Author Topic: Paying off Mortgage Early – How bad is it for your FI Date?  (Read 203255 times)

Scandium

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #400 on: March 26, 2015, 07:45:35 AM »
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?

Quote
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

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.

brooklynguy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #401 on: March 26, 2015, 07:50:16 AM »
I leave it to someone else to put everything on one graph if interested.

MDM, thank's for digging up this data.  One point to keep in mind when comparing historical mortgage rates to historical investment performance is that the US mortgage market was not always quasi-government-subsidized the way it is today, so the mortgage rates in the early part of the last century may overstate the relationship between prevailing mortgage rates and the overall interest rate environment (fixed rate, 30-year mortgages also weren't always available, but that I don't think matters for purposes of the analysis).  We can also examine the correlation between investment performance and another proxy for the interest rate environment, such as a treasury yield benchmark as NewNormal suggested, to control for the effect of quasi-gov't-subsidization of mortgage rates.

If anyone can find a data source with historical rates going back as far as MDM's chart that gives the actual numbers broken down by year, I would be willing to do the gruntwork of mortgage vs. investment return performance analysis (especially now that cfiresim is back online), but not until tonight or later in the week (my slow period at work that has allowed me to (over)contribute to the forum the past few days has now come to an end).

tomsang

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #402 on: March 26, 2015, 07:57:01 AM »
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?

TheNewNormal2015

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #403 on: March 26, 2015, 08:11:41 AM »
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?

http://dqydj.net/sp-500-return-calculator/

There has never been a 30yr period (albeit since 1928) where we have had sub 4% equity returns.

But then again we have never before in history had negative bond yields and it seems to be a growing trend in Europe.

Seems like a lot of "first time ever" events have been happening the last decade or two across all asset classes, from the tech bubble to the housing crash to the current bond bubble.


TheNewNormal2015

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #404 on: March 26, 2015, 08:17:35 AM »
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?

Quote
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

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.

I didn't see several commenters say the hypothesis in the article(s) is incorrect - where is that?

If the data in the article is correct, it might be useful to look at what 30yr returns have been when the first 1-5yrs of the period were low due to negative real rates

brooklynguy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #405 on: March 26, 2015, 08:57:06 AM »
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).

TheNewNormal2015

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #406 on: March 26, 2015, 09:01:15 AM »
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

matchewed

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #407 on: March 26, 2015, 09:19:55 AM »
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

It is accepted, it is not rigidly adhered to. It may be more conjecture than fact but I think most people who get to the level of having saved enough to have a 4%SWR, understand what a SWR is, and can figure out withdrawal strategies and the like also understands nuance and flexibility.

That being said the general rules of thumb we're saying here can be turned on their head when the numbers change. The numbers have yet to change, if they even do.

BarkyardBQ

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #408 on: March 26, 2015, 10:53:45 AM »

- 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.

Our expenses would drop by 20%, and FI target would drop by 25%.

We're keeping our mortgage, most likely for 30 years. However, in 5 years we will have enough to meet our expenses if we don't have a mortgage. It would take approx 18 more months of working to save and invest to be able to withdrawal 4% just to pay the mortgage. I could instead work for 12 months or less to pay the mortgage off in cash and permanently reduce our savings target and future expenses. It makes a bit of sense to calculate your FI target minus a mortgage and see how much time it saves work for paying off the mortgage after you reach your No Mortgage FI target.

tomsang

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #409 on: March 26, 2015, 11:18:31 AM »
Somebody was talking about the great investors who are saying that the future returns are going to be lower than the past.  I am not sure who they were talking about, but I don't disagree with the yields being lower in the future, but to be clear those that I consider to be wise long term investors are all saying that they believe that the nominal yields will be in excess of 4%. 

Warren Buffett's take on the 30 year mortgage
http://www.bloomberg.com/news/articles/2014-10-07/buffett-says-no-brainer-to-get-mortgage-to-short-rates
You would think that people would be lining up now to get mortgages to buy a home,” Buffett said today at a conference hosted by Fortune magazine in Laguna Niguel, California. “It’s a good way to go short the dollar, short interest rates. It is a no-brainer. But so far home construction pickup has been slower than I had anticipated.”

His belief is that nominal yields will be in the 6-7% range.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a1.neDMy8DEU
"The economy, as measured by gross domestic product, can be expected to grow at an annual rate of about 3 percent over the long term, and inflation of 2 percent would push nominal GDP growth to 5 percent, Buffett said. Stocks will probably rise at about that rate and dividend payments will boost total returns to 6 percent to 7 percent, he said."

I believe that Wade Pfau has said 4-6 percent nominal returns for a conservative portfolio and greater than that for a normal estimate is what he uses. I will have to find the article(s)where he talks about that.  If others have credible sources that believe that the market is going to be lower than 4% over the next 30 years that would be very interesting to discuss as it would severely impact SWR for all members.   

Just to be clear, if the stock market returns less than 4% over the next 30 years then a safe withdrawal Rate would be in the 1% range for a long term retirement. So those who believe that the market will return less than 4% and are paying down their mortgage and are being safe with a 3% SWR.  Your portfolio will fail if we do not hit a 4% portfolio return.  Many failure scenarios relate to having high inflation.  A 30 year fixed rate mortgage creates a hedge to eliminates inflation risk.   
 

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #410 on: March 26, 2015, 11:30:51 AM »
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 - and some who are not even contributing the max. For anyone in that position, paying off a mortgage early is a difficult decision to defend.

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.
« Last Edit: March 26, 2015, 01:49:09 PM by Mississippi Mudstache »

BarkyardBQ

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #411 on: March 26, 2015, 11:41:06 AM »
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.

Very true. We're both in education with 403/457/IRA/1-HSA... We have 70k left on our mortgage. We could pay it off this year...it would cost us ~$10,000 of incomes taxes alone before even calculating the op-cost of not investing it.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #412 on: March 26, 2015, 11:52:49 AM »

- 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.

I'm pretty sure we are saying the same thing.

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.

brooklynguy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #413 on: March 26, 2015, 11:58:39 AM »
Your investments would have to underperform your mortgage rate by a ridiculous amount to fall short with that kind of advantage.

And if your situation allows you to obtain the benefit of tax deductions for mortgage interest during any portion of the 30-year period, that lowers the hurdle rate even further.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #414 on: March 26, 2015, 12:43:21 PM »
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.

It's pretty awesome that I came up with the exact same formula that kaizen did, and I didn't even know that thread existed. And it makes total sense. Math rules.

@ars. I've been a "don't pay extra to mortgage" person for a while, but seeing the math behind such reasoning confirms my choice. Yes it course it's assuming a flat CAGR which isn't super realistic, and it assumes investment returns are larger than your mortgage rate. It's always good to run the numbers for your personal situation, get a good grasp on the risk trade-offs for various scenarios, and then optimize.

Currently it's looking like the lowest risk avenue to minimize fire rate within the realm of this discussion is to ride out a 30 year mortgage and invest any extra, never paying extra on the mortgage. All the while the investments are in a balanced, diversified portfolio designed accordingly to your desired risk level. If you're investing in, for example the bogleheads 3-fund portfolio, then it would take a complete market self destruction for you to lose all your money. If that happened, then there's bigger problems... Otherwise, in a worst case scenario, you still have money you can pull out of investments, maybe selling at a loss, to pay of your expenses.

 There's no guarantee that you'll be able to drawdown on house equity in that situation, plus you'll still be paying interest on the money you pull out at what I guess is a higher rate than you'd get in the markets.

CorpRaider

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #415 on: March 26, 2015, 12:46:48 PM »
Yeah, with taxes and inflation its just about a no-brainer for a 30 year.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #416 on: March 26, 2015, 12:55:05 PM »
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.


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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #417 on: March 26, 2015, 01:12:34 PM »
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.

No because it's not really a 7% SWR, it just looks that way.  If you took out a lump sum and paid it off, your SWR suddenly drops to 4%.  That's because it's a fixed cost that will end, plus some is going to principal.

See my earlier post with the math example (1.1MM vs. 1MM and having a 100k mortgage).  In that example your SWR isn't 4.5% versus 4%, though it looks that way, because it's actually a leverage on the 100k invested.  The interest you're paying isn't living expenses, it's interest on the leverage  of that extra 100k.
« Last Edit: March 26, 2015, 01:14:25 PM by arebelspy »
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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #418 on: March 26, 2015, 01:30:35 PM »

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.

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.
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.


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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #419 on: March 26, 2015, 01:35:39 PM »

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.

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.
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.


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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.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #420 on: March 26, 2015, 01:37:40 PM »

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.

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.
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.


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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?

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #421 on: March 26, 2015, 01:44:36 PM »
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.

Yeah - it's exactly 3%. Which is a lot better than it was.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #422 on: March 26, 2015, 01:48:28 PM »


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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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #423 on: March 26, 2015, 01:48:50 PM »

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.

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.
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.


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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.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #424 on: March 26, 2015, 01:53:36 PM »


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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They can and theoretically should live on the down payment savings to fund tax deferred accounts.

If I were in that situation I would rent the cheapest place possible and live as frugally as possible while maxing tax deferred accounts - only when I could fund them all and still save enough for a down pmt would I then purchase a primary residence.

But in the situation you described, I might be in a situation to FIRE before I have a chance to own a home (which is not a requirement).

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #425 on: March 26, 2015, 01:55:09 PM »
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.

Quote
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.


Quote
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.
Scenarios 2 and 3 have exactly the same amount of money when the decision to retire occurs - agreed?

One can then immediately withdraw a large chunk of that money to pay off the mortgage (scenario 3) or continue to pay the mortgage using monthly withdrawals (scenario 2).  Both are, effectively, happening "in" retirement.
« Last Edit: May 30, 2018, 09:54:45 PM by MDM »

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #426 on: March 26, 2015, 01:58:49 PM »
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?

The point wasn't "max them out and then starve" it was that when you haven't maxed them out, prepaying the mortgage is likely leaving money on the table.

Naturally you'll need to eat, and invest whatever you can.
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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #427 on: March 26, 2015, 02:11:07 PM »
^^^ ARS -- got it.  Thanks.


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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #428 on: March 26, 2015, 02:13:43 PM »
Why on earth would payment need to be made using the passive return of the investment?

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

No, this is not true.

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

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

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

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

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

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

Ok, here is the example from earlier in this thread.

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.

The problem comes in when you hit your FI number and the time to mortgage payoff is now 10 years (or thereabouts).  Well in 10 year periods the stock market can go completely sideways or even down.  The 10 years between Jan 1, 2000 to Dec 31, 2009 yielded an S&P500 CAGR with dividends of -0.99%.  So there goes you easy money leverage plan!  You would have been better off just paying off the mortgage on FIRE day.

This is critical to understand.  If you don't match the loan term to the necessary stock market term to protect against volatility you can really screw this up!

Here is an illustration of the effect of time on expected stock market returns from A Random Walk Guide to Investing.  As you can see, in the short term it's anyone's guess what you'll get and negative returns are a definite possibility.  If you don't have the time to ride these out you could end up in trouble:


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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #429 on: March 26, 2015, 02:29:27 PM »
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....

Here is the method (I think I) used:
1) Start with the data from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html, specifically the spreadsheet downloadable from that site.  To tomsang's point, in that spreadsheet "The annual returns on stocks ... are estimated by adding the price appreciation during the year to the dividends ... paid ... during the year."
2) Convert the annual percent returns to ratios by adding 1.
3) Compute the Compound Annual Growth Rate (CAGR) over n years by multiplying n ratios, taking the nth root, and subtracting 1.
4) Plot the results.

I did spot check the numbers against the S&P 500 Return calculator linked previously, using December to December numbers.  The match is not exact: close enough for me to think the charts are useful enough for the discussion at hand, but someone may be able to do better.

Spreadsheet attached.  Spot checks are in column N of the first tab.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #430 on: March 26, 2015, 02:33:26 PM »
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.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #431 on: March 26, 2015, 02:41:28 PM »

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.

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.
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.


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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.

Meh...

You have to live somewhere, the question about the 20% deposit on buying house shouldn't be weighed against investment but against renting a house or other variations of the "shelter problem". You're trying to take an aspect of cost related to living itself and trying to optimize investment with it... that's like saying maybe I should just buy ramen because I can optimize my investments better. Well maybe you could but you still have to eat, and if you can't subsist solely on ramen or are someone who doesn't like ramen or someone who values yummy food then you're doing yourself a disservice. It's one thing to optimize your debt vs. investing when neither of those are essentials, but shelter is an essential, optimize the essential itself within it's own context then take that remaining money and optimize that.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #432 on: March 26, 2015, 02:41:37 PM »
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.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #433 on: March 26, 2015, 02:49:07 PM »
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.

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #434 on: March 26, 2015, 02:51:47 PM »
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. 

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #435 on: March 26, 2015, 02:58:05 PM »
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.

You guys are agreeing.  :)  Doug's point was that you may need to keep refinancing when rates are low to push out the payoff of your mortgage, before you FIRE.  I agree - the longer you can keep cheap money, the more likely you'll come out ahead.

Some people aren't comfortable with that.  They ask "would you take out a mortgage on a paid off house to invest?"  And my answer is "hell yes, at today's rates" -- but they obviously value what they view as safety/security (and the feelings thereof) differently than I do (and how I think it's safer to hold the mortgage).

That's okay.

But the point of "it works better on long timeframes, so you may have to refi to move out your timeframe" is valid.
« Last Edit: March 26, 2015, 02:59:50 PM by arebelspy »
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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #436 on: March 26, 2015, 03:06:19 PM »
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.


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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #437 on: March 26, 2015, 03:35:01 PM »
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.  :)
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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #438 on: March 26, 2015, 07:35:39 PM »
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.  :)

well you would also have to weigh the tax implications of paying off a 7-10 year chunk of your mortgage.  Taking out a large chunk of money for this could alter tax brackets etc.  likely not but if it does a lump some pay off could be even worse.

brooklynguy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #439 on: March 27, 2015, 02:30:21 PM »
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.

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:

1.  The highest mortgage rate with an absolute 100% historical success rate using cfiresim's default investment parameters (i.e., 75/25 stock/bond allocation and 0.18% expense ratio) is 1.88%.  But the conservative anti-leveraged-investing-via-mortgage crowd shouldn't get too excited yet, because the success rate remains in the 99% range for much higher mortgage rates (it's the single pesky 1929 start year that keeps preventing us from achieving absolute 100% success), and the success rate is still in excess of 95% for a mortgage rate of 4.0% (it is 95.65%, to be precise).  Moreover, see the penultimate paragraph below for an explanation of why these success rates may be seriously understating the actual historical success rates.

2.  Interestingly, a 100% historical success rate could be achieved for higher mortgage rates by increasing the bond portion of the portfolio's asset allocation.  The highest mortgage rate I could find having a 100% historical success rate using a non-default investment allocation was 3.15%, and it required an investment allocation of between 20-25% equities (and 75-80% bonds).  I think this can be explained by the fact that low equity exposure was needed for the 1929 start year (which was obviously a very bad year for stocks) to clear the hurdle for investments to outperform the mortgage rate, combined with the fact that each year's principal + interest outlay in a mortgage's amortization schedule represents a relatively large percentage of the mortgage's initial principal balance for all but the cheapest of mortgages.

For the above cfiresim testing, I used the methology I described in post # 292 above (i.e., enter the annual principal + interest payments required by the mortgage's amortization schedule and set the spending plan to "not inflation adjusted").

However, if you run a cfiresim test using an assumed fixed investment return (instead of actual historical data) in an amount equal to the mortgage's interest rate, cfiresim reports failure.  For example, the annual principal + interest outlay on a $1M mortgage having a 4% interest rate is $57,289.80.  When you run a cfiresim simulation with a $1M starting portfolio and annual non-inflation-adjusted spending of $57,289.80 and set the investment return to 4% constant market growth, that should result in perfect success with a portfolio ending balance of exactly zero dollars.  Instead, cfiresim reports failure, 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.  In any event, I think this means that this methodology of testing the historical leveraged-investing-via-mortgage success rate materially misstates the actual historical success rate, and I'm not sure but I believe the misstatement will usually (or always?) constitute an understatement of the actual success rate.

Thoughts, comments, and objections relating to this analysis are welcome.

arebelspy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #440 on: March 27, 2015, 03:01:43 PM »
Thanks for doing the legwork!

the success rate is still in excess of 95% for a mortgage rate of 4.0% (it is 95.65%, to be precise)

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)?
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MDM

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #441 on: March 27, 2015, 03:02:15 PM »
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:
...
...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.
Nice work!

I can get Excel to reproduce the -$150K, but someone (e.g. bo_knows) will have to confirm the cfiresim mechanics.

Take the table below, copy & paste into cell A1, then copy the last row down through year 31.  Yes, 31 - at least that's where I see the -$150K.

Assumptions here in Excel (and in cfiresim?):
 - spending occurs up front while returns occur on the amount left after spending. 
 - a negative balance generates $0 return.

The first row in the table below is irrelevant - I just used it to compare monthly (cell A4=12) vs. annual (cell A4=1) amortization.

1000000300.0412=PMT(C1/D1,B1*D1,-A1)=E1*D1
YearStart bal.SpendNetAfter growth
1100000057289.8=B4-C4=ROUND(D4+MAX(D4*$C$1,0),2)
2=E4=C4=B5-C5=ROUND(D5+MAX(D5*$C$1,0),2)

brooklynguy

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #442 on: March 27, 2015, 03:33:26 PM »
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)?

I don't have any of the sims saved (because I'm too paranoid to log in to cfiresim on my office computer, but not too paranoid to use cfiresim on my office computer, which I'll admit makes no sense), but it's easy enough to reproduce the sims to answer that question.

For a 4% mortgage rate (and sticking with cfiresim's default investment settings), for every $100k of mortgage paid off or not obtained, the historical median amount left on the table was $266k (in inflation-adjusted dollars).  For a 3% mortgage rate, that number was $368k.

That was the point I made in that same post #292 above describing the cfiresim methodology, that the historical investor who would have been able to take out a $200k mortgage with a 4% rate but chose not to would have left at least $532 THOUSAND DOLLARS on the table half of the time.  Of course, the actual historical investor would not have been able to do so, because such low mortgage rates were not available, which led to all the debate in this thread about the appropriateness of using historical investment performance data but not historical mortgage rates.

I also once used the same data to try to get sol to see the light and recognize the overwhelming probability of the optimality of this approach even when taking into account its potential effects on eligibility for means-tested government benefits and similar considerations, but I don't think I was successful :)

Of course, if you adjust the relevant variables in favor of higher returns (such as increasing the equity allocation or decreasing the expense ratio), the amount left on the table is correspondingly higher.

tomsang

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #443 on: April 05, 2015, 12:26:50 PM »
Another member was asking me about the calculator that I put together awhile back.  I have a number of versions and I want to make sure that the version that I believe has the correct formula is out there for people to play with.  If you see areas that are not working, need changing or are confusing let me know.

Note I also locked out the Math tab, but if you want to play with it the password is MMM.

Thanks,

Tom

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #444 on: April 06, 2015, 07:10:14 AM »
I've spent a long time reading this interesting thread, and now I'm having second thoughts!

We are planing on taking 200K in 15 year mortgage fixed 3% .
We could get 30 year at 3.9%

one of my hesitations now is that we will most likely not live in this house for more than 10 years.
I'm still leaning towards the 15 year, but from reading the thread I'm more confused now..

boarder42

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #445 on: April 06, 2015, 07:21:55 AM »
Bee Keeper 

http://michaelbluejay.com/house/15vs30.html

enter your info hear.  break even is usually around 6-7 years.  cant believe you cant get a lower than 3.9% fixed rate on the 30.

TheBeeKeeper

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #446 on: April 06, 2015, 07:40:41 AM »
Thanks boarder42! This is helpful.

the 3.9% is with no closing costs . I could get 3.675 with closing costs (about 5-6K$)


sirdoug007

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #447 on: April 06, 2015, 08:54:36 AM »
Thanks boarder42! This is helpful.

the 3.9% is with no closing costs . I could get 3.675 with closing costs (about 5-6K$)

Penfed is currently at 3.375% for a 30 year conforming.  https://penfed.org/30-Year-Fixed-Mortgage/

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #448 on: April 06, 2015, 06:56:16 PM »
So many questions. Tomsang, I took your most recent sheet and added a tab for SWR with no mortgage and a mortgage at 60 months. Wouldn't I need a larger portfolio to cash flow the mortgage payment for 30 years vs. it paid off?

INVEST THE MONEY   
   
CASH FLOW   
   
4% SWR   
   
60 Month Retire extra cash no more   
   4% SWR
P&I   3145
ANNUAL EXPENSES   37740
SWR   25
BALANCE REQUIRED   943500
   
ADDITIONAL ANNUAL EXPENSES   30000
SWR   25
BALANCE REQUIRED   750000
   
TOTAL PORTFOLIO REQUIRED   1693500

vs....

PAYOFF THE MORTGAGE FIRST   
THEN INVEST THE REST   
CASH FLOW   
   
4% SWR   
MORTGAGE BALANCE   0
60 Month Retire extra cash no more   
   4% SWR
P&I   0
ANNUAL EXPENSES   0
SWR   25
BALANCE REQUIRED   0
   
ADDITIONAL ANNUAL EXPENSES   30000
SWR   25
BALANCE REQUIRED   750000
   
TOTAL PORTFOLIO REQUIRED   750000


dabears847

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Re: Paying off Mortgage Early – How bad is it for your FI Date?
« Reply #449 on: April 06, 2015, 07:31:12 PM »
Attachment with sheet above.

Question: My mortgage paid off requires a lower Investment Portfolio at 60 Months and a net loss of $21m between the two options. I'm trying to figure out the scenario if I retire early and give up on the future extra cash how that impacts the plan. Basically which plan offers the out the fastest.

10 years 56,000 loss but then the cash flow catches up on the reverse return but I won't be working at that point and will need to start drawing down the investment.