FIRECalc simulations confirm that holding a low interest, long-term mortgage increases portfolio survivability. The reason is easy to understand. After a bad bear market, a portfolio survives if it has enough dollars left to grow in the recovery that follows. The more portfolio left to grow, the greater the chance for survival. A mortgage holder will have more money left to grow since the starting portfolio was not reduced by a mortgage payoff.
You have to run your own specific numbers in FIRECalc, but historically, paying off a mortgage has often resulted in greater portfolio risk -- not less.
run the numbers and you will see -- for balanced portfolios, ~6.25% mortgage rates or lower, remaining time on loans >~10 years, the financial advantage has historically been with keeping the mortgage. Paying off the mortgage actually increases the risk of running out of money in retirement.
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!
Hi Tom. Lots of points there -- let me focus on just a few.
I think you have an error in your Firecalc simulation. In scenario 2, you only include mortgage interest in your additional spending, so from what I can tell you're not accounting for the fact that you still must sell stocks every year to pay for your principal. While paying principal does not change your net worth, it does reduce your investment account (an important distinction because you won't be able to sell 4% of your house every year to pay bills). Assuming a 30-year retirement (matching a 30 year mortgage) and the default Firecalc investment assumptions, your real scenario looks like:
Scenario 1: House paid off, yearly expenses of $50,000, Portfolio of $1,200,000 >>> 92.8% success
Scenario 2: $300,000 mortgage, yearly expenses of $66,000 ($16k in house payments removed from investments every year), Portfolio of $1,500,000 >>> 86.5% success
Has anyone done the math to show the impact if you pay down/pay off your mortgage v.s. investing the money into mutual funds or other investments? Is there a calculator that shows your FI years and how many years it adds to your FI point if you pay off your mortgage vs. investing?
Quoterun the numbers and you will see -- for balanced portfolios, ~6.25% mortgage rates or lower, remaining time on loans >~10 years, the financial advantage has historically been with keeping the mortgage. Paying off the mortgage actually increases the risk of running out of money in retirement.
That is, not only should you not pay it off early as it will delay your ER, you shouldn't pay it off at ALL when you ER! Keep the larger portfolio and the mortgage.
I support paying off the mortgage for people who don't have the discipline to invest the money otherwise. That shouldn't describe a Mustachian, however.
The tax savings were calculated in the first post at $1,008. I used $1,000 for simple rounding. Interest, taxes, charitable, and state taxes were at $15,500 while the standard is $11,900 for Married Filing Joint. Take that at 28% or whatever your bracket is to come up with the benefit. I don't think the taxes sways the calc much though. Obviously if you have a house worth more than $300,000 then it becomes a bigger benefit while working.
That is crazy high interest rates. Do you know what is causing them? Is there huge inflation expected in the near term? Weak dollar? For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate. Seems like an opportunity to invest in mortgage notes. Is there a market for that in Australia?
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!
That is crazy high interest rates. Do you know what is causing them? Is there huge inflation expected in the near term? Weak dollar? For a 10 year loan, that is crazy to be paying 6% if it is secured by real estate. Seems like an opportunity to invest in mortgage notes. Is there a market for that in Australia?
I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.
I think you are way overthinking this, because the difference in interest will likely only be $5-10k. No matter which you choose, mortgage prepayment, stocks, bonds, whatever, you will be better off than if you had blown the money on fast food or booze. Do what you feel comfortable with, and in 30 years, if you chose the less optimal choice, have the intellectual honesty to admit it was impossible to know for sure and pat yourself on the back for not wasting the money on McD's or Budweiser, and realize that you are in a better situation than most of your peers.
Hah. You must be fairly young. 6% is quite low, historically, for most anywhere. I wouldn't mind having access to 6% mortgages for life.Within the last decade, 30 yr rates were over 6%. People must have really short memories.
It's impossible to do this math with any level of certainty. The second you try to plug in numbers, you will be making assumptions about the future that will ultimately prove inaccurate, perhaps wildly so.
Quote from: arebelspyHah. You must be fairly young. 6% is quite low, historically, for most anywhere. I wouldn't mind having access to 6% mortgages for life.Within the last decade, 30 yr rates were over 6%. People must have really short memories.
That is why it would be cool to create a calculator that figured this out. Your principal payments are an investment that pays out at your mortgage rate. The way you have it set up, is that it is household expenses that went up, which obviously would hurt your success rate. This is not what is happening when you pay down your mortgage. You are buying an investment that pays out at your mortgage rate. If you are liquidating investments that pay out at the level, it would not hurt your yield at all. IE take from your bonds vs your equities as you are buying a bond that pays out at 3.5% or your mortgage rate.
I have had mortgages with rates above 6%.
Quote from: arebelspyHah. You must be fairly young. 6% is quite low, historically, for most anywhere. I wouldn't mind having access to 6% mortgages for life.Within the last decade, 30 yr rates were over 6%. People must have really short memories.
I have had mortgages with rates above 6%. It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years. Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates.
The current historically-low rates in the United States are an attempt by the Federal Reserve to put money into the hands of consumers in order to encourage spending to drive economic recovery. Since the housing collapse, people have mostly been paying down debt or saving money, and decreased housing prices and incomes have driven down state government spending.Quote from: arebelspyHah. You must be fairly young. 6% is quite low, historically, for most anywhere. I wouldn't mind having access to 6% mortgages for life.Within the last decade, 30 yr rates were over 6%. People must have really short memories.
I have had mortgages with rates above 6%. It is just a bit unexpectant to see rates below 3% in the US for a 10 or 15 year loan, and greater than 6% in Australia for the same type of term, you would think that investors would pick up on the 3% spread, unless they are predicting the Australian dollar to weaken significantly during the next 10 years. Just an interesting observation as I considered Australia to be pretty stable, I would have thought that the rates would be close to our rates.
This is an oft discussed topic on the e-r.org forums.
So rather than recreate the wheel, here's plenty of reading for you. (http://www.google.com/search?q=site%3Aearly-retirement.org+mortgage+invest+firecalc+simulation)
You'll find people arguing both sides. Since I prefer the keep a mortgage option (mainly due to inflation risk - holding the mortgage is an amazing inflation hedge, as your payment stays fixed while your portfolio can grow - and inflation is the #1 enemy to retirement, especially an early retirement that lasts a long time), I'll cherry pick some quotes to support that. ;)
Right now I am in the process of getting 15 year mortgage, since the interest rate are so crazy low. I'll pay off my higher interest HELCO, do some real home improvements, buy an expensive car, and probably purchase another property in Vegas. But partly I'll be borrowing the money because rates are so low. One of the possible mortgage vendors is PenFed, and I will take great psychological pleasure in looking at the 2.75% interest I am paying them and comparing it to the 5% interest I am getting for some 10 year CDs with them. I like knowing that if interest rates raise dramatically I can roll over my 10 year CDs and get higher interest rate but the mortgage (actually Fannie Mae) is stuck with my pay 2.75% for 15 years.
Interesting to hear your strategy. Another successful retiree (besides Nords) getting a mortgage in retirement. Thanks for sharing.The lenders only care about cash flow: pension income, rental property income, dividends/interest income. Assets and unrealized capital gains don't count.
Aus, like Canada, is resource-and-finance. We are, probably, heading into a secular bear market for natural resources.
The AU$ and CAD$ are both, historically, really strong right now. Mortgage rates are, historically, really low right now.
What is "normal" at the moment will almost certainly NOT be normal in 5 years, 10 years.
You should consider the stability of your job and your monthly budget before deciding whether you will get a 15 year fixed mortgage or 30 year. Your FI will not be affected if you get the right computation for sure.
So you are suggesting not to take fixed rate mortgage?
So you are suggesting not to take fixed rate mortgage?
No a 30 year fixed rate loan is a gift from the government. If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.
If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.
So you are suggesting not to take fixed rate mortgage?
No a 30 year fixed rate loan is a gift from the government. If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.
If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.
So you are suggesting not to take fixed rate mortgage?
No a 30 year fixed rate loan is a gift from the government. If you pay it off early you are giving back the free money. Mathematically you will be better off if you think that your in investments will return 3.5% or better over the next 30 years. If you don't think that you can beat 3.5% which is about the level of inflation then you should not retire until your Safe Withdrawal Rate is in the 1% range as the models were based on the past and we have never had 30 year stretches where the investment returns were less than this. For long term retirement(40 years+) you need equities to perform above inflation to survive.
If you are paying off your mortgage early you are doing it for emotional reasons, not financial reasons. This is fine, but don't assume that you are being safer by doing this. A 30 year fixed rate loan is an amazing hedge against inflation. The government is giving away free money to stimulate the economy. Take advantage of it if you can. At the worst lock in a 15 year loan at below 3% and let it go to term.
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.
I disagree with both of these (the latter if you're ER'd, the former in most cases).
I am pretty sure that you will not be having a hard time obtaining another mortgage.As Arebelspy says, I've done a half-dozen refinancings since ER and every one of them has depended on cash flow. Pension, rental income, dividends, interest, good. Lenders care about those. Assets, capital gains, bad. Lenders don't care about those.
I understand now. But, I don't see any problem in paying the mortgage early.It's a perpetual debate.
I understand now. But, I don't see any problem in paying the mortgage early.It's a perpetual debate.
However before you retire you should maximize your opportunities to borrow money. I'd say that (at a minimum) a homeowner should arrange for a home-equity line of credit at no closing costs, even if it's just for emergency use. For some of us (like me) it's also a homeowner mortgage and a rental mortgage. Loans are a lot easier to get it while you're working, and a lot harder to get it when you've retired.
Arebelspy--
Your point is well taken. Maybe a few more facts may help:
I receive disposable income averaging $11000 per month after taxes, SS, withholding, etc., of which $2200 goes straight to 401k.
I intend to have all CCs paid off in 6 months(I am now paying about $3k/month). My $200k mortgage now costs me about $900/month--P&I (5/5 arm, 2.75%). My intent was to pay off the mortgage before the 5th year interest rate reset, i.e., about $40k/year in principal (=$3.5k/month). Interest on this mortgage is averaging about $450/month. I don't know how I would manage if in 3 or 4 years from now my income is drastically reduced and I have still to pay off a large mortgage balance. I would be able to dip into retirement savings for this (with no early withdrawal penalty as I am 62 yo) but it would have major impact on quality of life in my retirement years. It seems to me the sooner I can rid myself of the mortgage burden the better. Thoughts about this? Thanks
MorningCoffee: Amazingly some people here in the U.S. are paying off their 30-year fixed loans at 3.xx%. Mustachians even. Sometimes it's hard to override emotions, apparently.
If you have a financially efficient mortgage (no PMI) at a good rate, you probably have a 20% down payment. So everyone that has a mortgage has a partially paid off mortgage. So everyone with a mortgage may have made in Arebelspy's somewhat dismissive terms, an emotional decision to have a partially paid off mortgage. Now, if you are an efficient investor for a personal residence, wouldn't it make more sense to rent, not buy, and invest everything, especially given the liquidity issues of real estate? So, is the real question, rent or buy?
And it is not dismissive when it is math. It's just math.
But are you actually making money from this imputed rent? No.
Paying off your mortgage is the equivalent of investing in a vehicle which pays the mortgage rate.
No matter what the other investment happens to be, if it is capable of producing returns higher than the mortgage rate it is a better investment. Ramping up the risk of the investment is not changing the comparison. You are still looking at what it the most efficient use of your money. If you do not like risk I can understand what you are saying. And that is fine, you should invest in a manner which is consistent with your risk tolerance.
It just doesn't seem right, since paying off my mortgage early saves me over $200,000 in interest.
According to Washington Post, Capital Gains Tax will increase from 15% to possibly 25%. Not pleasant news to us investors.[/color]
Paying off your mortgage may "Save You $200,000 in mortgage interest", but the bigger issue is how much does it costs you in "Portfolio Gain".
If you have a $600,000 mortgage and pay it off over 30 years at 3.5% mortgage rate, then you will pay approximately $370,000 in interest over the 30 years. If you choose to make an additional $1,500 per month mortgage payment, then you will cut the 30 year mortgage down to 188 month mortgage and you will pay approximately $178,000 in interest.
So by making an additional $1,500 payment per month, you "save" $192,000 in interest. Close to your $200,000 savings that you mentioned.
So how does $1,500 per month going to your mortgage cost your portfolio over time?
That depends on what return you have over a 188 month/close to 15.5 year time frame.
Starting with 0, your portfolio would grow to the following at the following yields:
11% = $746,000
10% = $677,000
9% = $615,000
8% = $560,000
7% = $510,000
6% = $466,000
5% = $427,000
4% = $391,000
3.5% = $367,000
In 188 months your mortgage would be 0 if you made extra payments of $1,500 per month or it would be $367,000 if you paid $0 extra.
188 payments of $1,500 = $282,000 of capital
So the taxes would be calculated based on the return - $282,000. IE 11% = $746,000-$282,000 = $464,000 gain. 25% of the gain = 25% of $464,000 = $116,000 of taxes if you cashed them all in at once. You would probably manage taxes better. $746,000 - $116,000 = $630,000. Subtract off the mortgage that you still have of $367,000 and you have a benefit of $263,000.
After your tax rate of 25%, the results would be as follows:
11% = $263,000
10% = $211,000
9% = $165,000
8% = $124,000
7% = $86,000
6% = $53,000
5% = $24,000
4% = $-3,250
3.5% = -21,250
This is calculated at a very high capital gain rate of 25%, and not managing any taxes. Just cashing out in 188 months, and many other assumptions that don't make sense. The biggest one is all the current tax benefits that you get by itemizing your taxes and claiming your home mortgage deduction.
Using the current 15% tax rate would result in:
11% = $309,000
10% = $251,000
9% =$198,000
8% = $151,000
7% = $109,000
6% = $71,000
5% = $38,000
4% = $7,650
3.5% = $12,750
Again with managing your realization of the gains you should be able to bring down taxes even further and again this does not take into the benefits of having the home mortgage deduction on your tax return while you are still paying high tax rates while you are working.
So over a period of 30 years, if you can get anything above 4% you are better off keeping your 3.5% mortgage as long as possible.
I am confident that I can get above 4%, if I can't then I would probably be earning a 0% return after inflation. If we have that then our Safe Withdrawal Rate would be close to 1% which would cause significant issues to everyone. A 30 year fixed rate mortgage is a great hedge against inflation. The Government is giving those who take it free money to jumpstart the economy. Those who pay it down faster than required are foregoing the government's gift to homeowners.
But are you actually making money from this imputed rent? No.
In Europe they are considering taxing imputed rent so it is real to somebody somewhere; also, it is somewhat like interest on a zero coupon bond. Every month, the house gives me a value, tax free. It is not money you put in the bank, yes, but, if I want to live in this house, this is the market price. So that part is real; it's not just a dumb house, but a very crafty house. Just nobody sees the monthly gift and nobody taxes the benefit, except the property tax, but the mortgage guy pays that too, along with maintenance, as do I. It's like a company car type benefit, imputed. See William Bernstein in The Investor's Manifesto, page 37.
The person doing the mortgage, is paying the bill every month and pays with after tax money, so that is a cost to that investment in taxes. At 25% marginal tax, that's 4/3 times the principal and interest 360 times. That is the cost of that option, plus any transaction costs. If we compare after tax returns, the imputed rent is hard to beat.
If both the paid for house person and the investor start out with $203K, they just do what they want with the money. One pays for the house in cash; the other gets a mortgage and buys financial products. So each starts out with the same initial conditions.
Paying off your mortgage is the equivalent of investing in a vehicle which pays the mortgage rate.
For simplicity, I was assuming that the person just paid cash for the house. Each investor has the same amount of $ on day one. One bought the house; the other got a mortgage and invested the 80% remainder. If I paid off the mortgage on day 1 of the experiment, I got a paid for house free of the mortgage lien. The mortgage is just a document then, not a financial vehicle for me.
No matter what the other investment happens to be, if it is capable of producing returns higher than the mortgage rate it is a better investment. Ramping up the risk of the investment is not changing the comparison. You are still looking at what it the most efficient use of your money. If you do not like risk I can understand what you are saying. And that is fine, you should invest in a manner which is consistent with your risk tolerance.
The mortgage investor is competing against the imputed rent, not the 3.5% cost of the mortgage. If one return on investment number is bigger, that is better. But is the investor in equities going to go all hedge funds or oil futures? I think MMM's example of matching apples to apples is a point well taken. Can you point me to vehicles that gives me 9.6% tax free?
You may see it simply as an arbitrage, but it is not just that. Risk/reward calculations are important. For me, cost efficient means using Vanguard like mechanisms. Risk tolerance was intended as a part of the deal, as I think it is with all investors.
Now, if mortgage buyer invests in a taxable account. he will have the advantage of the capital gains tax rate for the count up at the end of the experiment. But he has to get the money home, so that is another charge. That means the taxable account would have to yield better than the lowest of my imputed rent projections, or 6%. So that means a net taxable gain of over 7.05% plus the cost of the mortgage and all the taxes he paid paying the 360 mortgage payments.
The mortgage investor is competing against the imputed rent, not the 3.5% cost of the mortgage.
AJ. I think you need to look at the math. I did an example in another post, but it logically makes sense that you have two choices. Pay downthe mortgage or take that money and invest it. If you can get a higher rate than the mortgage over the mortgage life then you are better off doing that. If you can't then it is better to pay off the mortgage. If you are in the United States, then you can get a sub 4% 30 year fixed mortgage. If you don't think that your investments are going to beat this over the next 30 years you are basically saying that your Safe Withdrawal Rate is at or around 1% as we have never had returns lower than 4% since we have tracked the market. firecalc is based on returns higher than 4%. This would be one of those firecalc black swan events.
https://forum.mrmoneymustache.com/throw-down-the-gauntlet/mortgage-payoff-club!!/msg73689/#msg73689It just doesn't seem right, since paying off my mortgage early saves me over $200,000 in interest.
According to Washington Post, Capital Gains Tax will increase from 15% to possibly 25%. Not pleasant news to us investors.[/color]
Paying off your mortgage may "Save You $200,000 in mortgage interest", but the bigger issue is how much does it costs you in "Portfolio Gain".
If you have a $600,000 mortgage and pay it off over 30 years at 3.5% mortgage rate, then you will pay approximately $370,000 in interest over the 30 years. If you choose to make an additional $1,500 per month mortgage payment, then you will cut the 30 year mortgage down to 188 month mortgage and you will pay approximately $178,000 in interest.
So by making an additional $1,500 payment per month, you "save" $192,000 in interest. Close to your $200,000 savings that you mentioned.
So how does $1,500 per month going to your mortgage cost your portfolio over time?
That depends on what return you have over a 188 month/close to 15.5 year time frame.
Starting with 0, your portfolio would grow to the following at the following yields:
11% = $746,000
10% = $677,000
9% = $615,000
8% = $560,000
7% = $510,000
6% = $466,000
5% = $427,000
4% = $391,000
3.5% = $367,000
In 188 months your mortgage would be 0 if you made extra payments of $1,500 per month or it would be $367,000 if you paid $0 extra.
188 payments of $1,500 = $282,000 of capital
So the taxes would be calculated based on the return - $282,000. IE 11% = $746,000-$282,000 = $464,000 gain. 25% of the gain = 25% of $464,000 = $116,000 of taxes if you cashed them all in at once. You would probably manage taxes better. $746,000 - $116,000 = $630,000. Subtract off the mortgage that you still have of $367,000 and you have a benefit of $263,000.
After your tax rate of 25%, the results would be as follows:
11% = $263,000
10% = $211,000
9% = $165,000
8% = $124,000
7% = $86,000
6% = $53,000
5% = $24,000
4% = $-3,250
3.5% = -21,250
This is calculated at a very high capital gain rate of 25%, and not managing any taxes. Just cashing out in 188 months, and many other assumptions that don't make sense. The biggest one is all the current tax benefits that you get by itemizing your taxes and claiming your home mortgage deduction.
Using the current 15% tax rate would result in:
11% = $309,000
10% = $251,000
9% =$198,000
8% = $151,000
7% = $109,000
6% = $71,000
5% = $38,000
4% = $7,650
3.5% = $12,750
Again with managing your realization of the gains you should be able to bring down taxes even further and again this does not take into the benefits of having the home mortgage deduction on your tax return while you are still paying high tax rates while you are working.
So over a period of 30 years, if you can get anything above 4% you are better off keeping your 3.5% mortgage as long as possible.
I am confident that I can get above 4%, if I can't then I would probably be earning a 0% return after inflation. If we have that then our Safe Withdrawal Rate would be close to 1% which would cause significant issues to everyone. A 30 year fixed rate mortgage is a great hedge against inflation. The Government is giving those who take it free money to jumpstart the economy. Those who pay it down faster than required are foregoing the government's gift to homeowners.
On the psychological front, you could consider a blending approach - you don't have to chose between full-speed towards FI or full-speed towards zeroing the mortgage. We did the maths ourselves and realised that ending the mortgage as soon as possible wasn't financially optimal. We opted to pay it off early, but not nearly so early as we could have. We got the warm and fuzzy collapsing-debt feeling, while our more rational selves admired that oh-so-rationally invested portofolio (well, mostly!).
The above is what I am doing. I think there's strong supportive evidence--given low interest rates--NOT to pay off the mortgage early. I want to pay mine off early anyway, so I am paying a little extra toward the mortgage and then saving a lot in investments. I know it's not rational, which is why I am only putting a little extra toward the mortgage.
The rational advice as many stated above is that it makes sense not to pay off the mortgage. Is that still the direction you take when you want to get costs down in preparation for retirement? Many RE-ers mention living on $25K. My mortgage--if I kept it into retirement--would keep my yearly costs high.
Thoughts?
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.
Is that still the direction you take when you want to get costs down in preparation for retirement? Many RE-ers mention living on $25K. My mortgage--if I kept it into retirement--would keep my yearly costs high.
It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.
Right. Mainly, I'm concerned with the additional expense (having a mortgage post-retirement vs not).
Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.
I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay.
Unfortunately this asset, 30 year fixed mortgage, is not transfersble; which is different from 20+ years ago.
The 30yr FR mortgage is a useful asset for someone who will stay in their house for quite a long time. For others, not such a good deal.
The loan is callable by the borrower - the worst kind of long term bond to own - and so it is priced accordingly by the lender. However, since it is non-transferable the term is also rarely 30 yrs and on average much less because people move. Thus it is priced more cheaply than a callable 30 yr bond would typically be (assuming yield curve not inverted).
This is an advantage to someone who will not move for a long time. They get to sell a 30 yr callable bond at rates more akin to a 10 to 15 year bond. However, to someone who will move more frequently the 30yr FR is a bad option and a 5/1 or 7/1 ARM will be more appropriate. These loans will have a lower rate since they only pay for rate protection over the period for which they will likely hold the mortgage. That is to say, they aren't subsidizing those folks who stay in their homes for greater than 5 to 7 years. This can be a huge difference, as in the difference between 4% and 2.75% - though of course the difference depends on the yield curve.
As to investing vs. paying off your mortgage this often makes sense but it is important to realize that the advantage for many people can have a significant speculative component to it. Again, if you can hold that mortgage for a very long time you'll likely get better return - but in the short term the volatility of the equities market could make it go either way.
So one has to be careful in making simplistic calculations or recommendations. That said, most of the factors that apply to FIRE folks who have already relocated to their low cost of living house for a good long sit are positive. However, for someone headed for FIRE in the next 5 to 7 years with a downsize and relocation in the not that distant future the benefits are less clear and more speculative.
Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.
Exactly.
I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay. If anything, having a lot of money tied up in a fixed asset like a house provides less flexibility to deal with uncertainties.
Maybe a simple example will help:
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 7%: $7000 annually = $583 monthly
Monthly expenses not covered by passive income: $1894
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
As you can see OP, you end up with less money available for your total expenses each month, because you are losing the investing opportunity cost of your money tied up in the house. Also, you have no (or less) cash on hand to deal with life's uncertainties.
I would like to add a link to this soon-to-be-legendary post by JLCollinsNH that should clearly illustrate the huge difference in investment value between one's home and companies: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
I would like to add a link to this soon-to-be-legendary post by JLCollinsNH that should clearly illustrate the huge difference in investment value between one's home and companies: http://jlcollinsnh.com/2013/05/29/why-your-house-is-a-terrible-investment/
Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.It all depends on your plan. You can plan on FIRE with a mortgage or without. Just be aware how difficult it can be to get one post FIRE.
Right. Mainly, I'm concerned with the additional expense (having a mortgage post-retirement vs not).
Pay only a small amount to your mortgage payment, then once you hit your early retirement number, work an extra couple year and throw your money into the mortgage
Bo_knows can your new calculator take into account a mortgage?
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?
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
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?
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
In this country, about 1 million houses are underwater.
In this country, about 1 million houses are underwater.
Only now they also owe more on their house than it's worth!
Zing ;)
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.
"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.
If your house was paid off, would you go get a mortgage and take the money and invest it in stocks?
I wasn't saying it might not apply to most people. I was saying it doesn't apply to me."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).
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
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.
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.....
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.
+1Your 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.
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, 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.
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....
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.
I ﬁnd that, on average, retirees with less than $300,000 in non-housing ﬁnancial wealth are better oﬀ keeping the mortgage and investing.
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.
Seems fairly straightforward.QuoteI ﬁnd that, on average, retirees with less than $300,000 in non-housing ﬁnancial wealth are better oﬀ keeping the mortgage and investing.QuoteHouseholds 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.
Seems fairly straightforward.QuoteI ﬁnd that, on average, retirees with less than $300,000 in non-housing ﬁnancial wealth are better oﬀ keeping the mortgage and investing.QuoteHouseholds 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.
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.
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.
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.
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?
Why on earth would payment need to be made using the passive return of the investment?
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).
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!
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.
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.
That's probably the easiest way. The other way is to calculate your expenses with the mortgage payment, but then, like you said, it'll have to cover the whole payment, and that might lengthen your time to FI.
It'll be a much more secure FI, however, because it doesn't purposefully draw down any of that "extra" principal you had that you didn't use to pay off the mortgage. Use the former method you suggested if you're comfortable with "bucketing" your portfolio like that, and drawing down on that part, otherwise the latter portion will be safer, but take longer.
If you want the same time to FI, but with likely more money at the end, do your method, or do the refi thing.
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.
That's probably the easiest way. The other way is to calculate your expenses with the mortgage payment, but then, like you said, it'll have to cover the whole payment, and that might lengthen your time to FI.
It'll be a much more secure FI, however, because it doesn't purposefully draw down any of that "extra" principal you had that you didn't use to pay off the mortgage. Use the former method you suggested if you're comfortable with "bucketing" your portfolio like that, and drawing down on that part, otherwise the latter portion will be safer, but take longer.
If you want the same time to FI, but with likely more money at the end, do your method, or do the refi thing.
Thanks, that all makes sense. But it also highlights another way that not paying off the mortgage could delay FI: even if I use my "bucketing" method, which in theory should allow me to retire at the same time as if I paid off the mortgage, if the markets go down in the next several years it will delay my early retirement (whereas if i directed all those payments to mortgage principal I would have attained FIRE sooner).
I think these are all the reasons I've been splitting my after-tax savings between vanguard investments and mortgage principal over the past few years to hedge my bets. But I've never really fleshed out the rationale and the pros and cons as well as this discussion has done for me. I am now reevaluating my approach, but I may ultimately decide to continue with it.
Using the outstanding balance is conservative. In reality you only need assets that will grow enough to pay off the mortgage. For example using you 100k/477 month example, you would need 80k earning 6% to pay off the mortgage. See you just cut 20k off the amount you need to save for retirement. It should be pointed out there are all sorts of tax and ACA things that can factor into this math also. You would have to evaluate them.
Yes if the market crashes, you are better off with a paid of mortgage. And if the markets soar, you are retiring years earlier. That is market risk. Paying off the mortgage in 2007 saved you from a 40k loss. Paying it off in 2009 cost you a 200k gain. Which one delays your FIRE date more? No one can say. This last crash was incredibly short. The experience out of 2000-2002 was a bit different
Using the outstanding balance is conservative. In reality you only need assets that will grow enough to pay off the mortgage. For example using you 100k/477 month example, you would need 80k earning 6% to pay off the mortgage. See you just cut 20k off the amount you need to save for retirement. It should be pointed out there are all sorts of tax and ACA things that can factor into this math also. You would have to evaluate them.
Yes if the market crashes, you are better off with a paid of mortgage. And if the markets soar, you are retiring years earlier. That is market risk. Paying off the mortgage in 2007 saved you from a 40k loss. Paying it off in 2009 cost you a 200k gain. Which one delays your FIRE date more? No one can say. This last crash was incredibly short. The experience out of 2000-2002 was a bit different
Great point foobar. And since, in general, the markets go up over time, you're more likely to have it rise than crash.
Again, play the odds that you're comfortable with, but historically the odds have heavily been on the side of invest over mortgage payoff.
There are a few seperate factors at play, and we all will have our own take on the various assumptions. Thats ok. As long as you do the math, and at the same time surface and accept the assumptions, cool.
consider:
- interest rates and your underlying assumptions about cost of and return on capital. A SWR of 4% assumes a nominal pretax CAGR of your investment portfolio of around 9%. But thats over 30++ years. In the usa we can borrow at 30 year fixed nominal rates of 4.5%. YMMV
- tax and government allowances can severly distort the effective tax rate at lowish incomes. A mortgage paid house is like free undeclared income when it comes for applying for means tested benefits, like health care. Imagine you own a sweet 300k house that would cost about 2k a month to rent. Thats like adding 30k per year to your effective income pretax. A lot of benefits dissappear between say 30k and 60 k per year indeclarable income. A cheap house in a rich area could give lots of other tax free benefits, like good schools, nice parks, efficient police, etc.
- quality of life. If you own the land and the house and you can do what you want. You cant get kicked out easily, build, etc. Peace of mind. Worth a lot. But remember you never really own it freehold, unless you want to live in the middle of nowhere. Property taxes. Can be huge. Dont pay, and you loose your property.
- real estate is a great investment, wrt the land value. Location location. Opportunities for capital gains are huge. Tax free if you live there more than 2 years in the usa.
300k house = 240k mortgage = 1100 a month. Call it 14k/yr. Does that mean your income needs to go up by 14k? Nope. 1k would be a reasonable high guess.
Owning a home versus renting has advantages and disadvantages. They have nothing to do with having a mortgage. Real estate is a good investment because of leverage. Get rid of that and it averages about 1% above inflation (some areas to a lot better. Some do worse).
Exactly. Thanks brooklynguy!
ACA is exactly one example. I could try to work a specific example...
imagine 2 FIRE couples. The first own their own 300k house. The second own the same house next door, but have an 80% mortgage, at 5%.
Both have a portfolio delivering 10% nominal returns. The Owners portfolio is 350k, generating 35k in mixed dividend and capital gains. Tax of 4200 less health subsidy of 2.5k leaves income of 33k.
The Borrowers have a 240k mortgage and a portfolio of 590k, thus generating 59k in mixed income. Plus a yearly mortgage payment of 12k in interest. Federate tax is 13%, 7700. Health care subsidy would be zero. Total income after tax, interest and healthcare, 39300. From that they would be saving 6k a year towards repayment, so end up with 33k.
it looks like a wash assuming 10% returns.
Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.
Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.
Math isn't going to justify paying off these low rate mortgages early in most cases. Sleeping better at night is a reasonable justification but realize that you are throwing 100ks away by doing it.
With the "in most cases" qualification, I agree. But it's worth being cognizant of these issues and running the numbers to see if this applies in one's own individual case. There's a handy ACA subsidy estimator available at http://kff.org/interactive/subsidy-calculator/
In my situation, if I keep my mortgage balance outstanding (and assume it will generate a nominal return of 7%), that additional income will disqualify me for annual subsidies having a value equal to 1% of the mortgage balance. (And that's looking only at ACA subsidies, putting aside any other means-tested tax benefits I might lose out on.) So there will be circumstances where the math justifies paying off the mortgage, primarily at the higher end of the "low" mortgage rate spectrum.
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest. If you end up needing more money sell every 7 years and skip 1 year of ACA subsidy. Even paying 15% in taxes you will come out ahead if your getting 7% returns. My goal in life isn't to max out government benefits and minimize taxes. It is to have enough money to do what I want. Paying less in taxes and getting ACA support is a means to an end not an end.
Obviously this situation really only exists because of the current low mortgage rates. 3.5% for 30 years means you almost assured of being a winner and the 4% rule is in real trouble if your not:). 8.0% for 30 years (you know like the ancient history of 2000) is a whole different ball game where unless you have some 12% bonds laying around, you might struggle to make much.
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?
Anyone have a spreadsheet to compare paying off a mortgage early with keeping the mortgage?
The overriding question on that would be "what assumptions would go into it?"
It's easiest to roll your own based on your assumptions.
You're right, you don't have to realize the full amount of the nominal return. But you do need to realize an amount sufficient to cover the mortgage payments plus the portion of health insurance premiums that otherwise would have been covered by ACA subsidies (and any other tax credits/avoidance, etc., that otherwise would have been obtained). I think you've convinced me that in the overwhelming majority of cases, if the mortgage rate is low enough, the math will justify keeping the mortgage outstanding even in light of these types of considerations. But these factors should still be taken into account when determining the optimal strategy--the determination isn't as simple as "if the expected market return exceeds the mortgage rate, don't pay off the mortgage, period."
I'd keep it simple. Unless you are a very experienced investor/trader/real estate guy who KNOWS they can beat current interest rates with their returns...just pay off the mortgage early. Holding stock index funds ASSUMING that they will return 5%+ over the lifetime of your mortgage is foolish. You have no idea if they will. Nobody does.
Retiring before 70 is also foolish by this logic. What if after you retire you get 0% investment returns and you out of money in 20 years? If you believe in the 4% rule, you expect to be making ~7% for the next 30+ years. Maybe we are in a bad period where the rules break down but the odds are against it.
Retiring before 70 is also foolish by this logic. What if after you retire you get 0% investment returns and you out of money in 20 years? If you believe in the 4% rule, you expect to be making ~7% for the next 30+ years. Maybe we are in a bad period where the rules break down but the odds are against it.
I would never recommend someone retire early unless they can live off of stable income for perhaps a significant period of time or have a way to bring in extra income if they need it.
Nobody can know what will happen, but I think it's foolish to assume markets always have to go up, just because we need them to in order to fund our retirements. Which is why there's diversification. Diversify globally, diversify asset classes. 100% buy and hold allocation to US stock index funds for an early retirement is retarded IMO. You are taking unlimited risk on that bet. You are assuming that because it's worked before, it will continue to work. Past performance is not indicative of future results.
This book should be required reading for those on this board recommending a 100% US stock allocation strategy http://www.amazon.com/Triumph-Optimists-Global-Investment-Returns/dp/0691091943
What is stable income? It sure isn't rentals (what happens when you can't rent for 6 months)
What is stable income? It sure isn't rentals (what happens when you can't rent for 6 months)
Rentals can be quite stable. In decent areas, vacancy is close to 0%. If you can't rent it for 6 months, you're doing something way wrong - your asking price is wrong. Everything will rent (or sell) at the right price. If you're in an area where an eviction takes three weeks or so, your worst case scenario is around a month total vacancy, with proper management.
I've never heard of a competent landlord or management not being able to rent something for 6 months.
I disagree that nobody is saying invest your mortgage payoff money in the stock market. That advice is rampant in this forum. And that is the specific advice I am adressing. It's the only thing I really disagree with Dave Ramsey about as well.
It is not generic advice.
But in the USA especially many of us feel that long term interest rates are artificially low, certainly last year when they were 3.5%, but even now at 4.5%, fixed at nominal rates for 30 years.
Now, no matter what your personal investment portfolio is, whatever your allocation between stock, bonds, real estate, tulips, .. if you are planning to FIRE there will be an assumption on SWR. MMM recommends 4%, not out of line with generally accepted rules of thumb and historic performances of investments.
But anything similar, even 3% SWR, inherently projects long term average CAGR nominal growth in your portfolio of about 7 - 9 %
so borrowing long term at these low rates as long as you can handle the cashflow implications and volatile portfolio ups and downs, tax implications too, seems a solid investment.
This must be considered in line with your overall portfolio gearing ratio - which should be low, and preferably only comprise this kind of long term fixed deal.
In other countries, interest rates are much higher, and usually floating. Fixed rates can be more expensive and only available for a few years. In these cases especially paying off that mortgage sounds like a great idea, because relative to your portfolio the risked returns are better, or at least comparable, in paying off the mortgage.
Note though that putting all your money and savings into 1 asset, your house, is also pretty crazy and very high risk.
Mobyrocket! Welcome-
Can you elaborate on your quote:
We also looked at different market scenarios. Scenario 3 beat Scenario 1 if historic rates of growth over the long term continue or if rates are lower. It is only a less optimal choice if the market does better than the historic rate of return over the long term.
Market averages are in excess of 8%, you are paying a mortgage at 3.5%, I can't see how you would not be better off under scenario 1 if you are using those rates in your fact pattern.
Are you taking into account that you can liquidate a portion of your portfolio in year 8, pay off your mortgage and still have more left over? I think something is missing or not calculating correctly.
I would love to see your spreadsheet.
Welcome to the forum!
Tom
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.
Again why are you realizing the income? Why not invest in products that give you capital gains and not income? That is the great part of living on investments. You only realize what you need and defer the rest.
...because the majority here are stashing money in tax deferred investments, not taxexempt investments. In the USA , mostly stashing in a 401(k) - and you realize income when the money is taken out.
Additionally for the "Refi/Take out a loan" crowd - when you take out that $300,000 loan, you are paying perhaps $5,000* for origination fee, title search, et cetera.You aren't getting $300,000 to invest - you are getting $295,000
Does it dramatically change the equation? No. Just another nibble, like needing to pay taxes on the gains you are using to pay the mortgage, and tax incentive phaseouts due to higher income.
Does a 4% mortgage for 30 years and investing the rest make sense in the USA? In lots of cases - yes. But you cannot overlook all of the additional costs.
Personally, I have 7.5 years left on a mortgage @ 2.5% - I am not planning to pay it down, but I'm not planning to refi anytime soon either.
*YMMV, of course. $5,000 is just an example number.
I have a couple of questions. I didn't see where you factored in the interest payment avoidance. As you could tell from my analysis, I discounted each ending balance by the interest paid over the lifetime of the loan. Do you feel this is a bad assumption on my part in comparing the scenarios? I understand that you did not factor in mortgage interest deduction, but the cost avoidance seems like it's not chump change.
Mobyrocket- I think you hit on a major hurdle for people when you talk about Interest Payment Avoidance. The typical reply is that by paying XYZ Debt vs. investing that I avoid paying interest. My spreadsheet does take this into account. Under the Math Tab, Column A - We are required to make the full mortgage payment to term. Therefore, we don't have the money to invest. So this is accounting for the interest avoidance. It is basically saying that we are ok with paying interest if we can get a better yield in Columb B (Investment)
Also, once we pay off the loan we immediately moved the mortgage payment and the excess principle into the stock market. So under the scenario where I don't pay off my mortgage early, I don't increase investments into the stock market until year 15, but under the paying early scenarios, I increase my yearly stash into the stock market at year 6 or 8. Under my analysis, this would reduce the difference in gains between paying nothing extra versus paying extra. I looked at the math tab and your analysis looks just at investing the extra over the 30 year period of time. Could you explain your thought process in leaving this out? It makes intuitive sense that investing 1k a month for 30 years at 7% gets me farther ahead than 1k at 3.5% for 7 years + 1k at 7% for 7 years. However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments.
Under my previous calculator once you paid off your mortgage the remaining payments were going into an investment account and earning the equivalent to the mortgage rate. I updated the calc to be earning the investment yield when your mortgage is paid off. Under the Math Tab, under the Mortgage Paydown Extra Payment calc you will see that the mortgage starts off as a positive number in column T. Once your mortgage is paid off it becomes a negative number. That negative number represents your investment account growing. The formula that I created says that if the mortgage balance is a positive number the interest is calculated using the mortgage rate. If it is a negative number than the interest is calculated using the investment rate. So if you have a 30 year mortgage you can go to the last row and see the investment account balance, the paid off mortgage early investment account and see the difference. I captured that on the Input sheet in 5 year increments, but you can capture it by year if you want. I just wanted to keep it simple. If you see a negative in Column F or Column H on the Input Sheet that is indicating investments or investments exceeding the loan.
The spreadsheet is really great, much more elegant than our scenario analysis. I have a couple of questions. I didn't see where you factored in the interest payment avoidance. As you could tell from my analysis, I discounted each ending balance by the interest paid over the lifetime of the loan. Do you feel this is a bad assumption on my part in comparing the scenarios? I understand that you did not factor in mortgage interest deduction, but the cost avoidance seems like it's not chump change.
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments.
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments.
Another great topic that is discussed!!! People focus on what they are paying vs. what they are receiving or the net of what they are paying netted with their investment returns. Your cashflow is vastly better off having a huge stache! Under the input sheet you can see your Stache under B (Column D). This is your cash flow. You have all of this money to pay bills, spend, invest, etc. At some point the return kicking off of this is greater than your mortgage payment. Therefore your cash flow is positive even though you still have a mortgage payment.
However, our motivation to paying the mortgage early is to be able to increase cash flow that we can redirect into equity investments.
Another great topic that is discussed!!! People focus on what they are paying vs. what they are receiving or the net of what they are paying netted with their investment returns. Your cashflow is vastly better off having a huge stache! Under the input sheet you can see your Stache under B (Column D). This is your cash flow. You have all of this money to pay bills, spend, invest, etc. At some point the return kicking off of this is greater than your mortgage payment. Therefore your cash flow is positive even though you still have a mortgage payment.
+1. EXCEPT in the case brooklynguy wrote about earlier, when you have a ton of trapped equity so your payment is high and the invested amount that covers the balance doesn't kick off enough for the high P&I payment. In that case, you may need to Refi.
But in general, having the amount liquid and earning more will net you more cash flow at the end of the day, aside from more overall money.
Arebelspy, you and others have convinced me that even in that situation, in most cases it's still better not to pay off and draw down on the invested principal for cash flow, as long as the time horizon until mortgage maturity is long enough (which, of course, will be inversely correlated with the amount of trapped equity).
You are changing the problem from
a) I have 200k laying around should I invest it or pay off my mortgage
to
b) Do I take extra 260k out of my 401(k) (Probably be more as you will be paying 33% on the money you take out for you living expenses ) or would I be better off taking an extra 14k/yr out of my 401(k).
You are changing the problem from
a) I have 200k laying around should I invest it or pay off my mortgage
to
b) Do I take extra 260k out of my 401(k) (Probably be more as you will be paying 33% on the money you take out for you living expenses ) or would I be better off taking an extra 14k/yr out of my 401(k).
No, I'm not. I am countering your position, which you also stated thusly: "You don't need to realize income to pay your bills. "
For most people here, a significant fraction of their 'stache is inside a 401(k)* - in order to pay bills in retirement, they have to get money out of the 401(k). When they get money out of the 401(k) - ALL of that money is income. They have realized income. They have to pay taxes on it.
My understanding of your assumption (which I disagree with**) is that most of the assets are already outside the 401(k) and you will only pay taxes (realize income) on the gain.
*Or rolled over to a Traditional IRA. Whatever. Irrelevant to the point.
**For most people here, obviously not all.
Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.
http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/
Peter
Are you aware of any place that will offer me a 30 year fixed rate margin loan at <4% that will not be called if the asset drops 50%? They aren't remotely the same product.
Yes leverage adds risk but it also adds return. In this case the added return drastically outweighs the risk due to the extended time period. Imagine you shove all the money in to an S&P 500 fund (lets assume no taxes to keep it real easy and this is NOT how I would invest money I didn't need for 30 years) during the worst 30 year period ever. Hmm that's an 8% return. Maybe we are starting a new worst 30 year period that will only return 2%. Its possible. But I wouldn't want to bet on it.Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.
http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/
Peter
Are you aware of any place that will offer me a 30 year fixed rate margin loan at <4% that will not be called if the asset drops 50%? They aren't remotely the same product.
Yes leverage adds risk but it also adds return. In this case the added return drastically outweighs the risk due to the extended time period. Imagine you shove all the money in to an S&P 500 fund (lets assume no taxes to keep it real easy and this is NOT how I would invest money I didn't need for 30 years) during the worst 30 year period ever. Hmm that's an 8% return. Maybe we are starting a new worst 30 year period that will only return 2%. Its possible. But I wouldn't want to bet on it.Here is a link to a good article on the subject. The author mentions the mental accounting often done to justify using mortgages for leverage. But what is even better is that he makes the case of increasing risk exposure in the remaining portfolio to improve potential returns. The logical conclusion is that one should get rid of bonds and use the proceeds for debt payments or trade bonds at the same time you are directing new money towards the mortgage. As always, the decision what to do in the individual case has to be, well, individualized...
Rest assured all of you who are paying off your mortgages early that it is much less of an emotional issue than is commonly perceived. Or, in other words, it may be of psychological benefit but it is supported by risk analysis and may lead to higher overall returns when done as part of a dynamic investment allocation strategy.
http://www.kitces.com/blog/why-is-it-risky-to-buy-stocks-on-margin-but-prudent-to-buy-them-on-mortgage/
Peter
There is no question that a young person with little invested and a 30 years low rate mortgage should continue investing in tax advantaged accounts and defer paying off the mortgage. There's really not much choice in the matter.
There is also no question that borrowing on margin is different because of the possibility of a margin call, although I would look at what happened to many people with underwater mortgages and job loss a few years ago as somewhat of a margin call equivalent. The fact remains that leveraged investments can turn ugly in a hurry.
What I am having trouble understanding is that many people have not only mortgage debt but also significant investments in bonds. I have never had more than 10% in bonds ( ok, had another 5% in TREA which I believed at the time to be bond-like, well it isn't but I was able to time it in 2009).
The reason is probably that asset allocation is often looked at as something happening just within the investment portfolio. So one hears that someone has an AA of 30/70 but then learns that the same person has a mortgage balance as large as their investment portfolio. That makes no sense at all.
In reality, this person is facing volatility risk of way more than a 100% stock allocation (referenced to all investable assets of course) with the bond investments only limiting upside potential. And upside potential is clearly all what counts for an investor with such a high stock allocation and that is all what a young person with good future earning potential and low net worth should be worrying about.
I think it is important to note that by considering carrying debt to be similar to holding negative bonds, the AA becomes more realistic in terms of real world consequences of volatility risk - that is the effect on net asset worth. I really do not care about how my investment portfolio is doing in isolation. I do care about net invested asset worth increase over time.
Stock market investments have the highest return potential but unfortunately also have the greatest dispersion of portfolio end value. The way to deal with this is asset allocation. Look at your AA with your debts figured in as negative bonds and see what you need to do to get to your desired AA (30/70, 40/60 or whatever).
If you don't look at debts as negative bonds you may end up not knowing the actual risk you are taking as a young person and you may end up way too conservative when you are older.
By the way, I am about one year away from FIRE and my current AA is way over 100% stock market but buying back my mortgage debt will get me to about 15% bonds within the year. This excludes real estate equity and annuities.
Peter
Peter,
I like that approach, viewing a mortgage as an inverse or negative bond.
but make sure you're comparing apples and apples.
a fixed 30 year nominal in us$ mortgage, at say 4.5%, for someone in solid accumulation mode, seems to be a no brainer. As long as they instead of putting equity into the house they put extra equity into the rest of the portfolio. This represents a counter play to buying a 30 yr treasury. A fixed nominal 30yr mortgage is effectively an inflation hedge., plus should return well on the leveraged equity elsewhere ( ie I expect my portfolio of stock to average 9% nominal over 30 years, pre tax.)
But my bond portfolio is not in corresponding 30 yr treasuries, but mid duration (1 - 7 yr) mid rating bonds, yielding more than 3% and the rate will roll up if rates go up.
Interesting perspective. I agreed with most until he uses an example of paying down a 15% credit card or saving. Maybe he is saying that the stress of having the debt will cause the person to be mindful and pay it off within the year and will therefore only cost $100 of interest to get money locked up in an IRA. if you are Mustachian you invest or payoff based on expected returns vs. games to save or paydown.
http://finance.yahoo.com/news/debt-unstuck-123024913.html
Say you are 25 years old and are carrying a $1,000 balance on a credit card at 15% interest, and you get a $1,000 bonus at work. Which is better, paying off the credit card or saving the money and paying off the debt slowly during the next year? The instant payoff of paying down a 15% interest credit card balance is obvious (it would save you roughly $100 in interest payments, assuming you paid the card down throughout the year). But in the long run, $1,000 saved in an IRA for 30 years will be worth $10,935 (assuming an 8% annual return). The $100 savings on interest payments at age 25 is worth $830 by age 55. So, which is greater, $10,935 or $830?
And how do you plan on paying off the mortgage with that tax advantaged money? After you take the money out to pay off the mortgage, are you not back to where we started with 200k that you can either pay off the mortgage or invest? And in this case the investment works out even better because you can roll that 200k into a Roth (yeah you have to work around with the 5 year rule) and generate no income forever. Wasting that tax space on paying off your mortgage early would be sad.
I see.. However, your credit score will improve if you pay off your mortgage early. I am pretty sure that you will not be having a hard time obtaining another mortgage.
I disagree with both of these (the latter if you're ER'd, the former in most cases).
Can you elaborate this?
Glad I finally found this thread!
IMHO paying off more than 30% of a mortgage is the opposite of badassity. I would characterize it as wussassity.
Psychologically have the money to pay cash for your home and then put it into a REIT that you name "paid off home account." Then party on Garth because you have both an investment and a home you get to live in! You still "own" it because on the boxes you check with the choices "rent" or "own" your home? You always check "own."
That said consider the following.
1. A home is a titled item -- that is the King or Government grants you a title. The King or Government can and will tax you on that title. There is also the chance the King may want his house back. In the US, (since we are approaching a Greek point of debt) it is likely at some point there will be a national property tax that is very substantial. So from a psychological standpoint you are fooling yourself if you think you "own" your home or that it is paid off. The King owns your home. You own a piece of paper.
2. A mortgage is a long term rental agreement. Yes that is correct. Read the fine print on that 40 page contract. The bank owns the home. You are renting at a super low rental rate. You are also responsible for all repairs and maintaining the property.
3. Your home is too big and/or expensive. Yes, I said it! 90% of readers of this thread are living in homes that are "clown houses." A good rule of thumb is 400 sq foot per person. Otherwise your are living in the house equivalent of a "Hummer." Very unmustachian. (by the way, MMM lives in the house equivalent of a "clown car."
4. Home prices do not always go up. We have seen this recently. In one scenario you put 50K down on a home and the home value goes down so much in the next 3 years that you lose 100K in total. At least in the stock market your loss is limited to your initial investment.
5. Renting an appropriate size and priced home has many advantages. A. You don't do maintenance. B. Your risk is very limited. C. Your need to/want to move risk is very limited as in you can move anytime you like. D. Should you decide to take an extended trip you will have no worries back home. You are free. E. This is a truism - "You don't own a home, it owns you" And that pull is deeply psychologically based. It is why people struggle so much with this thing, because it has been drummed into their psyche from an early age to own a home.
So if you must fool yourself and "own" a home ---
Buy the smallest least expensive, on sale home, you can and put down 20% while investing the value of your home.
Or
Rent the most appropriately sized, nice and inexpensive place you can find. Invest the entire difference.
By the way, if the starter of this thread has 1.5 mill in assets they are doing very well and way past the blog definition of FI. Were it me, I would dump the home concept and take a very, very long RV trip followed by a very, very long world hiking trip. That would give you 3-6 years to consider your home options.
Right, but the idea is since you haven't paid it off, that money you WOULD have paid it off with would be invested and earning enough money to pay the mortgage each month and put some extra in your pocket.
Exactly.
I'm not getting the confusion here with folks asking about their expenses being different without a mortgage, and somehow having more flexibility with expenses if there is no mortgage to pay. If anything, having a lot of money tied up in a fixed asset like a house provides less flexibility to deal with uncertainties.
Maybe a simple example will help:
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 7%: $7000 annually = $583 monthly
Monthly expenses not covered by passive income: $1894
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
As you can see OP, you end up with less money available for your total expenses each month, because you are losing the investing opportunity cost of your money tied up in the house. Also, you have no (or less) cash on hand to deal with life's uncertainties.
With markets at all time high, I struggle with the feeling to dump $100K into stocks this month instead of just paying down 4.25% mortgage as Schiller predicted 10yr returns at 4% from here... But then of course I don't have that capital to do what I want with a buy/sell/withdrawal if needed.
BooksAreNerdy- The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous. I put together an Excel workbook to show this. But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover. Check out the workbook and let me know if it clarifies or confuses.
If you already have more money than you know what to do with then having a paid off house makes sense.
If you already have more money than you know what to do with then having a paid off house makes sense.
So if you had multiple millions and someone offered you free money, you'd say "nah, I'm good"?
If you already have more money than you know what to do with then having a paid off house makes sense.
So if you had multiple millions and someone offered you free money, you'd say "nah, I'm good"?
I don't do it as it isn't worth my time.
I don't do it as it isn't worth my time.
That wasn't what I was asking. I don't do that either. The question was about free money. (If it takes time/effort, it's not free.)
Someone offers you a wad of cash, legally, would you say no, because you have enough?
I don't do it as it isn't worth my time.
That wasn't what I was asking. I don't do that either. The question was about free money. (If it takes time/effort, it's not free.)
Someone offers you a wad of cash, legally, would you say no, because you have enough?
BooksAreNerdy- The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous. I put together an Excel workbook to show this. But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover. Check out the workbook and let me know if it clarifies or confuses.
Mostly clarifies, but I feel like I should add some more specifics to our particular situation as the workbook just can't address all of my various ins and outs. Our current house is on the market, its sale would leave us about $130-150k cash. We are looking at houses in the $100k range for our next purchase, as this range allows the house to be quite livable for our family or a future rental/investment should we ever desire it to be such.
DH is planning to retire in 6 years at age 38. We aim to have enough in taxable accts to hold us over for 20 years, and then enough in retirement accts to last indefinitely. We would also like to have a total of 3 houses in this 80-100k range, one for living and two for rentals.
DH is of the opinion that we want to minimize our costs/payments in retirement. So, he would rather have a paid off house and paid off rentals. DH's argument is than in a downturn, you want to be withdrawing as little as possible from investments. ie, have low enough expenses that you could easily use a side hustle to pay the bills. So, he would rather pay cash up front and make sure our expenses are low when we hit retirement. I, otoh, am trying to figure out the exact math of which is better. Funny enough, he is the engineer and I am the english lit major. So, I do appreciate the hand holding as I struggle with the math. :)
One thing in my post above that I didn't think of, was that if we didn't have a mortgage, we likely wouldn't budget an extra $477/mo (or $382 in the case of an 80k mortgage) into our post retirement budget to invest instead of making a mortgage payment. So, that investment benefit goes away.
Scenario A, no mortgage:
Pay $100k cash for house
$382/mo is invested (vs spent on mortgage payment) for next 6 years, netting $35k. Untouched, this would grow to $177k over the following 24 years.
Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest.
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k.
In Scenario A, you end up with a value of $100k+$177k=$277k in home cost plus investment growth.
In Scenario B, you end up with $100k+$183k-$57k=$226k as your total value from home cost plus investment growth, minus mortgage interest paid.
So, in this situation, it looks like NOT having a mortgage would actually be a better move financially, as you would end up with an extra $51k at the end. Does that seem right? It isn't exactly comparing apples to apples as I had originally posted, but it gives more of a real life example.
Though it doesn't relate to my question, I had to jump in here. I would hope that as soon as any one of us had enough, we would know when to say 'no thanks' to anything in excess. :)
BooksAreNerdy- The simple way to think about it is if you have a mortgage at 4% and your investments earn 7%, then it is pretty easy to see that putting more money into the bucket that gets you 7% vs. 4% is going to be advantageous. I put together an Excel workbook to show this. But what a lot of people miss is that in a point in the future you could liquidate some of your investments and payoff the mortgage and still have a chunk leftover. Check out the workbook and let me know if it clarifies or confuses.
Mostly clarifies, but I feel like I should add some more specifics to our particular situation as the workbook just can't address all of my various ins and outs. Our current house is on the market, its sale would leave us about $130-150k cash. We are looking at houses in the $100k range for our next purchase, as this range allows the house to be quite livable for our family or a future rental/investment should we ever desire it to be such.
DH is planning to retire in 6 years at age 38. We aim to have enough in taxable accts to hold us over for 20 years, and then enough in retirement accts to last indefinitely. We would also like to have a total of 3 houses in this 80-100k range, one for living and two for rentals.
DH is of the opinion that we want to minimize our costs/payments in retirement. So, he would rather have a paid off house and paid off rentals. DH's argument is than in a downturn, you want to be withdrawing as little as possible from investments. ie, have low enough expenses that you could easily use a side hustle to pay the bills. So, he would rather pay cash up front and make sure our expenses are low when we hit retirement. I, otoh, am trying to figure out the exact math of which is better. Funny enough, he is the engineer and I am the english lit major. So, I do appreciate the hand holding as I struggle with the math. :)
One thing in my post above that I didn't think of, was that if we didn't have a mortgage, we likely wouldn't budget an extra $477/mo (or $382 in the case of an 80k mortgage) into our post retirement budget to invest instead of making a mortgage payment. So, that investment benefit goes away.
Scenario A, no mortgage:
Pay $100k cash for house
$382/mo is invested (vs spent on mortgage payment) for next 6 years, netting $35k. Untouched, this would grow to $177k over the following 24 years.
Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest.
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k.
In Scenario A, you end up with a value of $100k+$177k=$277k in home cost plus investment growth.
In Scenario B, you end up with $100k+$183k-$57k=$226k as your total value from home cost plus investment growth, minus mortgage interest paid.
So, in this situation, it looks like NOT having a mortgage would actually be a better move financially, as you would end up with an extra $51k at the end. Does that seem right? It isn't exactly comparing apples to apples as I had originally posted, but it gives more of a real life example.
Your scenarios are not equal. You are double subtracting the $382 per month. And it looks like you are subtracting the interest AGAIN. Or I'm missing something.
Scenario A, no mortgage:
Pay $100k cash for house. At the end of 30 years, you have a house.
Scenario B, mortgage:
Pay $157k for house; $20k down, $80k principal, $57k interest.
Invest $80k and take out a monthly withdrawal of $382 to cover monthly P&I. At the end of 30 years, this acct is worth $183k and you have a house.
Both houses are the same value at the end. Drop them from the calculation.
$382 you said covered P&I - the I being the interest on the loan. No need to subtract it yet again.
Scenario B ends up with an extra $183k.
However, I don't think you can ignore the potential added investment of $382 from cash purchase date until retirement
Ah, I see how that is double subtracting interest in scenario B. However, I don't think you can ignore the potential added investment of $382 from cash purchase date until retirement, and then its growth during the time we would have had a loan. So, perhaps the actual gains in each situation (house being equal in both scenarios and removed from the calculations) is Scenario A is $177k and Scenario B is $183k.
Holy balls, I understand! Thank you for the light bulb. I totally get it. The 'budget' stays the same, the money for the house/mortgage only comes from that lump sum. Why was I making that so complicated?!
OK, so how does it actually work to USE that investment?
tomsang,
I wanted to thank you for this thread. After a fairly thorough review of the numbers you provided throughout this thread (others as well - especially the concept of the mortgage as bond portion of one's retirement), we are refinancing from a 15 year loan into a 30 year loan and reinvesting the difference from the monthly mortgage payment. It actually allows us to top off our pretax savings as an added bonus. We are completing this now as the rates are super low and we have a lot of confidence in our plan, in part, based on information in this thread.
Thank you mmm community and especially tomsang!
But wouldn't pulling out the lump sum to pay off the mortgage increase your income a HUGE amount for that year and trigger a ton owed in taxes?
Once FI though, at low income levels (<$35k) there may be tax advantage owning where you live, as the 'avoided rent' or mortgage payment, has to come from post tax income, whereas that free rent you get by owning is not declared income, so is effectively paid pretax.
It could also allow you to have a lower declared income for tax purposes, and hence gain tax credits and health insurance subsidies you wouldn't get if you had a mortgage and had to decalre and pay tax on that income draw from the stash. It could impact your capital gains tax, and tax paid paid on ordinary dividends perhaps.
In accumulation mode, or a significant earned income to declare, I agree a fixed rate 30 yr deal is the way to go. You can always pay it off early at no fee anyway!
Found an interesting result in mortgage payoff spreadsheet...
For a rental property, If one pays off the note, the fire date is months to years earlier.. This would be different near the end of a 30 year mortgage when the payoff date is in sight, but if only a few years in, why not payoff the mortgage, increase monthly cashflow, and be closer to FIRE than if just continued saving...
ready for anyone to poke holes in my math..
Interesting article on whether to payoff your mortgage. I think it says that if you are mustachian that you should keep your mortgage. If you buy high and sell low than you should pay off your mortgage.
http://www.fool.com/how-to-invest/personal-finance/credit/2014/09/14/should-you-pay-off-a-mortgage-early-the-answer-may.aspx
Interesting article on whether to payoff your mortgage. I think it says that if you are mustachian that you should keep your mortgage. If you buy high and sell low than you should pay off your mortgage.
http://www.fool.com/how-to-invest/personal-finance/credit/2014/09/14/should-you-pay-off-a-mortgage-early-the-answer-may.aspx
That's actually not a bad point - the average investor has earned 2.5%, so most people should pay off their homes, as they'll have mortgages higher than that. A buy and hold indexer, however, should probably expect quite a bit better than that.
Interesting article on whether to payoff your mortgage. I think it says that if you are mustachian that you should keep your mortgage. If you buy high and sell low than you should pay off your mortgage.
http://www.fool.com/how-to-invest/personal-finance/credit/2014/09/14/should-you-pay-off-a-mortgage-early-the-answer-may.aspx
That's actually not a bad point - the average investor has earned 2.5%, so most people should pay off their homes, as they'll have mortgages higher than that. A buy and hold indexer, however, should probably expect quite a bit better than that.
I am a bit suspect of the 2.5% number (can't find the report where it comes from). It looks like the number that a financial asset management firm would through out to encourage you to invest with them. And if JP Morgan clients are only making 2.5%, I don't think they would be advertising that:)
Interesting article on whether to payoff your mortgage. I think it says that if you are mustachian that you should keep your mortgage. If you buy high and sell low than you should pay off your mortgage.
http://www.fool.com/how-to-invest/personal-finance/credit/2014/09/14/should-you-pay-off-a-mortgage-early-the-answer-may.aspx
That's actually not a bad point - the average investor has earned 2.5%, so most people should pay off their homes, as they'll have mortgages higher than that. A buy and hold indexer, however, should probably expect quite a bit better than that.
I am a bit suspect of the 2.5% number (can't find the report where it comes from). It looks like the number that a financial asset management firm would through out to encourage you to invest with them. And if JP Morgan clients are only making 2.5%, I don't think they would be advertising that:)
http://www.businessinsider.com/typical-investor-returns-20-years-2014-8
Read the small print under the chart for how they calculated average asset allocation investor return.
But let's assume you take that 165k you could use to pay off the rental and instead put them as down payments on 4 other rentals at ~40k each that cash flow $4800 each annually after expenses and debt service (say, purchase price of 160k each, putting down 25%, 120k loan at 4.4%, gross rents 1800/mo, net 1000 after expenses minus P&I of $600/mo = 400/mo cash flow = 4800 annually).
Option 1: Use 165k to pay off mortgage. Gain $830/mo to your cash flow due to not having P&I any more.
Option 2: You use the 165k to buy 4 properties as described. Gain 1600 to your monthly cash flow (and you get all the extra appreciation benefits, depreciation tax benefits, principal paydown, etc. that you don't get in scenario 1 that I'm completely ignoring but also makes it WAY better).
Gaining 1600/mo rather than 830/mo will let you FIRE way sooner. In fact, if we put that in your spreadsheet, let's see what you get.
If we change "holding mortgage" to "buying more", stache amount is 85k, adjusted spending after rental income is now (original 18.6k - new 4800 x 4 = 19200 negative. I.e. You're already FIRE! (You spend 36k annually, bring in 17400 from your rental 1, bring in 19.2k from the new rentals, and you don't need any more income, you use the 85k you have left as cash reserves).
In option 2 you are much more leveraged, which adds risk, you have more properties to manage, etc. etc. There are certainly downsides to scenario 2.
But my point wasn't to address leverage versus not, but just your math that paying off a mortgage reduces your time to FIRE. It doesn't, if you have a better place for that money. If you want FIRE as fast as possible, paying off low interest mortgages is not the way to go. Cheap leverage is, especially if it's on something that cash flows well and so you don't need to worry too much if the paper value dips.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Only 2.2%?
What is your 401k in? Mine this year is double yours, at 4.4%.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
No way, my beginning balance was 120k. In december 2013 it was 64k...
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
No way, my beginning balance was 120k. In december 2013 it was 64k...
Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.
Medinaj2160. If you would be open it would be interesting to use your case as a real life example of how paying off your mortgage early effects your stock portfolio, net worth and your financial independence date.
To calculate. We would need to know.
House cost 122k
Down payment 3.5k
Date of purchase June 2012
How much extra you paid each month as much as I could... december 2013 balance was 64k. Todays balance is 10550.
Any large extra payments. Amount and date.
Do you itemize for your taxes or take the standard deduction I was barely able to itemize last year
If itimize. What tax rate.
We have your mortgage interest rate, your investment allocation. So we can calculate the returns of the funds and the interest that you would have paid.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
No way, my beginning balance was 120k. In december 2013 it was 64k...
Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.
How are you getting a 30k return in 16 months from investing 54k gradually.
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
No way, my beginning balance was 120k. In december 2013 it was 64k...
Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.
How are you getting a 30k return in 16 months from investing 54k gradually.
Thats the hand waving part given I don't know exactly when your money showed up. Given TSM is still up over 6% for the year(and the previous 20 months were even better), it is hard to come up with case where paying off early works out. And no you don't invest money like this in bonds. And 2.4 years is a lot more than 16 months last time I checked:)
I just looked at my 401k and so far my return for the year is 2.2%. I am glad I chose to pay my 3.75% mortgage early. Keep in mind that I will be done with my mortgage this year and I bought the house 2.4 years ago.
Care to tell us how much money you would have today if instead of paying off the house, 2.4 years ago you would have invested it? You saved 3.75% at the cost of annual returns in the 14 and 24% range in 2012 and 2013. With something like a 100k you cost yourself 30k to save 10k in interest. You can put your exact dates and numbers in, but I can assure you that paying down the house over the past 2.4 years has been a losing strategy. Long term it might workout better.
No way, my beginning balance was 120k. In december 2013 it was 64k...
Yep and your 60k stock investment back then is now worth 90k so you could have sold it and only had a 34k mortgage instead of a 64k one:) Yes there is a lot of handwaving(I don't know your exact access to funds or anything or have a tool to generate actual results) but I can assure passing up 14% and 24% returns to make 3.75% is a poor tradeoff financially.
How are you getting a 30k return in 16 months from investing 54k gradually.
Thats the hand waving part given I don't know exactly when your money showed up. Given TSM is still up over 6% for the year(and the previous 20 months were even better), it is hard to come up with case where paying off early works out. And no you don't invest money like this in bonds. And 2.4 years is a lot more than 16 months last time I checked:)
By 16 months I meant the good months since my return for this year is only 1.9% ;).
I believe you should pay off your mortgage based on the term of the mortgage, and you should choose the mortgage with the lower interest rate. The 15 year is an excellent choice now with sub 3% rates, usually between .6-.8% from the 30 year. Now it is true that you spend more on the 15, and you could divert that cash into investments, however, in the early years, the hurdle rate is fairly high. Including a tax shield of 25% and an opportunity cost of 10%, you would still be better off for the first 30 payments, which would be the inflection point at which the stock investment would begin to outperform, and your stock portfolio would break even at around 55 payments.
this has to do with the spread between the 30 year and the 15 year, and the principal amount applied to that spread. My example takes a $230,000 mortgage. Another way to think about this is looking at the first year, where you give up ~$6000 in extra payments, but in return reap $2000 savings in interest payments--that is a 33% return in that year. However, by year four this advantage disappears. However, the faster payoff is a much better deal than many would make it seem, and so many here are not properly looking at the short term returns of such a move, instead only focusing on the long-term.
I wasn't able to follow exactly what you were trying to say, but you seem to be confused. The only way a 15 year mortgage can effectively generate a 33% "return" as compared to a 30 year mortgage is if the interest rate were 33 percentage points lower. The "return" on prepaying your mortgage is equal to the interest rate on your mortgage--that doesn't change based on the fact that a mortgage's repayment schedule backloads the repayment of principal. And the tax deduction for mortgage interest (for those who can take advantage of it) weighs in favor of investing and keeping the mortgage outstanding, not the other way around.
2) After paying off the mortgage (at possibly your highest earnings point in life), you lower your tax burden by contributing as much as possible pre-tax to savings. More % "return" on the prepayment.Or you could have been lowering your tax burden all along by contributing as much as possible pre-tax to savings, while paying only the minimum mortgage payment.
3) For people 50 years old or more, losing your job with a mortgage is a high risk proposition.Maybe. One can also make the case that having liquid assets is preferable to illiquid assets. Depends on what one assumes about the performance of the liquid assets at the time coinciding with the job loss.
Mortgages are capitalized up-front, investments are capitalized "late".Don't understand - could you elaborate?
Did you win if you die before earning your investment returns?One might say that dying is a losing proposition no matter where one put one's money.
QuoteMortgages are capitalized up-front, investments are capitalized "late".Don't understand - could you elaborate?
QuoteMortgages are capitalized up-front, investments are capitalized "late".Don't understand - could you elaborate?
You don't understand because it's a fundamental misunderstanding.
People look at mortgage amortization charts and think because you pay more interest up front, it makes sense to pay off some of those early years, not understanding that the interest you're paying is just a function of the amount owed and the interest rate and payment size, and of course later more goes to principal because you're paying the same payment amount but the amount owed at that point is a lot less.
But they say that it's "capitalized up front" like you have to pay more interest up front. You're still paying the same rate though.
(And an investment would be capitalized "late" because you earn more money "late" - well duh, that's when you have more invested.)
It's not true if you understand the math, so don't sweat trying to wrap your head around the misunderstanding, MDM. :)
I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?
I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?
Just noticed that you are parallel posting in this thread as well as the one I responded to in the general discussion subforum. Yes, post your numbers (mortgage interest rate and remaining life to maturity being the most relevant). I think it would be most helpful to do it in this on-topic thread for continuity for anyone following along.
Yeah, there's two discussions going on and I'm hooting and hollering in both - and it's making me tired. I want to get to the meat of it and move on. You want me to do my own case study here in this thread? I'll do it either way - here, or start a new thread, don't matta.
I think unless the mortgage rate is in the low 3s and the interest deduction is meaningful (i.e. the homeowner is in a very high income tax bracket) paying down principal is a more stable road towards financial independence and decreases the chances of "making a catastrophic mistake" with one's asset allocation or investment portfolio (buying high and selling low) which is not a trivial risk for 95% of the population
I think unless the mortgage rate is in the low 3s and the interest deduction is meaningful (i.e. the homeowner is in a very high income tax bracket) paying down principal is a more stable road towards financial independence and decreases the chances of "making a catastrophic mistake" with one's asset allocation or investment portfolio (buying high and selling low) which is not a trivial risk for 95% of the population
I'd draw this line somewhere higher than "low 3s with a meaningful tax deduction." A portfolio with a reasonable allocation of stock and bond index funds has a very high likelihood of outperforming a 4% mortgage (even with no tax deduction) over the next 30 years, and if it doesn't then just about all of our retirement plans are in a lot of trouble.
I would say betting on substantially more than 4% for the next 10-15yrs for a portfolio of stocks/bonds (60/40, 80/20 pick whatever allocation you want) is not a great proposition. We are not talking about this year or next year or even the next 3-5 years, but decades from now: history has shown that asset returns are almost impossible to predict in the short run, but very predictable in the medium to long run based on traditional measures of valuation due to mean reversion in financial asset returns. Buffett, Gross, Bernstein, Shiller, Jesse Livermore (from Philosophical Economics) - all the investing greats are in agreement that medium to long term returns going forward will be significantly lower than what we have seen the last 20-30yrs.
I would say betting on substantially more than 4% for the next 10-15yrs for a portfolio of stocks/bonds (60/40, 80/20 pick whatever allocation you want) is not a great proposition. We are not talking about this year or next year or even the next 3-5 years, but decades from now: history has shown that asset returns are almost impossible to predict in the short run, but very predictable in the medium to long run based on traditional measures of valuation due to mean reversion in financial asset returns. Buffett, Gross, Bernstein, Shiller, Jesse Livermore (from Philosophical Economics) - all the investing greats are in agreement that medium to long term returns going forward will be significantly lower than what we have seen the last 20-30yrs.
Fair enough, and I don't disagree with any of that. With a 10 or 15 year period until maturity I would probably choose to pay down a 4% mortgage today. But over a 30-year period, prepaying a 4% mortgage would have put you ahead less than 5% of the time historically (assuming you invested in a portfolio with at least a 50% stock allocation). I would probably choose to invest today with a 4% mortgage rate, but reasonable minds can differ on the advisability of that approach -- perhaps we are currently in a situation closer to one of the 5% failure cases. My mortgage rate is 3.875% with about 24 years remaining until maturity, and I'm choosing not to make prepayments.
The meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying. With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.
QuoteThe meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying. With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.
I definitely disagree with this point.
QuoteThe meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying. With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.
I definitely disagree with this point.
How so? The first part is axiomatically true, so you must mean the second sentence... So you think the next 30 years will be a sub 3% nominal return (i.e. a negative real return)?
Please clarify.
QuoteThe meat of it is very simple -- if you can get a return on investments higher than your mortgage's interest rate during the mortgage's remaining life to maturity, you're better off economically by investing instead of prepaying. With mortgage rates like those available today, over a 30 year period, that is very likely to be the case.
I definitely disagree with this point.
How so? The first part is axiomatically true, so you must mean the second sentence... So you think the next 30 years will be a sub 3% nominal return (i.e. a negative real return)?
Please clarify.
First:
I have never, ever had an investment that acts like a mortgage. The interest rate or percentage yield has never been something constant - it goes up, it goes down, it goes negative, it goes positive. So my disbelief in the statement is really a disbelief that there's an investment out there that acts as consistently positive as a mortgage such that the final $$ yield exceeds that of my mortgage.
The one investment I have that "acts" like a mortgage is my bank savings account, and I get a whopping 1% there. Now, if I could find a savings account that would pay me >% than my mortgage, I'd be all over that.
Second:
My timeframe for paying off the mortgage is five years, not 30 years.
We weren't talking about five years. Read his statement, that you quoted and disagreed with. It was on a 30-year time scale. Why would you quote and disagree with a statement about a 30-year time scale and then come back and reply later with "my timeframe is 5 years"?
But who in their right mind has a 30 year mortgage in this day and age? Haven't you overbought, badly, if you MUST have a 30 year mortgage?
Now, let's suppose me and "Smarter Guy" work for the same employer and that company goes belly up, or lays off both of us.
Neither one of us has money to invest, so higher yield investments are meaningless.
I keep my house, he loses his house, or burns through his 401k to keep it.
As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.
Now, here's the rub: my "what if" scenario I cite above is not made up - it's happened to several of my good friends and co-workers.
Now, let's suppose me and "Smarter Guy" work for the same employer and that company goes belly up, or lays off both of us.
Neither one of us has money to invest, so higher yield investments are meaningless.
I keep my house, he loses his house, or burns through his 401k to keep it.
As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.
Now, here's the rub: my "what if" scenario I cite above is not made up - it's happened to several of my good friends and co-workers.
This is completely apples and oranges. If you and "smart guy" had exactly the same monthly payments, to either a mortgage or investments, and you have paid off your house then the smart guy will have enough liquid investments to pay off his house too the day he lost his job. What people here are arguing is that he'd (historically) have more left than you do. You'd have a paid off house and no liquid assets, he'd have the money to either pay off his house or buy food.
Mortgage vs bank account does not make any sense for the same reason. A bank account is liquid, your house is pretty much as illiquid as it gets. A half paid off house does you no good if you loose your job, and you can't eat your house.
I'm guessing the examples mefla mentions were during the financial crisis, when stocks (and home prices) crashed at the same time that a lot of ppl lost their jobs (and had an extremely hard time finding another one)
A lot of ppl fail to realize that employment security and asset prices are often very highly correlated - bull mkts tend to make ppl complacent I guess
You guys keep talking in generalities, saying these things like they are natural laws. Maybe they are true in the abstract sense, but there's nothing abstract about the premise of this thread.
But who in their right mind has a 30 year mortgage in this day and age? Haven't you overbought, badly, if you MUST have a 30 year mortgage?
There's further complication, in that as I pay down, I refi at certain points so that I'm not paying against a very high initial borrow. When I get at-or-under $100k owed, I'll refi to a shorter 10 year term, drop my monthly payment and then push until I'm done there also
As soon as I'm done, 100% of what I was putting toward the mortgage goes into investing. So I start racing to catch up with that guy, smarter than I am, who didn't pay off his mortgage.
As time passes, his luck continues worse while mine is stable. He'll burn through his entire 401k because he can't maintain SWR. I'll keep mine because I'm already at SWR.
And BTW: My example I cited above, is my brother-in-law. His scenario occurred last September. However, from the 2008 timeframe I do know about a dozen people affected in the housing bubble in the way you speak of.
This is a long thread, and maybe this question is best posted in a new thread but I will fire away. Let's say someone uses 100% capital gains in retirement (taxable account). We all know that up to a certain point these will be free from federal taxes. Let's say a mortgage forced you to realize additional capital gains which would be fully taxed. Would it be worth it in this case to pay off the mortgage before retirement with w2 income already being taxed to avoid the federal taxes in retirement? I know it will depend on interest rate, return assumptions, etc. but what do people better at math than I think about this scenario? Sorry if this has been addressed.
You are not just attacking the primary assertion as untenable; you are making claims that reflect a misunderstanding of the math behind mortgage loans and investments and therefore also reflect a misunderstanding of why we are saying that prepaying long term, low interest, fixed rate debt is suboptimal.
How is it that your brother-in-law and other victims of regional economic hardship are worse off by not having prepaid their mortgages? If you would read and respond to the points we are making in our posts, I think you would see that they would be better off by investing instead of prepaying. Prepaying your mortgage leaves you in a worse spot if you unexpectedly find yourself without a job; you are left with less options to pay that mortgage payment that the bank is still going to be expecting every month.
1) Who keeps a mortgage for 30 years any more when you save so much money with a 15 or 10 year? OK, a 30 year mortgage is a "lesser investment" than...investment. I get that. But I refi'ed to 15 ages ago and am trying to refi $100k (or less) to 10 years to save even more money. (And if the answer is "run FIREcalc to figure this out for yourself, that's OK, I can do that.)
2) WHAT investments are best for outstripping that terrible 30 year mortgage? I offered examples of savings instruments that CANNOT outstrip my mortgage: My credit union's CD's, savings accounts and mutual funds. They have pathetic yields far less than my mortgage's % rate.
3) What happens when you sell the house and buy another with a new mortgage, especially if the property has increased in value and you make money off the sale?
4) What happens when your investments crash and you lose 50% and it takes time for things to recover? I thought the prevailing wisdom is that you never recover the time value of the cash lost during the downturn? (This happened to me in a 401k and in a plain stock purchase, so don't give me any crap like "that doesn't happen". Ask folks who bought stock in the "Old GM"...)
QuoteHow is it that your brother-in-law and other victims of regional economic hardship are worse off by not having prepaid their mortgages? If you would read and respond to the points we are making in our posts, I think you would see that they would be better off by investing instead of prepaying. Prepaying your mortgage leaves you in a worse spot if you unexpectedly find yourself without a job; you are left with less options to pay that mortgage payment that the bank is still going to be expecting every month.
You are better off only after you've made it beyond what I'll call "the zone of risk", when your investments are not only large enough to support paying the mortgage, but large enough so that you don't deplete them. What is that, 12 years? 15 years?
In other words, with an SWR of 4% and let's say a mortgage of $2k/month and living expenses of, say, $1k/month ($3k/month total, $36,000 a year), you need $900,000.
But, oh no, he's lost his job with only, say, $100,000 in savings/investments and he's got to have $3k/month to live on . He's no longer contributing to the investments, so that gets stuck at $100,000 save for the yields.
He depletes his savings in less than four years. If he's not found a job in four years, he loses house, investments, etc.
He'd be better off walking away from the house the moment he loses his job, moving in with dear old mom and dad and trying to drop his monthly cash needs as low as possible, until he finds a new job.
Right?
As long as the CAGR at the end of the 30 years is > the mortgage rate, you came out ahead, regardless of any crashes along the way. This has happened in every 30-year period in history, IIRC, compared to today's mortgage rates.
There has been comments about trapped equity which seems to be a bit of a fallacy
The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)
The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.
There has been comments about trapped equity which seems to be a bit of a fallacy
The owner with a 15yr mortgage can easily take out a HELOC now (before disaster strikes) to prepare for the inevitable rainy day (which includes buying stocks with proceeds of HELOC if stocks crash)
Many HELOCs were shrunk or cancelled in the recession. It's something that's nice to plan for, but I wouldn't count on. And most people trying to pay down their mortgage aren't thinking about taking out a second mortgage (essentially). And good luck trying to get it if you don't do it ahead of time, after you've lost your job.The practice of taking out a 30yr mortgage and never paying it down is only realistic for a small minority of homeowners who will never have to move OR are in the business of being a landlord.
This is true. Or smart Mustachians who read the arguments, do the math, and purposefully decide to hold their low-rate, fixed mortgage and invest everything they can instead.
If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater. And yes my premise did assume the owner took out the HELOC while employed.
Additionally, those arguing so strongly for never paying down principal may have their dream house in the perfect location with the ideal family size for the next 30yrs (or may simply add it to a portfolio of rental properties if not) but I think it is fair to say that probably is not the case for most readers.
If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.
If HELOCS are cancelled due to a large nationwide drop in housing prices again, I think it is probably fair to say stocks will be significantly lower than where they are now and the 30yr "no early payments" strategy will be massively underwater.
I disagree that that's a fair statement. It doesn't matter if stocks are "massively underwater" (as compared to the "return" on mortgage prepayment) at any given point during the 30-year run; it only matters if the CAGR outperforms the mortgate rate over the entire 30-year period. At the snapshot in time when HELOCS were cancelled during the financial crisis, stock performance would have been trailing mortgage prepayment performance for someone who started down that road right before the financial crisis, but now stock performance is back on track to outperform. If you look at the entire history of the markets, with all the market crashes and calamities, there hasn't been a 30 year period where the markets didn't outperform today's super-low mortgage rates.
You are better off only after you've made it beyond what I'll call "the zone of risk", when your investments are not only large enough to support paying the mortgage, but large enough so that you don't deplete them. What is that, 12 years? 15 years?
In other words, with an SWR of 4% and let's say a mortgage of $2k/month and living expenses of, say, $1k/month ($3k/month total, $36,000 a year), you need $900,000.
But, oh no, he's lost his job with only, say, $100,000 in savings/investments and he's got to have $3k/month to live on . He's no longer contributing to the investments, so that gets stuck at $100,000 save for the yields.
He depletes his savings in less than four years. If he's not found a job in four years, he loses house, investments, etc.
NewNormal -
I agree with the overall sentiment in your post above. You need to compare the risks associated with each strategy and pick your poison. But I would say that for most people, all things considered, the odds will favor the strategy of carrying the mortgage. If there's a strong chance you will be selling your house in the short-term, it would be stupid to leverage up and invest the proceeds in the stock market, but generally speaking it is a bad idea to buy property in the first place if there's a strong chance of selling in the short-term. Yes, shit happens and unexpected circumstances may arise that force you to sell early, but generally you can control the timing of your sale -- so do you pick the plan that protects you against the remote risk of being forced to sell at a bad time, or do you pick the plan that protects against the very large risk of harming your chances of retirement success (i.e., requiring you to either work longer than what would otherwise be necessary, or cut expenses or seek alternative income in retirement, or some combination)?
But some of the bad outcomes in your list of correlated events argue against your point. Instability of employment income is a good reason not to pay down your mortgage. If you lose your job midway through an aggressive prepayment plan (which, as you said, will quite possibly happen at a time when your access to cash through other alternatives, including extraction of home equity, is also limited), you would have been better off had you been investing in lieu of prepaying (because even a depreciated pile of investments provides better liquidity than nothing).
Again, over a 30 year time horizon, with mortgage rates like those available today, investment performance would have failed to enable you to pay off the mortgage in accordance with its scheduled amortization and still have a pot of money left over at the end of the 30 year period less than 5% of the time (which includes all the recessions, depressions, market crashes, bear markets, etc., in the history of the markets).
NewNormal,
These are mostly valid points. Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.
But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin. I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding. The first person at least has some depreciated investments to be liquidated.
Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options). And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.
The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio. If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so. By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time. Leveraging up your investments is doubling down on this approach. For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate. If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed atdebunking[EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.
I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).
NewNormal,
These are mostly valid points. Like I said, one needs to weigh the risks and potential benefits of the two approaches against one another.
But I'm struggling to understand your point about the correlation of unfortunate circumstances leading to financial ruin. I'm not questioning the correlation (it's the opposite -- I assumed it to be true for the sake of argument); I'm arguing that a person who loses his job during a financial crisis that simultaneously devalues both housing and stock prices and also cuts off normal methods of accessing liquidity will be worse off if he was in the middle of an aggressive mortgage prepayment plan (as opposed to the same person who instead never prepaid a penny), higher balance sheet leverage notwithstanding. The first person at least has some depreciated investments to be liquidated.
Your point is really comparing the mortgage vs. no mortgage options (or mortgage vs. pay-off-in-full options). And the person who is in a position to pay off their mortgage in its entirety but chooses not to is likely also a person whose other balance sheet assets are high enough to provide sufficient buffer to get through most any unexpected circumstance.
The considerations are similar to whether or not you should have an aggressive asset allocation for your portfolio. If you want to retire as early as possible with the highest chances of retirement success, you need an aggressive allocation to do so. By using an aggressive allocation, you do assume the risk that unexpected liquidity needs will arise and force you to liquidate some of your investments at a bad time. Leveraging up your investments is doubling down on this approach. For the reasons you and skyrefuge mentioned regarding the current market environment, there may be reasons to believe that right now we're in a situation like one of the 5% historical cases where investment returns sub-performed a mortgage with a 4% rate. If you believe that, you also need to realize that you're going to need to plan your retirement around a super-low withdrawal rate, and the arguments in this thread have mostly been aimed atdebunking[EDIT] revealing the intellectual inconsistency of believing in the safety of your supra-3% withdrawal rate of choice and at the same time believing that paying off your sub-4% mortgage reduces risk.
I want to give a proper response to skyrefuge's post, which I may do later tonight (I'm leaving the office shortly).
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
Dividends are mathematically equivalent to selling stock. If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock. They are mathematically equal.
This is my understanding thus far. There are two strategies here.
I. If you are exceedingly risk-averse, go ahead and prepay your mortgage and get that guaranteed current sub-4% return on your prepayments over 30+ years.
II. If you are OK with the risk and have a long remaining investing life ahead of you, go ahead and invest for the higher returns. It will probably be higher than the 4% but no guarantees.
Mathematically (financially) over long durations (20-30 years) investment ROR under II. will most likely beat I. It will be a bumpy ride. If you need the comfort, safety, and security, stay out of the ride.
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
Dividends are mathematically equivalent to selling stock. If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock. They are mathematically equal.
This is incorrect.
When you receive a dividend, you receive a % of the corporation's profits. While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.
When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits. The going rate for profits does change dramatically over time. If you sell today you will receive a much higher multiple than if you sold just a few years ago.
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?
I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.
cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)
Since we're looking at the historical record (which I agree is the correct approach here), isn't it at least slightly optimistic to universally apply today's historically-low mortgage rates to all historical periods, given that there is likely to be at least some correlation between interest rates and forward-looking 30-year equity/bond returns?
I'm trying not to be too much of a market-timer here, but it seems likely to me that the "equity risk premium" is a real thing that's at least somewhat constant. So the idea that today's low interest rates might result in lower-than-average returns going forward doesn't seem totally insane to me.
cFIREsim probably isn't the best tool for this, since it doesn't know anything about historical mortgage rates, but it would be interesting to see the success rate if "prevailing mortgage rate at the beginning of the 30-year cycle" was used as the rate rather than "4%". Maybe this has already been done? (maybe even in this thread sometime in the last 2 years it's been going, but I'm too lazy to go back and check!)
I thought about this my entire bike-ride home. I think the best answer is the Churchillism you coined that history-based prediction is the worst form of retirement success prognostication we have, except for all the others. The caveat that the future may not resemble the past applies to all the retirement planning we discuss in this forum. As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate. Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right? Is there any reason to think it works in this context but not that context?
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points. It shouldn't be hard to calculate.
Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
Dividends are mathematically equivalent to selling stock. If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock. They are mathematically equal.
This is incorrect.
When you receive a dividend, you receive a % of the corporation's profits. While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.
When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits. The going rate for profits does change dramatically over time. If you sell today you will receive a much higher multiple than if you sold just a few years ago.
Oh boy!
Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)
http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
I understood his question to be similar to mine, which is what have realized historical returns been from low rate (use treasury yields as a proxy for mortgage rates) starting points. It shouldn't be hard to calculate.
Intuitively, future rates of return for all asset classes should be depressed when rates are extremely low, as the price for assets is bid up to account for the low risk free rate set by global central banks.
Somewhere in the neighborhood of current mortgage rates (maybe 3.5% or so), in every single historical 30-year period (including all of those with low-interest starting environments) the market returns would have outperformed the mortgage (if cfiresim were working, we would be able to confirm the exact level, and I've become so dependent on cfiresim as to have near-total incompetence at using other calculators).
The claim that we're in a new world, and have never before experienced low interest rates combined with other aspects of the current market climate, and therefore can't use history as a guide, is pessimistic perspective, similar to what Pfau argues.
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
Wow, no relevance? Did you even read the thread??
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
Dividends are mathematically equivalent to selling stock. If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock. They are mathematically equal.
This is incorrect.
When you receive a dividend, you receive a % of the corporation's profits. While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.
When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits. The going rate for profits does change dramatically over time. If you sell today you will receive a much higher multiple than if you sold just a few years ago.
Oh boy!
Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)
http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
Wow, no relevance? Did you even read the thread??
Yes
How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?
... whether selling a share of stock (index) is equivalent to receiving a dividend...
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
Wow, no relevance? Did you even read the thread??
Yes
How is it relevant to my comment earlier of using dividend yield as a valuation measure for the market (similar to real yields on TIPS)?
I don't want to derail this thread into yet another discussion on dividends so this will be my only reply on it.
You brought up dividend yields with the assumption that the valuation of a company changes depending upon their dividend payout. The link that Eric posted contains comments and links that are a direct response to this assumption as well as:... whether selling a share of stock (index) is equivalent to receiving a dividend...
I personally don't think a 4% withdrawal rate is prudent in this environment. Inflation adjusted bond yields are flat to negative, and dividend yields for US stocks are roughly 2%, so withdrawing 4% a year and increasing for inflation sounds like one would be relying on capital gains and tapping into principal. Sounds to me like high sequence of return risk.
Dividends are mathematically equivalent to selling stock. If you'd be comfortable with a 4% SWR if all 4% were from dividends, you should also be comfortable with a 4% SWR if it consists of 2% dividends and 2% selling stock. They are mathematically equal.
This is incorrect.
When you receive a dividend, you receive a % of the corporation's profits. While the payout ratio changes over time, and more recently has declined due to investor tax preferences, perceived legality of corporate buybacks and incentives for executive compensation, it does not fluctuate dramatically from year to year or even decade to decade.
When you sell a share of stock, you receive what the market is willing to pay for the corporation's profits. The going rate for profits does change dramatically over time. If you sell today you will receive a much higher multiple than if you sold just a few years ago.
Oh boy!
Rather than re-invent the wheel, try reading through the math based examples in this thread (or any of the linked threads therein)
http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/
The link you pasted has no relevance to what the dividend yield of the entire mkt (index) is, whether selling a share of stock (index) is equivalent to receiving a dividend, and the perceived safe withdrawal rate of a portfolio.
Sure there is. It's one example after another showing how dividends are mathematically equivalent to selling shares of stock. Above you claimed that was incorrect. So since they're equivalent, it's irrelevant to the withdrawal rate whether those withdrawals come from all dividends, all shares, or some combination.
Maybe I could've pointed you a little more directly. Try here (http://forum.mrmoneymustache.com/investor-alley/total-stock-vs-500-vs-dividend-growth/msg184781/#msg184781) or here (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/msg584803/#msg584803)The dividend yield is one of many ways to determine valuation - whether you use div yield, price to book, price to sales, price to earnings total mkt cap vs gdp you get the same result: they all seem to point to overvaluation vs historical returns (which many here seem to be blindly adhering to when comparing to the present low mortgage rate).
I'm not sure what this has to do with the difference (or lackthereof) between dividends and sales of shares to fund your withdrawal. It seems like a wholly different argument, so I'm not sure how it got tacked on here. But if you don't think that your stocks are going to return greater than 3.5% per year over the next 30 years, then your proposed withdrawal rate will have to be extremely small, leaving you at work for a long long time. (basically the whole point of this thread)
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).Nicely done. Great spreadsheet. I'll play with it some.
Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.
What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.
In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet
Define risk. Stocks are more volatile, but not more risky, IMO, over a long enough time period.
Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.
I thought about this my entire bike-ride home.
As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.
Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?
Where did I say the valuation of a company changes depending upon their dividend payout?
Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?
I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).
I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).
No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post (http://forum.mrmoneymustache.com/welcome-to-the-forum/but-aren%27t-we-ignoring-inflation%27s-impact-on-our-cost-of-living-in-retirment/msg469217/#msg469217) for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)
Where did I say the valuation of a company changes depending upon their dividend payout?
Er....right here (http://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/msg602238/#msg602238): "The dividend yield is one of many ways to determine valuation".
Sure, it's a way to determine valuation, but it's a naive and worse-than-useless way to do so. You might as well use Facebook "likes". Looking at earnings makes a lot more sense, since a company can choose to stop distributing its earnings via dividends and distribute them via buybacks instead, and that wouldn't change anything about the company's value.Let me ask you: do you think the long term (say 30yr) return on the S&P will be the same irrespective of whether the dividend yield at the starting point is 2% vs 4%?
It certainly could be. If the dividend yield was 4% because companies were distributing 100% of their earnings via dividends, and then changed to 2% because they started distributing their earnings 50% via dividends and 50% via buybacks, then yeah, the total return would be the same. It seems like you understand how this works for a single company, so it's a pretty small leap to see how it works the same way for a group of companies, aka, "the market". Or just imagine that "the market" is made up of a single giant company.
Ok, like Runge, to avoid derailing the thread, this is my last post on the matter of dividends. If you'd like to discuss it more, please post in the referenced thread about dividends. (http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please)
But while I'm here going off-topic...I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).
No, the 4% SWR rule-of-thumb has absolutely nothing to do with average investment returns. See this post (http://forum.mrmoneymustache.com/welcome-to-the-forum/but-aren%27t-we-ignoring-inflation%27s-impact-on-our-cost-of-living-in-retirment/msg469217/#msg469217) for the response I have already made to the exact same comment. (everything else in your post seemed cool but I couldn't let the screeching nails-on-the-chalkboard of that comment pass without complaint!)
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet
Define risk. Stocks are more volatile, but not more risky, IMO, over a long enough time period.
Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.
Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.
Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation. People have been trapped and unable to relocate due to being upside down on a mortgage.
Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.
Why would the home equity you have built up with prepayments be less than the value of securities you accumulated by taking that money and investing in stocks?
Because I'm sticking with your proposition that the capital markets, housing markets and job markets are all correlated, so when you lose your job it happens at a time when the value of your house has plummeted together with the value of your securities, and in any event you can't access the home equity you do have through a HELOC, which has also become unavailable in this market crisis.
It sounds to me like someone who would be in such dire straits in that situation would have no business levering up his personal balance sheet with risky (which is how they give a higher expected return over the long run) common stocks at the expense of deleveraging and shoring up his net worth and balance sheet
Define risk. Stocks are more volatile, but not more risky, IMO, over a long enough time period.
Also the person prepaying their mortgage and having less liquid assets is in a much worse position, IMO, unless they have the whole thing paid off.
Your logic is valid as long as the risk of ruin is negligible, which is far from the case. I've already mentioned equity extraction methods (recast of loans, HELOC, even opening other credit lines) but you seem to ignore them in your "having less liquid assets" comment.
I consider ROR of holding a market index fund to be very close to zero. And in the case of total economic collapse, having a bit more equity in your house won't help you one bit. And yes, equity extraction in a time of turmoil I consider much less liquid than selling a publicly traded stock.Another consideration which hasn't been mentioned is, if you are forced to sell your home for whatever reason in a down market, it is much easier to do so with positive equity as opposed to a short-sale situation. People have been trapped and unable to relocate due to being upside down on a mortgage.
If you have years of payments saved up that you haven't put into the mortgage, you won't need to sell.Perhaps an expert in credit (corporate spread investing) could chime in, as I am at a total loss as to how ppl actually believe adding stocks to a personal balance sheet over paying down debt (deleveraging) is less risky for the typical household, even for a 30yr period, if for no other reason than that there are a non-trivial number of paths that would cause a suboptimal outcome.
If my mortgage balance at a given time should be 50k according to the standard amortization table when I got the loan, if I had just made all my regular payments, my PITI is $400/mo, and I've put an extra $30k into it, so it's actually only 20k, and I lose my job, I still have to make that $400 payment. It doesn't matter one whit that I'm slightly less deleveraged. But if I still owe 50k, and have that 30k extra in the bank (which is reduced by 30%, say, from a market drop to 21k), that extra 21k gives me over 4 years of payments in the bank. That's lots of time to find a new job, wait for the stock market to correct, etc.
Not having being forced to sell low is less risky, IMO.
If instead my mortgage is only 20k at that point, but I have very little in the bank (say, a 1K emergency fund, or just over 2 months of mortgage payments) and I'm forced to sell the house to extract that equity (as my well prepared HELOC plan gets me a letter in the mail saying the bank has closed it due to economic times), I could be in quite a bad spot, start taking hits to my credit as I'm unable to make the payment in the meantime, etc.
I much favor the person with cash in the bank (even invested in equities that have dropped) over the one with it as equity in the house, even if that person is a bit more leveraged on paper.
As long as we're using "success rate" and similar concepts as code-speak for "success rate assuming the future looks like the past," prevailing mortgage rates are irrelevant to the question of the odds that investments will outperform the mortgage rate.
No, that'd be like saying "the inflation rate at the beginning of a 30-year cycle is irrelevant to the question of portfolio survival". If we just look at nominal investment returns (ignoring inflation), the 30-year cycle starting in 1966 would look just fine with a 4% WR. But we know that inflation affects real returns, so we include the historical inflation value when running the simulations, which reveals 1966 to be a bust.
So ignoring the historical inflation levels and using the current-but-historically-low 1.5% inflation rate for all cycles would cause cFIREsim to overestimate the success rate for portfolio survival. Likewise, I think it's probable that ignoring the historical mortgage rates and using a the current-but-historically-low 4% mortgage rate for all cycles would cause cFIREsim to overestimate the success rate for leveraged-investing-via-mortgage. Maybe the cycle starting in 1980 shows that it would have been a fantastic idea to borrow money to invest if you could have borrowed it at 4%, but a terrible idea if you had to borrow it at 10%. If so, the 1980 cycle would be a "false positive" in your cFIREsim results, since you couldn't actually borrow money at 4% in 1980.Your proposed method of re-examining the issue, if it worked, would also have broader application for determining what WR to use to avoid portfolio failure in light of a given measure of the starting market climate (CAPE, or something else), right?
No, those are different things. Something like CAPE would have no role in the cFIREsim model. It's not necessary to tell us what actual returns were like in a historical cycle. Inflation-adjusted prices are sufficient for that. While there are surely things that could be added to the cFIREsim model to refine its re-creation of history (the change of bond modeling was one such thing), CAPE is not one of those things. On the other hand, when you're using cFIREsim as a leveraged-investing-via-mortgage simulator, you're implicitly adding the need for more historical data, namely mortgage rates, and using a constant, current rate is a crude substitute when everything else is historically-accurate.
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?
Why do you once again assume you cannot extract equity or recast the loan (decreasing your minimum monthly pmt)?
My understanding is that lenders are not required to recast mortgages on request. This can especially happen if the loan has been sold to a different investor who may or may not be willing to recast. In fact, there is nothing I see in the usual mortgage agreement that contains a provision for recast. You can certainly prepay without penalties but the lender is not required to recast/re-amortize the balance.
That said, my lender is willing to recast currently but their policy may change in the future. I'd rather on be dependent on the whims of my lender. It is a policy not within my control and no guarantee that I'll be able to when needed.
And even if you can recast to a lower payment, that still doesn't help you access the equity - in other words, you still need to make that payment, and have very little money with which to do so.
First, mefla, I'm about to talk some mid- to high-level shit here that doesn't actually impact the low-level stuff that brooklynguy and arebelspy are trying to help you to understand. So no need to read this until you understand everything they're saying.
There's no reason you can't use history-based cfiresim as the best (that is, the worst, but better than all the rest) predictive tool to determine the chances of success for this pretend spending plan, right? And if the answer is no, because you want to take each historical period's actual interest rate environment into account, then why should that not be the case for all of the cfiresim analyses we ordinarily do?
What your argument implies (I think) is that some characteristic about a market exists (the prevailing mortgage rate? a treasury yield benchmark?) from which it is possible to determine future returns.
I suppose to the extent that your yearly expenses are attributable to historically-known factors, those factors should be incorporated into the simulation for ultimate accuracy. We just enter "$20,000" for our yearly expenses because it's easy. "100 lbs. of beef, 500 gallons of gasoline, 100GB of mobile data, interest payments on a $200k loan, etc" would actually be better, since our desire is not really to make a particular amount of dollars disappear, but to acquire products and services we need in our lives.
However, in the special case of leveraged-investing-via-mortgage, 100% of the expenses are easily attributable to a knowable factor, and furthermore, that factor is much more likely to be correlated with other cFIREsim factors than the price of beef is.
I would say more that I'm offering the hypothesis that prevailing mortgage rates have a correlation with future market returns, and plugging that data into cFIREsim would be an informative exploration of that hypothesis.
I mean, this is the reason why we (I think?) like historical simulators like cFIREsim vs. Monte Carlo simulations, because Monte Carlo simulations ignore the possibility of equity returns, bond returns, interest rates, and inflation being interrelated. The Fed (these days) directly connects inflation to interest rates, interest rates directly affect bond returns, and bond returns theoretically and indirectly affect equity returns. None of those links are ironclad, and the gross effect is pretty unpredictable, but the ability to at least recognize any interrelation is one big thing that differentiates cFIREsim from Monte Carlo simulations.
Say 4%-or-lower mortgage rates actually existed in only 20% of cFIREsim's start years. If it showed that the success rate of the leveraged-investing-via-4%-mortgage plan was 50% when looking at only those years, vs. the 96% success rate when you use 4% for all years, would you still say that the leveraged-investing-via-4%-mortgage plan has a 96% chance of beating the pay-off-your-mortgage plan? (for the record, if historical mortgage data was used, my random-ass guess is that the cFIREsim success rate would only be reduced to 80% or something; I'm not at all saying that the leveraged-investing-via-4%-mortgage plan is the wrong choice, just that it's possible that "there's a 96% chance of it being the right choice" could be overstating it a bit).
And yes, this is similar to the recent thread on CAPE and SWRs (http://forum.mrmoneymustache.com/investor-alley/using-market-valuation-measurements-to-affect-swr/) where I made the possibly-heretical admission that I feel the odds of success for someone retiring at today's high CAPE-levels may be slightly lower than the overall cFIREsim success rate indicates.
This is profoundly true. I still need to make that payment.
But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.
This is profoundly true. I still need to make that payment.
But I have money, because I wasn't simple-mindedly writing a check to pay down the mortgage from my paycheck: I was funding my mortgage pre-payments through short-term liquid investments. So I have a stepwise liquid cash reserve I use, much like an FU FUND, until I find the next job, get the loan re-cast, or use the cash reserve to do a refi.
So now your previous plan to prepay in lieu of investing has morphed into a plan to invest in cash in lieu of investing in stocks/bonds? That is not addressing the "carry mortgage vs. pay off mortgage" decision (which is the subject of this thread), and is instead addressing the question of the advisability of engaging in market timing. Even the person with no mortgage has to decide whether to deploy excess cash towards their bank account or their brokerage/mutual fund account. And, consistent with the upthread attempts to stymie the off-topic detours into the matter of dividends, that's all I'm going to say on the subject.
I sense a new tagline:The MMM forums:The Internet: Home of the most irrational people on the internet.
I'd truly be a lost soul to take guidance from people who've been so irrational in a public forum ... you poop-flinging monkeys ...
... ideas in your head about what I'm really doing, simply because I contested a point and asked questions ...
arebelspy offered his opinion of what you were thinking, but it would be better to hear a first person response. There has been a lot of back and forth since then, so I may have missed it, but what do you mean about the capitalization timing?Mortgages are capitalized up-front, investments are capitalized "late".Don't understand - could you elaborate?
... ideas in your head about what I'm really doing, simply because I contested a point and asked questions ...
Speaking of questions:arebelspy offered his opinion of what you were thinking, but it would be better to hear a first person response. There has been a lot of back and forth since then, so I may have missed it, but what do you mean about the capitalization timing?Mortgages are capitalized up-front, investments are capitalized "late".Don't understand - could you elaborate?
Hey arebelspy, it's not MDM that doesn't understand. MDM was quoting my comment, it's me saying "capitalized up front" so it's me who is not understanding.
Look: I'm not coming to you or anyone else to determine "my plan". I have a plan and I'm sticking to it based on my prior personal investment experience and the experience I've seen other people go through. If avoiding another Enron or GM bailout is "market timing", then I have to accept that you and I are never going to have a reasonable discussion about this question.
All investing is subject to risk, TRUE
including the possible loss of the money you invest. If you take out or sell your principal when it's down
Diversification does not ensure a profit or protect against a loss. sure... 1 goes up 1 goes down... usually more like 10 go up, 2 go down, 1 goes out
Investments in bonds are subject to interest rate, credit, and inflation risk. Cash in a savings account loses 2% when inflation is 3% on average and your savings account returns 1%... same for bonds if inflation goes above the average.
2008 151000 - left old job - options also underwater - lost them - downturn also
2009 103834 - at one point even lower like 70K
2010 161963
QuoteQuoteI thought mefla agreed with my interpretation based on his response:
Hey arebelspy, it's not MDM that doesn't understand. MDM was quoting my comment, it's me saying "capitalized up front" so it's me who is not understanding.
But if not, feel free to chime in with what you did mean.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
mefla - it might be best to just focus on winning in life rather than on this Internet forum.
There do seem to be a few jerks, and I guess is it is human nature to state things confidently as black and white, when in reality there may be gray areas (I am guilty of this myself at times). There are quite a few friendly + helpful ppl as well and they are really the ones who add value to the discussions.
I have gotten irritated at times myself, which has forced me to consider how much time I want to spend participating rather than just casually observing. I do think it would ultimately be in everyone's interest to keep the tone friendly and welcoming, lest ppl who actually have something meaningful to contribute decide to disengage, but I leave that to others to police and manage, particularly the forum moderators and established participants.
Good luck in your endeavors
As for arebelspy "enjoying the thread", more power to him. I sure as hell haven't. If he's supposed to be a moderator and trusted keeper of the forums, he damn well failed in that mission on this thread.
I appreciate your comments. I got an answer that satisfies me from VikB in the other thread.
And what-the-hell are these awesome pre-tax investments I'm missing out on besides:
- 401k (Buying Vanguard but it's Fidelity. It has a contribution cap and .15% fees)
- HSA, which I dived into when it became available to me 3 months ago which I think has zero yields.
Post-tax I'm using Betterment.
I'm serious about this, I want to get it right. What can we do here - start another thread with me as a case study?
As for arebelspy "enjoying the thread", more power to him. I sure as hell haven't. If he's supposed to be a moderator and trusted keeper of the forums, he damn well failed in that mission on this thread.
Most people take disagreement as just that -- disagreement ... You're taking things that aren't personal and making them so. The rest of us (arebelspy included I'm sure) enjoy the discussion even if there is disagreement.
I do think it would ultimately be in everyone's interest to keep the tone friendly and welcoming, lest ppl who actually have something meaningful to contribute decide to disengage
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).Nicely done, but there are some items that seem pertinent.
Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.
What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.
In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
When I run a cfiresim simulation, I want to find out the historical success rate of withdrawing $20k per year, and not the historical success rate of withdrawing an amount of money sufficient to purchase $20k worth of beef as of the date I run the simulation.
Take the hypothetical example of someone whose entire living expenditures does and will always consist of nothing but purchases of large quantities of pocket calculators. When this person uses cfiresim to plan his retirement, should cfiresim take into account the actual historical cost of pocket calculators (which, I'm assuming, was extraordinarily higher in today's-dollars in 1965 than today)?
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).Nicely done, but there are some items that seem pertinent.
Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.
What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.
In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.
When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K
...and retirement occurs at exactly the same time in both scenario 2 & 3.
The math remains the math: investing at 7% is better than prepaying at 4.25%. Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
No, but it is arguably logical to assume that they should do so, assuming they are capable of completely excising all emotion from their investing decisions (which most people (or all people?) aren't). Some of us (including me) routinely argue that there is no logical reason to hold bonds, period, if you can be absolutely certain that your time horizon is sufficiently long (30 years passes that test, IMO), except to the extent the bonds operate as self-restraint tool to prevent your own irrational, emotionally-driven self to panic-sell during a market downturn (there are lots of threads on that topic, like this one (http://forum.mrmoneymustache.com/investor-alley/why-would-i-be-in-anything-other-than-100-stocks/)). But it is especially illogical to do so while simultaneously carrying a mortgage (which effectively operates as a bond holding and can be used as a substitute for the desired bond portion of your allocation).
Except for the whole rebalancing thing.
Except for the whole rebalancing thing.
You mean as far as a reason that it makes sense to hold bonds, or as far as why you can't equate carrying a mortgage to holding a bond?
The spreadsheet analysis makes no assumption about asset allocation. It assumes only that one receives a certain (in the example, 7%) investment return, in order to demonstrate numerically that investing at a higher return is better than paying a mortgage with a lower interest rate....So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
The math remains the math: investing at 7% is better than prepaying at 4.25%. Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
MDM and Runge -- Thank you.Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).Nicely done, but there are some items that seem pertinent.
Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.
What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.
In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.
When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K
...and retirement occurs at exactly the same time in both scenario 2 & 3.
The math remains the math: investing at 7% is better than prepaying at 4.25%. Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
Getting back to the question posed in the thread title, I ran some calculations on a (I believe) realistic scenario. I assumed a 30 year mortgage with a beginning balance of $160,000 and an interest rate of 4.25%. This gives a monthly mortgage payment of $787. Annual expenses including the mortgage are $40,000, and excluding the mortgage equates to $30,500. I'm also assuming a 7% CAGR for investments (which is what the 4% rule is based off of).Nicely done, but there are some items that seem pertinent.
Let's say I have an additional $1,200/mo to either:
*pay down my mortgage early and then invest $1,987/mo after the mortgage is gone
*invest the $1,200/mo.
What I find is that in scenario 1, I can pay down the house in the 7th year, and have zero investments during that time period. Fast forward to year 25 and I finally have enough invested that I can live off 4%/year.
In scenario 2, I reach FI in year 26, one year after scenario 1 and can live off my investments and continue paying my mortgage.
HOWEVER, there's another option. What if I did scenario 2, and right before I FIREd, I paid off my mortgage in balance. This leaves me with the lower annual expenses of not having a mortgage while capitalizing on the higher returns of the market compared with the mortgage interest rate. I find that I can retire in year 23, a full 2 years earlier than scenario 1. I get the benefits of having liquid assets to live off of if I lose my job in the first decade over scenario 1 while putting that hard earned cash to work earlier. And this is assuming I never increase my savings over 30 years (and a pretty lame savings rate to boot).
I've attached my spreadsheet. Green cells mean I can FIRE on 4%. Did I miss anything crucial? Yes of course I'm assuming a steady 7% rate of return. Also, in scenario 2, after year 30, my SWR would drop well below 4% considering I'm going from 40k/year expenses to 30k/year expenses, so scenario 2 works out even better assuming I can get through the last 5 years.
1) After retirement, presumably the extra $1200/mo (or $1987/mo in scenario 1) is not available.
2) In scenario 2, the monthly payments have to be deducted from the investment balance for calculating subsequent growth.
3) In scenario 3, the lump sum has to be deducted from the investment balance for calculating subsequent growth.
When those items are included (see attached), the investment balance after 30 years is
Scenario 2: Invest all savings and pay minimum on mortgage = $1,417K
Scenario 3: Invest all, then pay lump sum at retirement = $1,409K
Scenario 1: Pay Down Mortgage before investing = $1,266K
...and retirement occurs at exactly the same time in both scenario 2 & 3.
The math remains the math: investing at 7% is better than prepaying at 4.25%. Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
The spreadsheet analysis makes no assumption about asset allocation. It assumes only that one receives a certain (in the example, 7%) investment return, in order to demonstrate numerically that investing at a higher return is better than paying a mortgage with a lower interest rate....So is it logical to assume anyone who is following this strategy of paying the minimum mortgage payment has 0% allocation to bonds and is 100% stocks?
The math remains the math: investing at 7% is better than prepaying at 4.25%. Of course one can debate the riskiness of one vs. the other, but if one chooses to assume 7% investment vs. 4.25% mortgage then the answer is to pay the mortgage minimum.
Here is what *I* want cFIREsim to tell me, where, if "A" is not implementable, then I'll settle for the next one on the list, and so on:
A) A visitor from the future to tell me that my retirement worked perfectly, where I never wanted for money, and died with $1 to my name.
B) A time machine that sends versions of me into the past, and tells me that "1871 skyrefuge" through "1970 skyrefuge" all would have made it successfully and happily through their retirements.
C) A time machine that sends a Generic Money-Spender into the past, and tells me that "1871 GMS" through "1970 GMS" don't run out of money.
Note that each step down comes at the cost of decreased accuracy in the prediction of my actual life path. "A" is the ultimate, because it removes all concern about whether the future is likely to resemble the past. "B" doesn't tell me anything about the future, but it tells me how *I* would have done in the past, with my desires and behaviors and flexibility in the face of differing economic conditions. "C", believe it or not, is what cFIREsim actually does ("whoa....")
And so similarly, a one-off B-Level cFIREsim for a leveraged-investing-via-mortgage nut would also be possible. If I was such a nut and had the choice of using a B-Level cFIREsim or a C-Level cFIREsim, of course I would choose the B-Level, because it would provide a more accurate prediction of my actual life path than C-Level. It would still be a terrible prediction, since, unlike an A-Level cFIREsim, it can't actually know the future. But that doesn't mean I'd say "pfft, since it's not as good a A-Level, I'm just gonna stick with C-Level".
So I can imagine a C-plus-Level cFIREsim, that sits between C-Level and B-Level, where there would be optional fields for "percentage of expenses directed to mortgage payments" and "percentage of expenses directed to pocket calculators". In fact, the variable spending method options are already a significant step in the direction of C-plus-Level, as they allow the user to incorporate some of their personal behaviors into the simulation, making Generic Money-Spender slightly less-generic.
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.
By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege. So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Sweet swirling onion rings!
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Bingo! :D Do we have another convert to "keep the mortgage"? ;)
It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.
Also, I loved this:Sweet swirling onion rings!
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Bingo! :D Do we have another convert to "keep the mortgage"? ;)
It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.
Also, I loved this:Sweet swirling onion rings!
I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.
Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.
But I think it would be more interesting and useful to see how it actually fared historically
And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner). I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk
See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm
http://dqydj.net/sp-500-return-calculator/
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Bingo! :D Do we have another convert to "keep the mortgage"? ;)
It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.
Also, I loved this:Sweet swirling onion rings!
I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.
Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.
But I think it would be more interesting and useful to see how it actually fared historically
And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner). I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk
See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm
http://dqydj.net/sp-500-return-calculator/
In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing. We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Bingo! :D Do we have another convert to "keep the mortgage"? ;)
It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.
Also, I loved this:Sweet swirling onion rings!
I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.
Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.
But I think it would be more interesting and useful to see how it actually fared historically
And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner). I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk
See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm
http://dqydj.net/sp-500-return-calculator/
In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing. We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.
Right, and the sooner one reaches fire, the more dramatic keeping that mortgage money in investments grows compared with paying off the mortgage with a lump sum at retirement. Doh! The math really is that clear.
Bingo! :D Do we have another convert to "keep the mortgage"? ;)
It really does take some digging to convince onesself (as it should - question everything), but once you see it, you can't unsee it.
Also, I loved this:Sweet swirling onion rings!
I wish I could share some ppl's enthusiasm for a strategy that relies on assuming historical equity returns (despite the fact that there has been a massive bull move and with stretched valuations as a starting point) combined with once-in-a-lifetime low mortgage rates.
Only time will tell whether implementing the strategy now would work sufficiently well to reward the investor for the risk taken 30yrs from now.
But I think it would be more interesting and useful to see how it actually fared historically
And based on a few data points I looked at spending just a few minutes searching Google, the strategy hasn't worked that well historically (including the last 30yrs, despite the 1985 starting point which would have seemed like a no-brainer winner). I haven't run all the numbers but just eyeballing it doesn't look like it would have paid to take what seems like a meaningful amount of risk
See for yourselves:
http://www.freddiemac.com/pmms/pmms30.htm
http://dqydj.net/sp-500-return-calculator/
In 1985 the 30 year FRM was 12% while the annualized S&P500 TR CAGR was 11%. You would have been right in 1985 not to mortgage instead of investing. We were coming off historical highs in 30 year rates. Big difference between that and the current 4%. All we are hoping for is that the next 30 years, we will get >4%.
Low real rates = low equity returns
http://www.economist.com/blogs/buttonwood/2013/02/investing
Do we have another convert to "keep the mortgage"? ;)
Low real rates = low equity returns
http://www.economist.com/blogs/buttonwood/2013/02/investing
With data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets
Do we have another convert to "keep the mortgage"? ;)
Probably. After all the talk on this topic over the past few days, I have certainly revised my opinion. I'm not going to prepay my mortgage as it stands now (we recently refinanced to a 15-year and put some money in to get the loan below jumbo level; I'm not sorry for that part, although I'm sure some will disagree). Instead, I've added the mortgage amount to my stache threshold for FI. I haven't decided if I would pay off the mortgage at that point - so I guess you can color me not ENTIRELY converted), but I'm certainly more comfortable with the idea of investing the cash rather than paying down the mortgage.
Note this is not a typical “should I prepay my mortgage or invest” situation. Merely prepaying your mortgage does not lower the rate on the entire outstanding balance. You get the lower rate on the whole balance only when you make a firm commitment to make a higher monthly payment each and every month. It’s a gift to the committed.
Quote from: TheNewNormal2015
Low real rates = low equity returns
http://www.economist.com/blogs/buttonwood/2013/02/investing
This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?QuoteWith data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets
Thanks, but this requires a registration/subscription which I don't have.
I guess it is up to each individual to decide how he wants to interpret the data provided. I have a feeling many will just want to continue to believe what they want and keep their head in the sand.
I wonder whether that type of cognitive bias would be categorized under "Ostrich Effect"
It seems a bit illogical to use historical data to assume future equity returns to calculate perceived safe withdrawal rates and other investment strategies but not use the data staring you in the face for mortgage vs equity returns.
TheNewNormal2015 -- there are many roads to Dublin as they say. Pick whichever works for you.
I was able to read that article. Thanks for the link. Unfortunately, that article does not say very much about long term returns of the market following a period of low interest rates. All it says, is that there is a strong relationship between the interest rate and the return from securities for that year.
There are a couple of possibilities.
I. Interest rates remain depressed for quite a while, say the next thirty years. Could happen, e.g. Japan. In this case stock returns would also be muted over this entire duration. In such a case everything is bad, stocks, bonds, etc.
II. Loose monetary policies eventually lead to higher inflation. And in periods of higher inflation, stocks have a lower real return. But I would assume that interest rates would rise and people with investable assets could presumably get CDs which would definitely pay more than the lower interest rate that are locked with low mortgages from now.
Sent from my iPad using Tapatalk
It seems a bit illogical to use historical data to assume future equity returns to calculate perceived safe withdrawal rates and other investment strategies but not use the data staring you in the face for mortgage vs equity returns.
In my view, it's exactly the opposite. It seems illogical to use historical data to assume future equity returns for the purpose of determining perceived safe withdrawal rates but not use the same historical data to assume future equity returns for the purpose of determining the advisability of leveraged-investing-via-a-mortgage-having-today's-low-rate. This is exactly the debate skyrefuge and I have been going back and forth about. I completely agree that there may be reasons to think that current indicators could possibly be signs that future returns will be lower than historical returns (even though I'm not sure if that's actually true and don't share the level of pessimism some people, like Pfau, have on that question), but once you make an assumption about the sub-performance of future returns, that affects your perceived SWR just the same as your perceived advisability of leveraged-investing-via-mortgage. If the next 30 years don't produce returns high enough to outperform today's low rate mortgages, then anyone retiring today on anything higher than an extremely-low WR is in a boatload of trouble.
- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.
-- Vik
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return.
Typically the times that the market did not perform well were the times that the US had high inflation.
Quote from: TheNewNormal2015
Low real rates = low equity returns
http://www.economist.com/blogs/buttonwood/2013/02/investing
This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?QuoteWith data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets
Thanks, but this requires a registration/subscription which I don't have.
I leave it to someone else to put everything on one graph if interested.
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return.
The link I provided above does calculate total returns on the S&P with dividends reinvested.Typically the times that the market did not perform well were the times that the US had high inflation.
I am not sure this statement is correct for pre-war data, and is mixed at best for post-war. The two largest selloffs in market history from peak to trough were during periods of low or negative inflation.
When everyone is digging up market returns you need to be grabbing nominal market returns with dividends reinvested as a 30 year fixed rate mortgage is a perfect hedge against inflation and dividends are part of the return.
The link I provided above does calculate total returns on the S&P with dividends reinvested.Typically the times that the market did not perform well were the times that the US had high inflation.
I am not sure this statement is correct for pre-war data, and is mixed at best for post-war. The two largest selloffs in market history from peak to trough were during periods of low or negative inflation.
Can you provide the link again? Sorry I must have missed that one. The economist articles you linked were all talking about real returns not nominal returns. Inflation was huge in many years, which a mortgage would hedge that. I saw MDM's graphs of 30 year nominal returns and noticed that it never dropped to 4%. Do you believe that the graphs that MDM posted are incorrect?
Quote from: TheNewNormal2015
Low real rates = low equity returns
http://www.economist.com/blogs/buttonwood/2013/02/investing
This only shows correlation between rates and subsequent 5 year equity returns. Is there a table showing 30 year equity returns?QuoteWith data going back to 1926:
http://www.economist.com/news/finance-and-economics/21564845-low-real-interest-rates-are-usually-bad-news-equity-markets
Thanks, but this requires a registration/subscription which I don't have.
I didn't find either of those particularly worrying, even if the hypothesis is correct (which several commenter don't think it is). Like you said they are only concerned with 1 and 5 year returns. I couldn't care less. In fact I'm rubbing my hands at the thought of a 5 year bear market now as I just started maxing out my 401k! I'd prefer 10 years of low returns, then 10 years of 20%+ CAGR then I retire. Deal? kthxbye.
And the oldest article is from 2012, so we should be almost 3 years into this 5 year slump?
If you're retiring today maybe it could be a concern, but even then 5 years is not really much to worry about if the market return in years 5+ are greater.
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.
It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).
If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum
Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward. For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.
It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).
If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum
Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward. For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)
My point (in both my response to you and my ongoing debate with skyrefuge) is that the argument that using today's low mortgage rate's in conjunction with using all historical investment performance data constitutes "cherry-picking" is not limited to the question of whether it makes sense to take out a mortgage today and invest the proceeds. It is equally applicable to the question of whether it makes sense to retire today on a planned 4%, or 3%, or 0.01% WR and expect your retirement to be successful, because it's addressing the larger question of what we can expect future returns to be.
I think you agree with this. I keep harping on it only because the discussion in this thread, I believe, actually revolves around the question of whether it makes sense to pay off fixed-rate, low-interest, long-term debt assuming that MMM-style early retirement is possible in the first place. Some of the same people who gleefully plan their 4%-SWR-based retirements simultaneously pay off their sub-4% 30-year mortgages believing it increases the safety of their retirement plan, but those two notions are necessarily, logically inconsistent (but that conclusion is not at all self-evident or intuitive--it takes a very firm grasp of the math and underlying economics to understand why it is so).
The discussion in this thread has mainly revolved around whether mortgage rates beat equity returns for long holding periods, not what a perceived SWR actually should be.
It seems that proponents of using a mortgage as leverage are cherry picking today's record low interest rate without considering whether the interest rate strongly influences or determines future equity returns (which they seem to do, both theoretically - discounting cash flows? - as well as in practice).
If 4% withdrawal appears to have been safe historically, it seems like it would make sense to look at what the range and average historical yields and valuations of assets were and compare vs where we are today to give you a sense of where we lie on the spectrum
Your last sentence is precisely what the investing greats and legends of finance are saying today: expect much lower asset returns going forward. For purposes of this discussion that leads me to be cautious in assuming the unknown part of the equation (future equity returns)
My point (in both my response to you and my ongoing debate with skyrefuge) is that the argument that using today's low mortgage rate's in conjunction with using all historical investment performance data constitutes "cherry-picking" is not limited to the question of whether it makes sense to take out a mortgage today and invest the proceeds. It is equally applicable to the question of whether it makes sense to retire today on a planned 4%, or 3%, or 0.01% WR and expect your retirement to be successful, because it's addressing the larger question of what we can expect future returns to be.
I think you agree with this. I keep harping on it only because the discussion in this thread, I believe, actually revolves around the question of whether it makes sense to pay off fixed-rate, low-interest, long-term debt assuming that MMM-style early retirement is possible in the first place. Some of the same people who gleefully plan their 4%-SWR-based retirements simultaneously pay off their sub-4% 30-year mortgages believing it increases the safety of their retirement plan, but those two notions are necessarily, logically inconsistent (but that conclusion is not at all self-evident or intuitive--it takes a very firm grasp of the math and underlying economics to understand why it is so).
I do agree with you and see your point
I guess I just never thought 4% was a perceived SWR *in this environment*, and didn't realize it was so rigidly adhered to and accepted
- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.
-- Vik
You are Canadian so you are different.... Well at least your access to a 30 year fixed rate mortgage is non existent, but your comment is consistent with a lot of people. The problems with this comment is it fails to take into acount the asset side of the equation. Your FI does not drop by $250k. As you are building up your asset you are getting closer to FI. If your assets are returning more than your mortgage interest rate then you are getting to the finishline quicker by keeping your mortgage.
The second fallacy is that your mortgage payment includes principal payments. This should not be listed as an expense. You are moving money from one pocket to the other. Ie taking money out of investments to pay down a debt. The downside is the money that could have been invested could earn more than the mortgage payment. On a longterm scale this has happened every time over the past 144 years on a 30 year time frame. With your short timeframe is gets more complicated, but it is still something to consider.
The third area is liquidity, which if it all hits the fan having investments vs a partially paid off house provides a provides the funds to live off of while the world is coming back online.
If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
- If I killed my mortgage my COL drops by ~25% and my FI target drops by $250K.
-- Vik
You are Canadian so you are different.... Well at least your access to a 30 year fixed rate mortgage is non existent, but your comment is consistent with a lot of people. The problems with this comment is it fails to take into acount the asset side of the equation. Your FI does not drop by $250k. As you are building up your asset you are getting closer to FI. If your assets are returning more than your mortgage interest rate then you are getting to the finishline quicker by keeping your mortgage.
The second fallacy is that your mortgage payment includes principal payments. This should not be listed as an expense. You are moving money from one pocket to the other. Ie taking money out of investments to pay down a debt. The downside is the money that could have been invested could earn more than the mortgage payment. On a longterm scale this has happened every time over the past 144 years on a 30 year time frame. With your short timeframe is gets more complicated, but it is still something to consider.
The third area is liquidity, which if it all hits the fan having investments vs a partially paid off house provides a provides the funds to live off of while the world is coming back online.
Now that I am deep into FIRE planning I'm back to wanting a long mortgage because I realize I can probably make more money investing my savings than to pay down my mortgage. And that cash flow is more important than killing debt if the interest on the debt is low.
Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
Nice charts!
The discussion in http://forum.mrmoneymustache.com/welcome-to-the-forum/trying-to-get-a-better-understanding-of-that-%2725-times-annual-spending%27-rule/, particularly kaizen soze's post #10, helped clarify some things in my head.
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.
Scenarios 2 & 3 are identical through year 23, correct? Then, to pay the mortgage, you either withdraw a large amount at once (scenario 3) or smaller amounts every month (scenario 2).
In scenario 3 you have a withdrawal rate of (30000 + 57000) / 820000 = 10.6% in your first year due to the large lump sum payment. But that's ok because it lasts only 1 year and then you drop to something <4% for years after that.
Similarly, scenario 2 has the higher withdrawal rate you note, but only for seven years. That's ok because after the mortgage is paid you drop to something <4% for years after that.
By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege. So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.
I don't agree with the change to scenario 2 in that you reach FIRE at year 23 in your attached spreadsheet. You're assuming that the annual expenses are ~30k, when you still need to be paying off your mortgage. This would require a higher portfolio value to make sure there is enough money to cover the mortgage payment. Otherwise you'd be pulling out 40k from a $760k balance which equates to a 5.26% withdrawal rate at the very beginning of FIRE. That doesn't sound like a recipe for success to me, cFIREsim calc notwithstanding. Your change in reflecting the drawdown of investments after FIRE looks correct to me, it's just starting too early.
Scenarios 2 & 3 are identical through year 23, correct? Then, to pay the mortgage, you either withdraw a large amount at once (scenario 3) or smaller amounts every month (scenario 2).
In scenario 3 you have a withdrawal rate of (30000 + 57000) / 820000 = 10.6% in your first year due to the large lump sum payment. But that's ok because it lasts only 1 year and then you drop to something <4% for years after that.
Similarly, scenario 2 has the higher withdrawal rate you note, but only for seven years. That's ok because after the mortgage is paid you drop to something <4% for years after that.
By not withdrawing the lump sum coincident with retirement, you take advantage of earning 7% on that amount while paying only 4.25% for the privilege. So you really can retire at the same time either way - maybe even a little earlier if you don't pay the lump sum, but close enough.
Aren't you opening yourself up to a larger sequence of returns risk by starting your retirement seven years with a much higher withdrawal rate?
We are talking about average 30 year CAGRs to match the term of the mortgage, but let's remember that in the short term the market return could be quite ugly.
In scenario 3 I would disagree that is a 10%+ withdrawal rate because that withdrawal really happens at the moment of retirement, not IN retirement.
However for scenario 2, the 5%+ is very much IN retirement and increases sequence of return risk.
I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.
I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.
I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
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I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.
I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
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If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
Do we have another convert to "keep the mortgage"? ;)
Probably. After all the talk on this topic over the past few days, I have certainly revised my opinion. I'm not going to prepay my mortgage as it stands now (we recently refinanced to a 15-year and put some money in to get the loan below jumbo level; I'm not sorry for that part, although I'm sure some will disagree). Instead, I've added the mortgage amount to my stache threshold for FI. I haven't decided if I would pay off the mortgage at that point - so I guess you can color me not ENTIRELY converted), but I'm certainly more comfortable with the idea of investing the cash rather than paying down the mortgage.
cressida -- The 15 year is a great way to go especially, if you got a sub 3% rate.
If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.
I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
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If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
Why? If you need a place to live and owning a home is optimally better than renting in a financial sense how does your maxing of tax deferred accounts matter in that determination?
If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
Don't you think the advice above depends on the situation?
A hypothetical employee (married) working for a state organization earns roughly 50k and has access to both a 403b and a 457k with a total contribution limit of 36k and an IRA of 11k. Should they max out all of them? What will they live on?
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Aren't you opening yourself up to a larger sequence of returns risk by starting your retirement seven years with a much higher withdrawal rate?Good question. Maybe. Maybe not. Don't know if this particular scenario has been backtested with Trinity study methodology, but see the next section.
We are talking about average 30 year CAGRs to match the term of the mortgage, but let's remember that in the short term the market return could be quite ugly.Sure can be. Over 7 years, however, even the worst results don't look too bad so the sequence of returns risk mentioned above seems very low. Data from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html. X-axis is the beginning year of the 7 year period.
In scenario 3 I would disagree that is a 10%+ withdrawal rate because that withdrawal really happens at the moment of retirement, not IN retirement.Scenarios 2 and 3 have exactly the same amount of money when the decision to retire occurs - agreed?
However for scenario 2, the 5%+ is very much IN retirement and increases sequence of return risk.
A hypothetical employee (married) working for a state organization earns roughly 50k and has access to both a 403b and a 457k with
a total contribution limit of 36k and an IRA of 11k. Should they max out all of them? What will they live on?
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)? :)
Can you provide the link again? Sorry I must have missed that one. The economist articles you linked were all talking about real returns not nominal returns. Inflation was huge in many years, which a mortgage would hedge that. I saw MDM's graphs of 30 year nominal returns and noticed that it never dropped to 4%. Do you believe that the graphs that MDM posted are incorrect?I'll be the first to admit that they could be incorrect. I think they are correct or would not have posted them, but....
The whole premise of this discussion is that LONG TERM stock market returns are greater than current long term (30 year) mortgage rates.
This works great as long as you continue to refi to 30 years at low rates before you retire.
I haven't stepped foot in this thread, but I've watched with interest. I just wanted to add that there are probably many people like myself who have very little left over to invest after maxing out tax-advantaged accounts - possible some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.Exactly. My wife and I are in a similar situation with tax deferred space of 50k including employer matches. A large part of those contributions comes from a 33% marginal tax bracket (includes federal + state). It is a no brainer to contribute to those first. Our effective mortgage rate including deductions is somewhere just above 3% for 30 years.
I can put $18,000 (+$4750 employer match) in to a 401k, $11000 into IRAs for myself and my wife, and $6650 into an HSA. That's over $40,000 in tax-deferred savings (really tax-free, because I do not expect to owe any income tax in retirement). If you have have a spouse that also qualifies for a 401k, add another $18,000. If you are eligible for 403bs and 457s, your tax-deferred space can get ridiculous. Every dime that goes into those accounts saves me 15% immediately. If I could get my bank to chip in $15 for every $85 that I pay on my mortgage, then hell yes, I'd pay it early. So far, no luck. On the other hand, Uncle Sam is happy to do that when I contribute my money to a tax-deferred account. Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.
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If you are not maxing out tax deferred accounts (or have high interest consumer debt) you arguably shouldn't even own a home to optimally maximize your rate of return.
Why? If you need a place to live and owning a home is optimally better than renting in a financial sense how does your maxing of tax deferred accounts matter in that determination?
I'm assuming one would be putting down at least a 20% deposit.
Paying down high interest debt or living off of savings in order to fund tax deferred accounts (with potential employer match) would potentially be a better use of that chunk of capital.
The whole premise of this discussion is that LONG TERM stock market returns are greater than current long term (30 year) mortgage rates.
This works great as long as you continue to refi to 30 years at low rates before you retire.
I'm not following your point. It works great as long as you lock in a low-interest rate, period (before or after retirement). Low rates are available now, so now is a good time to do it. If someone has 10 years left on their mortgage at a time when rates are high, they should not refinance, and it may very well make sense to pay off the remaining mortgage balance once the remaining life to maturity is only 10 years because you no longer have decades for market returns to outpace your mortgage rate.
My point is this strategy does not work with short/medium term returns (<=10yrs) so if you are going into retirement with a mortgage loan, even at a low rate, you risk losing money over that last 10 years. So a good case for paying the mortgage off at that time can be made in this case.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.Here we get to the root of many (most? all?) of the disagreements. sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return. Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.
My point is this strategy does not work with short/medium term returns (<=10yrs) so if you are going into retirement with a mortgage loan, even at a low rate, you risk losing money over that last 10 years. So a good case for paying the mortgage off at that time can be made in this case.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.
I admit I haven't studied (or even looked at) MDM's spreadsheet, but in the body of this thread I don't think anyone has argued that this strategy works on a short-term horizon. As you said, the whole point of this strategy is that it's for the long-term. With a 7-year time horizon, I wouldn't bet on market returns outpacing my mortgage rate either, even if it were low. But someone going into retirement with 7 years left on their loan at a time when rates are super-low (like now) can refinance into a 30-year and get the (very likely) optimal result we've been talking about in this thread.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.Here we get to the root of many (most? all?) of the disagreements. sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return. Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.
Each of these perspectives is defensible, based on one's risk tolerance.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.Here we get to the root of many (most? all?) of the disagreements. sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return. Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.
Each of these perspectives is defensible, based on one's risk tolerance.
Exactly. I also agree this is likely the source of most of the disagreement through this thread.
Over a 30 year period, I'm completely comfortable betting on >4% returns. Less than 10 years the odds aren't nearly so heavily in your favor.
In the spreadsheet example MDM provided, scenario 2 has you going into retirement with 7 years left on a mortgage. Well there is plenty of sub 3% CAGRs on that 7 year chart. With a 7 year time horizon I would happily take a guaranteed 3-4% yield.Here we get to the root of many (most? all?) of the disagreements. sirdoug007 takes the defensible perspective that "the risk is too high" and takes the guaranteed low return. Others will look at the same data and take the defensible perspective that "the risk is low enough" and seek the more likely higher return.
Each of these perspectives is defensible, based on one's risk tolerance.
Exactly. I also agree this is likely the source of most of the disagreement through this thread.
Over a 30 year period, I'm completely comfortable betting on >4% returns. Less than 10 years the odds aren't nearly so heavily in your favor.
It's not as ridiculously weighted in your favor, but it's still in your favor. What's the median 10-year return? Though, of course, the current environment comes a lot more into play then. It's all a lot of guesswork. :)
As long as the CAGR at the end of the 30 years is > the mortgage rate, you came out ahead, regardless of any crashes along the way. This has happened in every 30-year period in history, IIRC, compared to today's mortgage rates.
Thankfully our powers of recollection are not necessary, because the internet can recall for us. Cfiresim tells us that this failed to happen less than 5% of the time assuming a mortgage rate of 4%. Unfortunately, cfiresim.com seems to be down at the moment (an unfortunate coincidence that detracts from my point about the internet's ability to substitute for our human recollection :-P), but when it's back up we can easily check whether this statement is true for any given mortgage rate. For rates less than 3.5%, I think you are definitely correct.
the success rate is still in excess of 95% for a mortgage rate of 4.0% (it is 95.65%, to be precise)
Ok, for anyone interested, I just spent more time in cfiresim than I'd care to admit trying to answer this question and here's what I found:Nice work!
...
...with a portfolio ending balance of negative $150k. I think this is most likely due to cfiresim's assumptions about the timing of the portfolio withdrawals, which probably don't line up with the monthly payment schedule required by a mortgage.
...
Thoughts, comments, and objections relating to this analysis are welcome.
1000000 | 30 | 0.04 | 12 | =PMT(C1/D1,B1*D1,-A1) | =E1*D1 |
Year | Start bal. | Spend | Net | After growth | |
1 | 1000000 | 57289.8 | =B4-C4 | =ROUND(D4+MAX(D4*$C$1,0),2) | |
2 | =E4 | =C4 | =B5-C5 | =ROUND(D5+MAX(D5*$C$1,0),2) |
If you have those sims saved, a few quick Qs:
What's the median portfolio difference for paying off the mortgage versus investing the lump sum at a 4% mortgage rate (and 3%) for that matter?
In other words, how much money are the people paying off the mortgage leaving off the table, on average (in today's dollars)?
Thanks boarder42! This is helpful.
the 3.9% is with no closing costs . I could get 3.675 with closing costs (about 5-6K$)
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...Am having some trouble following the assumptions being used. E.g.,
Investment Balance/Benefit Gain/Years?
How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...
Investment Balance/Benefit Gain/Years?
similar to what I'm trying to determine. The equation assumes I'll be working for the loan terms, 180 or 360 months as example. I've been trying to look at this from additional angles such retirement in 5 yes, 10yrs., etc.How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...Am having some trouble following the assumptions being used. E.g.,
Investment Balance/Benefit Gain/Years?
- Is there income from a job at any time in these scenarios? If so, when (if ever) does it stop?
- Do the mortgage payments start at the same time retirement starts? If not, when (number of months before or after retirement) do they start?
- If the house is paid off with a lump sum, does that happen at the same time retirement starts? If not, when (number of months before or after retirement) is the lump sum paid?
I'm good with the worksheet and formulas. Just looking for perspective. For instance, my risk reward calculation 21,000 gains/349,000 portfolio balance/5 years , the difference is not millions.How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...
Investment Balance/Benefit Gain/Years?
dabears847 - In the worksheet that I created, the various years of 1,5, 10, 15, 20, 25, 30 are summarized on the input tab with the gain or loss calculated in Column J with the formula D-C. You can go to the Math Tab and see the benefit by month in Column V if you want to view it by month.
I think that some of the confusion is that you are not understanding the formulas that are built into the calculator. It appears that you are trying to create or calculate what is already calculated. Let's go through how it works.
Title A: Mortgage Paydown Traditional. This just a standard amortization schedule for a loan. This is calculating the loan to term as defined on the input sheet which Column B rows 5-8 and cell c6 is the monthly amount.
Title B: Investment. This is the calculation of an investment account earning the yield that is input on the Input sheet which flows to B13. With the monthly additional investment coming from cell B10.
Column P: Is if you liquidated all of your investments and paid any taxes as calculated in title C or Column N and paid down your mortgage. This show what the mortgage would be once your investments were liquidated.
Column S: Is the calculation of your mortgage payment and your extra payments reducing your mortgage balance. Note that once the mortgage balance is eliminated the formula has it grabbing the investment yield. So if you go to the example as it is set up to row 222 column T you will see the loan balance going negative. What that means is that the loan is paid off and all future mortgage payments and future extra payments are all being invested at the investment yield as input by you and listed as B13 and monthly yield at C13.
Column V: Is just comparing the what the mortgage would be if you paid down your mortgage each month as calculating in Column T minus Column P which is your standard mortgage balance minus the amount of money in your investment account. A positive number shows the benefit of keeping your mortgage a negative shows the loss of keeping your mortgage.
So as you can see if your investment yield is greater than your mortgage, then at any point in time you can liquidate your investments and use the proceeds to pay down your mortgage and be better off. If you enter a capital gains rate then the investment yield needs to be greater than the mortgage rate to have a positive impact. As noted usually you can manage your capital gains to minimize or eliminate the tax under the current tax law.
Hopefully, this helps explain the calculator
My apologies for not making my question clearer: dabears847, I was trying to understand what assumptions you are using.similar to what I'm trying to determine. The equation assumes I'll be working for the loan terms, 180 or 360 months as example. I've been trying to look at this from additional angles such retirement in 5 yes, 10yrs., etc.How would I calculate the benefit gain in 5 years, 10 yrs, etc. for the rate of return over the mortgage payoff. Rate of return over the mortgage...Am having some trouble following the assumptions being used. E.g.,
Investment Balance/Benefit Gain/Years?
- Is there income from a job at any time in these scenarios? If so, when (if ever) does it stop?
- Do the mortgage payments start at the same time retirement starts? If not, when (number of months before or after retirement) do they start?
- If the house is paid off with a lump sum, does that happen at the same time retirement starts? If not, when (number of months before or after retirement) is the lump sum paid?
If I do a lump sum in 5 or 10 yrs. I better be in the money or all the risk is for not.
My gains were only 21,000 in five years which isn't much for risk reward.
The group appears to be proposing keeping the mortgage for the full term. If I did that, the calculation appears to show a loss of investment of $550,000 with the the no early payoff plan. This assumes I'll be working though.
In 30 years the value is in acceleration of the mortgage payoff generating a greater return of $550,000 due to the extra cash flow. At the 15 year marker the value shifts to mortgage accelerated payoff.Are you saying that if you have a $500K mortgage balance at 4%, and $500K available cash, and an investment opportunity that will return 7%, and a choice between
What are your thoughts on the impact on savings withdrawal rates with mortgage vs without? Mine go from needing 750,000 without mortgage to 1.7mm with mortgage.
For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25)All you "need" (assuming we believe the Trinity Study) is E/SWR + B, where
Nope, I don't understand. Not saying you are wrong (and I have not followed this whole thread!) but why don't I need to make the interest portion of my mortgage payment after I retire?Good question! Assuming you continue to pay monthly, you absolutely do continue to make the interest portion of the mortgage payment. But let's review the assumptions:
DaBears - I found the same, except on a smaller scale.
For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25)
So while I technically come out ahead in my investment account if I don't pay it off, it's not by much, and I need a larger investment account to FIRE.
I'm with you - not sure that the risk is worth the reward and if we work a few months longer to make up the difference....it's months of our lives. I will work 5 more months - heck - a bunch of people end up in the one more year syndrome, what's 5 more months?
DaBears - correct me if I'm wrong - the way you did it assumes that you still have the "snowball" for all of the 30 years, right? So it assumes the person is working for the entire 30 year term?
To be clear, this strategy has a very high likelihood of success IF you are in it for the long haul.
I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Portfolio: 100% stocks
Expense Ratio: 0.05%
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
The success rate is 97.39% (fails 3 out of 115 periods). Those periods start in 1928, 1929, and 1930. All other periods, including the bad ones in the mid 1960's do very well with a median ending portfolio of $498,335.
Now that is 30 years. If you don't keep your mortgage and corresponding investments that long you can have different results. Here is a 10 year run. After 10 years the remaining mortgage balance would be about $77k. The cases starting in 1999/2000 are pretty ugly!
I'm *this* close to understanding. LOL. So in my example above, I need a cool million instead of 900K to retire without paying off my mortgage (Oh goodness, I write that and still worry I don't get it! LOL).If the unpaid mortgage principal is $100K - yes, you have got it!
I believe "without a mortgage" means "if the mortgage is already paid off."For example, without a mortgage we only 'need' about 900K (super spendy budget of 36K a year) but if I don't pay the mortgage off I end up needing 1,082,100 to support the PI portion of my payment (607X12X25)
Are you taking into consideration you will also need the cash to own your house free-and-clear? Seems like you would need 900K + cost of house in your first example that I bolded.
I ran the following scenario on cFIREsim.com:This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.
Not so much, the newer excel sheet with my inputs show results in favor of the a fast payoff of the mortgage and then investing the cash flow compounding those extra dollars for 30 years. This results in a larger stash of $550,000 vs straight investing without extra principal.So I've rerun the scenarios with a 30 year mortgage to compare and I would need $250,000 more in retirement assets to make the plan work with a SWR of 4%. Not sure how I feel about having to refi my lower 15 year rates for a higher 30 year rate to then have to save more money so that I could go the path of investing instead of just paying off the house.
I'm not working that long so I'll need to find a way to pull the extra principal payments in scenarios which reflect the change in cash flow.
What are your thoughts on the impact on savings withdrawal rates with mortgage vs without? Mine go from needing 750,000 without mortgage to 1.7mm with mortgage.
Hmmm... gears are turning... Is the success rate due to the locked in costs for 30years and inflation of 3% But I'm still stuck on the idea that I'm taking a higher level of risk when I could withdraw at 4% SWR with 250,000 less with savings.I ran the following scenario on cFIREsim.com:This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.
Note that sirdoug007's example starts with a 5.388% withdrawal rate and "only" $100K. Given the success demonstrated in cfiresim, it's not clear how one justifies the need for $134,700, let alone $214,200.
E.g., run the numbers for a 15 year $100K loan at 3.5%, withdrawing from a $100K investment returning 7% for the monthly payments. After 15 years the investment will still have $58,306 and the mortgage will be paid.
Hmmm... gears are turning... Is the success rate due to the locked in costs for 30years and inflation of 3% But I'm still stuck on the idea that I'm taking a higher level of risk when I could withdraw at 4% SWR with 250,000 less with savings.I ran the following scenario on cFIREsim.com:This helps! The big part is needing a 30 year mortgage to lower the swr. For the 4% withdrawal rate you would need $134,700.
Initial balance: $100,000
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
15 year mortgage on 100,000 is 714 monthly, 8568 annually x 25 is 214,200 needed for the 4% swr.
Note that sirdoug007's example starts with a 5.388% withdrawal rate and "only" $100K. Given the success demonstrated in cfiresim, it's not clear how one justifies the need for $134,700, let alone $214,200.
E.g., run the numbers for a 15 year $100K loan at 3.5%, withdrawing from a $100K investment returning 7% for the monthly payments. After 15 years the investment will still have $58,306 and the mortgage will be paid.
Hello,
Glad someone is worried about the same things as I. Yes I did the plan based on a 15 year payoff plan and it was right around then the excel sheet (Tomsang's sheets) stated it was better for me long term to payoff the mortgages.
4. tbd, Rental Income with Payoff cash flow and investing, once the rentals are paid off then the cash can be invested.
To be clear, this strategy has a very high likelihood of success IF you are in it for the long haul.
I ran the following scenario on cFIREsim.com:
Initial balance: $100,000
Portfolio: 100% stocks
Expense Ratio: 0.05%
Annual Spending: $5388 Non-Inflation adjusted (equals $100,000 loan for 30 years at 3.5%)
The success rate is 97.39% (fails 3 out of 115 periods). Those periods start in 1928, 1929, and 1930. All other periods, including the bad ones in the mid 1960's do very well with a median ending portfolio of $498,335.
http://www.cnbc.com/id/102570850
finally some common sense. to some level...
I'm wondering about how the success rate looks if you only use this strategy once the (stock) market has dropped 25%. Or 40%.
The equity in the house could be considered "dry powder" which could be used to purchase equities when they are on sale.
Yes, this edges onto market timing territory, but for me I would need something like that to make it worthwhile (emotionally) to slow down paying off the house.
Agreed that it is hard (or at least costly) to get cash back out - which is why I am not taking equity back out of my house, nor am I paying extra.
If there is a stock crash, it could be worth the closing costs to get money back out of the house for investment.
Lots of good info in this thread, but now I have to really think about putting a $180,000 windfall from grandparent life insurance into the $260,000 left in house principle (30-year fixed loan at 3.5% which still has 28 years left on it) or investing that amount into vanguard index funds (which will have a higher return above 3.5%)... I still feel like paying off the house ASAP is better, to allow for FI sooner, right?Wrong. Apparently the good info in this thread hasn't been absorbed....
Lots of good info in this thread, but now I have to really think about putting a $180,000 windfall from grandparent life insurance into the $260,000 left in house principle (30-year fixed loan at 3.5% which still has 28 years left on it) or investing that amount into vanguard index funds (which will have a higher return above 3.5%)... I still feel like paying off the house ASAP is better, to allow for FI sooner, right? Maybe after the principle gets down to 80,000 really ramping up hard all the payments that would have gone to 401k / Roth IRA and have it go to Principle instead (i've been contributing to Roth IRA / 401k for 10+ years now and have a current value of $170,000 at the age of 34. I feel like I can cool those contribution jets for a few years to help get the house down to near paid off ...
thoughts ?