rates around 6%, no 30 year lock in, tax benefits, etc.
Came out around the same for me, plus or minus, depending on what average return estimates I used for share market, other investment property, etc. considering tax on any gains.
But with almost zero risk in paying off the house, guess which one I'm choosing.
Should be done in a couple of years so we'll have to come up with the next plan soon!

Tempting at 6%. Bird in hand.