Author Topic: STOP SAYING IT IS NOT MATHEMATICALLY CORRECT TO PAY OFF YOUR MORTGAGE EARLY!  (Read 47631 times)

LLL

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It just makes you look silly.

I keep reading posts where people say "it is not mathematically correct to pay off your mortgage early" or "The only benefit of paying your mortgage off early is the physiological benefit". The problem is both of these statements are incorrect. The individuals that make these statements are only considering the expected return of their investment portfolio over an extended period of time with the rate paid on the debt. This is flawed comparison because it leaves out risk.

Stock and bond fund returns are not comparable to a mortgage rate because of risk which is typically measured in volatility. See below, they behave very differently.
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A mortgage is much closer to the risk free rate of return. Even this is not a perfect comparison because you mortgage likely has less risk then the risk free rate due to the homestead exemption. All or a portion of the equity in a primary residence is subject to a homestead exemption in most states which protects it from lawsuits and bankruptcy, treasuries and bank accounts don't have these protections. When we compare the risk free rate of return 0.52% (typically the 3 month treasury is used as a proxy for this rate) to the 30-Year fixed rate 4.375% or the 15-Year fixed rate of 3.18% it becomes clear that paying off the mortgage is a great idea. 

So when we run the numbers with a comparable rate of return, paying off the mortgage produces a larger net worth over time. Even if your investments generated no tax burden and you could find a risk free investment that matched your mortgage rate, paying off your mortgage is still better. Why? Because of cash flows. Paying off your mortgage significantly increases your monthly cash flows every month.

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With all this said I think a mixture of investing and paying down the mortgage early is optimal after you have an emergency fund. This is partly because we have a limited amount of space each year in our tax advantaged accounts which cannot not be caught up after we pay off the mortgage.

An individuals net worth is not a pie that is uniform but a conglomerate of unique pieces with different purposes. The emergency fund provides our net worth with liquidity. The debt free house decreases our monthly cash flow and deleverages our net worth. The tax advantaged accounts provide long-term growth which allows them to withstand the volatility of a 100% stock portfolio.

A final thought. If someone offered to loan you $100 million for 5 years at 9.90% interest, given that the long-term rate of return in the stock market has been above 10% would you take the deal? That represents an expected arbitrage of ~$500,000 over 5 years. Most people wouldn't because in an extreme example the risk is clear.
 
« Last Edit: March 22, 2019, 04:48:18 PM by arebelspy »

Cwadda

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+1 and I will take some pop corn too : )

Telecaster

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It just makes you look silly.

I keep reading posts where people say "it is not mathematically correct to pay off your mortgage early" or "The only benefit of paying your mortgage off early is the physiological benefit". The problem is both of these statements are incorrect. The individuals that make these statements are only considering the expected return of their investment portfolio over an extended period of time with the rate paid on the debt. This is flawed comparison because it leaves out risk.

You are making the rookie mistake of confusing volatility with risk.   Volatility is not risk.  Risk is the chance of the permanent loss of capital.   There are no 30-year periods when the broader market lost money.   An asteroid could hit, or Canada could invade or something and change that, but the actual risk of losing money in the market over that length of time is effectively zero. 

A second minor mistake is that you assumed that the risk free return rate would stay constant at 0.52% for the entire 30 year period.   The long term average is more like 4%. 


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It just makes you look silly.

I keep reading posts where people say "it is not mathematically correct to pay off your mortgage early" or "The only benefit of paying your mortgage off early is the physiological benefit". The problem is both of these statements are incorrect. The individuals that make these statements are only considering the expected return of their investment portfolio over an extended period of time with the rate paid on the debt. This is flawed comparison because it leaves out risk.

You are making the rookie mistake of confusing volatility with risk.   Volatility is not risk.  Risk is the chance of the permanent loss of capital.   There are no 30-year periods when the broader market lost money.   An asteroid could hit, or Canada could invade or something and change that, but the actual risk of losing money in the market over that length of time is effectively zero. 

I agree with the use of the words risk and volatility.

But you are assuming that the portfolio in question is going to meet market rates of return, which we know is not always true.

Car Jack

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Virtus:  I would like to violently agree with your ideas!

:lol:

Ok....back when I was actively paying off debt and reached a point where nothing was left but the mortgage, I started paying it off.  I had plenty of friends who dissuaded me from doing this and suggested everything from buying railroad cars to getting an apartment building.  Even the stock market was too risky for me and my wife at the time and my retort was always "What investment is there with a GUARANTEED return better than paying off the mortgage?".  I honestly was looking for an answer.  Amway?  Circle of gold?  Oh yah, I had all of these suggestions and went merrily along and paid off my mortgage.  It is a safe, risk free way to reduce your debt.  Can the stock market bring better returns?  Sure it can.  So what?  If you're looking for safe, guaranteed returns, then pay off the mortgage.

What I found when the mortgage was paid off?  All these friends telling me not to pay it off still had mortgages and nothing from their fly by night investments.  Do I invest in index funds now?  Yah, I do.


RichMoose

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When we compare the risk free rate of return 0.52% (typically the 3 month treasury is used as a proxy for this rate) to the 30-Year fixed rate 4.375% or the 15-Year fixed rate of 3.18% it becomes clear that paying off the mortgage is a great idea. 

With all this said I think a mixture of investing and paying down the mortgage early is optimal after you have an emergency fund. This is partly because we have a limited amount of space each year in our tax advantaged accounts which cannot not be caught up after we pay off the mortgage.
Are you making a fair comparison that is in line with the argument many have about early mortgage payoff on this site?

We generally compare mortgage paydown vs. index investing, not mortgage paydown vs. T-bills. Big difference.

That being said, the second highlighted part is key here. After maxing out tax-advantaged accounts, mortgage payoff becomes increasingly attractive. But it's important not to concentrate your net worth in one asset - your house. While mortgage rates might be a steady 3.18% for 15 years, your house will go up and down in value similar to stocks or bonds. If your house is your only asset, it becomes more than just a roof over your head.

It is realistic in the long term to expect a 80/20 stock bond index fund to return 9% a year (Vanguard said 9.4%). Your house on the other hand will appreciate a little more than the rate of inflation over the long term (Case-Shiller says around 3.4%). Would you rather focus on growing an asset that returns 9%, or paying down a possibly tax-deductible loan on an asset that returns 3.4%?

I also believe cash flow is important, but not when you sacrifice growth and diversification.

nereo

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pass the popcorn please!

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It just makes you look silly.

I keep reading posts where people say "it is not mathematically correct to pay off your mortgage early" or "The only benefit of paying your mortgage off early is the physiological benefit". The problem is both of these statements are incorrect. The individuals that make these statements are only considering the expected return of their investment portfolio over an extended period of time with the rate paid on the debt. This is flawed comparison because it leaves out risk.

You are making the rookie mistake of confusing volatility with risk.   Volatility is not risk.  Risk is the chance of the permanent loss of capital.   There are no 30-year periods when the broader market lost money.   An asteroid could hit, or Canada could invade or something and change that, but the actual risk of losing money in the market over that length of time is effectively zero. 

I agree with the use of the words risk and volatility.

But you are assuming that the portfolio in question is going to meet market rates of return, which we know is not always true.

Where did I assume that?  :)

Here's the correct way to frame the question.  Is a mortgage rate of ____ % likely to be more or less than the expected 30 year rate of return of the market (minus fees and taxes)?   Determining the mortgage is easy, mine is 3.5%.   Now we have to guess what the stock market will do for 30 years.   History says that the worst 30-year period since 1926 was about 8%.   That's was the worst case, not the average.

So even if assume the future will be worse than any time in the past, you still have have a reasonable margin where you would safely outperform.   So I am making an assumption, but I don't need the market to perform at average levels for this strategy to make sense. 

FIreDrill

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

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On a side note, one of the reasons I hear about why you shouldn't pay your mortgage off is because of the tax deduction for the interest.  Yet with the last mortgage I had I ended up taking the standard deduction because it was greater than the sum of my itemized deductions. So there wasn't any tax benefit.  And this was the case only a few years into the mortgage's term, not the end when the payment is mostly principal.

And many early retirees have low enough taxable income that the tax deductibility a non-issue.

Joel

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A final thought. If someone offered to loan you $100 million for 5 years at 9.90% interest, given that the long-term rate of return in the stock market has been above 10% would you take the deal? That represents an expected arbitrage of ~$500,000 over 5 years. Most people wouldn't because in an extreme example the risk is clear.

I'm just going to address one statement. I would not accept a 5-year loan at 9.9% interest to put the money into the stock market. However, I would absolutely accept a 30-year loan at 0% interest to put money into the stock market.  Same with any loan up to 3%. When it starts creeping into the 4-6% range, that's where it becomes less clear to me. There is no hard and fast rule for all people though. That's it. Enjoy the conversation.

Midwest

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

If there is remaining equity after the debt and fees are paid, you do not lose that entire sum. 

Conversely, in some states, if you have no equity and are foreclosed, you remain liable for the shortfall.  If you have substantial non-retirement assets in that situation, I would assume the lender would attempt to collect.

nereo

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

Not only when there is no risk of foreclosure, but also when there is no risk that the property will decrease in value, as it might in a natural disaster.
Ignoring the ethical arguments for a second, generally speaking retirement accounts are protected in bankruptcy. Ergo, holding the mortgage and funding your retirement accounts is a sound strategy.

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Here's the correct way to frame the question.  Is a mortgage rate of ____ % likely to be more or less than the expected 30 year rate of return of the market (minus fees and taxes)?   Determining the mortgage is easy, mine is 3.5%.
Absolutely, but let's make sure not to forget the effect of taxes, which can be considerable. If you are not already maxing out your tax-advantaged accounts and are in a higher (say the 25%) tax bracket, every $100 extra you pay towards your mortgage is another $25 in taxes.  You'll also lose your mortgage interest deduction quicker.

Quote
Paying down a mortgage does not increase the amount of real-estate you have on your balance sheet. Paying down the mortgage reduces the debt on an individuals balance sheet which means the appreciation on the house is irreverent to this decision.
Conceptually, it increases the proportion that you own.  See above for how htis is relevant.
Also - I'm hoping you meant to right "irrelevant" and not "irreverent".  Otherwise you are just being unnecessarily hostile.

Telecaster

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Although volatility is not the same as risk it is often used as a proxy for risk.

In the chart, I used the historical return from 2001 to 2016 for VMMXX to get a feel for how historic market rates for a similar risk investment stack up. In the calculation I used a point in time risk free rate because trying to predict the risk free rate over the next 15-years would be a speculation.

But you still speculated. You assumed the risk free rate would remain constant for the next 30 years, and at a rate so low it hadn't been seem before in the our lifetimes of our parents, grandparents, or great grandparents in this country.   Is that a good, safe assumption, or is it on the risky side?   

Just 35 years ago, the 3-month was at 15%.  Knowing that, is it smart to plan on 0.5%?   Or is it kind of risky? 





nereo

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

This is not correct. If you are foreclosed on the mortgage company sells your house. The net proceeds are used to pay off the mortgage. If there is any money left over the mortgage company mails you a check for the difference. If the net proceeds don't cover the mortgage they can sue you for the difference. If they sue you there really is no difference on being foreclosed on with equity of -10% or 99%.

Laws differ from state to state, but regardless of that - if a bank has to foreclose on a property it is in their best interest to do so as quickly as possible, unloading the property at a steep discount and without any of the normal improvements homeowners might do to fetch the best price.  why?  Because what they want is to get their money back, not to make YOU money or protect YOUR equity.
An example:  suppose you've paid off 50% of $250k mortgage when 'bad stuff' happens and it goes into foreclosure.  You still owe the bank $125k.  The bank may sell very well list the property at $175k (30% below market) for a quick sell.  They get their money back, subtract closing costs and fees, and you may be lucky to get $30k of the $125k in equity you've put into the home.

That's risk.

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In my decision analysis classes we first learned the concept of an expected value, which is simply the expected payout multiplied by the probability of getting it. I think most people understand that concept, especially when we talk about the lottery. As an example, I'll offer you a $1 wager that when I flip a coin if it is heads I'll give you $2 and if it is tails I'll give you nothing. The expected value of this is exactly the cost of the wager. HOWEVER, this does not take into account risk tolerance.

Once you take into effect risk tolerance, you start multiplying these expectations by another factor (how to determine your own risk tolerance is another topic entirely). Pretend I am risk intolerant so I will multiply my expected values by 0.9. Suddenly the wager above is unattractive to me because I would pay $1 for a $0.90 expected value. Conversely, my friend might love risk and get a little thrill out of this wager, and have a risk tolerance factor of 1.1. That means for my friend, the expected value of the above wager is above $1, so it is worth it to him/her to flip the coin.

I say all of this as a preface to the debate on paying off the mortgage or not. We can run the strict numbers for probabilities and expected value, but that ignores each person's individual risk tolerance. This is real and important and influences decision making. It doesn't matter if the numbers say that holding the mortgage for 30 years is the best option if my second friend can't sleep at night and would rather take the lower, less volatile return. It isn't WRONG or RIGHT, it is one's individual risk tolerance. The important thing is to understand that and factor it in accordingly.

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Ehh I think a lot of people talk past each other on this because housing markets are so different across the world.

If you're an engineer working in the mid-west and you own a $90k home. Who cares? When compared to the size of a typical stache around here. It's small potatoes. But when you're talking San Fran 750k condo, that becomes a very different question. You're looking at multiple years of you salary instead of just 1 or less. And due to the compounding nature of investments the growing number of years delaying investing is a lot bigger dollar amount for the person living in San Fran. If you can pay off your mortgage in a year or two, then yeah, avoid the hassle and just live without it. If it's going to take 10-15 years of payments at the expense of investing, don't do that.

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The problem is you don't even use the above question to make the decision. You can obtain a margin loan of 100% for 5.5% which is less than the expected market return but I bet you don't have every investment that you own leveraged at 100%.

A mortgage is fixed rate, long term, and most important for purposes of this discussion, non-callable.   Margin loans are callable, and typically they are called at the least convenient time.   That really can lead to permanent loss of capital and that's the thing I'm trying to avoid.   

If I could get a 30-year 5.5% fixed interest non-callable margin loan I'd be all over it.   Such creatures don't exist. 


Midwest

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

This is not correct. If you are foreclosed on the mortgage company sells your house. The net proceeds are used to pay off the mortgage. If there is any money left over the mortgage company mails you a check for the difference. If the net proceeds don't cover the mortgage they can sue you for the difference. If they sue you there really is no difference on being foreclosed on with equity of -10% or 99%.

Laws differ from state to state, but regardless of that - if a bank has to foreclose on a property it is in their best interest to do so as quickly as possible, unloading the property at a steep discount and without any of the normal improvements homeowners might do to fetch the best price.  why?  Because what they want is to get their money back, not to make YOU money or protect YOUR equity.
An example:  suppose you've paid off 50% of $250k mortgage when 'bad stuff' happens and it goes into foreclosure.  You still owe the bank $125k.  The bank may sell very well list the property at $175k (30% below market) for a quick sell.  They get their money back, subtract closing costs and fees, and you may be lucky to get $30k of the $125k in equity you've put into the home.

That's risk.

If you have substantial equity, you are going to have a better chance of avoiding the foreclosure process.  If I lose my job with no equity and mostly retirement assets, tough for me to sell the house or avoid foreclosure.  If I lose my job with substantial equity, much easier to sell the house.  I'm much more motivated than the bank to save money and my credit.

Midwest

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Ehh I think a lot of people talk past each other on this because housing markets are so different across the world.

If you're an engineer working in the mid-west and you own a $90k home. Who cares? When compared to the size of a typical stache around here. It's small potatoes. But when you're talking San Fran 750k condo, that becomes a very different question. You're looking at multiple years of you salary instead of just 1 or less. And due to the compounding nature of investments the growing number of years delaying investing is a lot bigger dollar amount for the person living in San Fran. If you can pay off your mortgage in a year or two, then yeah, avoid the hassle and just live without it. If it's going to take 10-15 years of payments at the expense of investing, don't do that.

It really comes down to diversification.  If you are putting every $ into paying down your mortgage (the San Francisco example) at the expense of all other investments and retirement, that probably doesn't make sense. 

Conversely, if paying down the mortgage is part of your overall strategy which involves saving and retirement, it might make sense.

Joel

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A final thought. If someone offered to loan you $100 million for 5 years at 9.90% interest, given that the long-term rate of return in the stock market has been above 10% would you take the deal? That represents an expected arbitrage of ~$500,000 over 5 years. Most people wouldn't because in an extreme example the risk is clear.

I'm just going to address one statement. I would not accept a 5-year loan at 9.9% interest to put the money into the stock market. However, I would absolutely accept a 30-year loan at 0% interest to put money into the stock market.  Same with any loan up to 3%. When it starts creeping into the 4-6% range, that's where it becomes less clear to me. There is no hard and fast rule for all people though. That's it. Enjoy the conversation.

I love it! The recognition that all leverage carries risk. How did you pick 4-6% as the point where the reward no longer out weighed the risk?

I look at debt paydown as a guaranteed return of the APR, while I'm conservative in estimating how my stock market index investments will do over the long-term. Around 4-6% is where I start feeling like it's probably going to be a wash. I'll be maxing my retirement contributions each year before contributing extra to my mortgage, but I will likely contribute extra to my mortgage before making taxable contributions. We will see. This 28 year old still rents because it's much more affordable to rent than buy where I live in California.

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

This is not correct. If you are foreclosed on the mortgage company sells your house. The net proceeds are used to pay off the mortgage. If there is any money left over the mortgage company mails you a check for the difference. If the net proceeds don't cover the mortgage they can sue you for the difference. If they sue you there really is no difference on being foreclosed on with equity of -10% or 99%.

Laws differ from state to state, but regardless of that - if a bank has to foreclose on a property it is in their best interest to do so as quickly as possible, unloading the property at a steep discount and without any of the normal improvements homeowners might do to fetch the best price.  why?  Because what they want is to get their money back, not to make YOU money or protect YOUR equity.
An example:  suppose you've paid off 50% of $250k mortgage when 'bad stuff' happens and it goes into foreclosure.  You still owe the bank $125k.  The bank may sell very well list the property at $175k (30% below market) for a quick sell.  They get their money back, subtract closing costs and fees, and you may be lucky to get $30k of the $125k in equity you've put into the home.

That's risk.

If you have substantial equity, you are going to have a better chance of avoiding the foreclosure process.  If I lose my job with no equity and mostly retirement assets, tough for me to sell the house or avoid foreclosure.  If I lose my job with substantial equity, much easier to sell the house.  I'm much more motivated than the bank to save money and my credit.

If your selling the house at "retail" it really doesn't matter if you have 80% equity or 10% equity, buyers aren't going to give a crap.

I'm assuming you're saying selling the house would be easier with equity because you could discount the sale in order to move it quicker.  In that case, you are still losing money by selling the asset at a discount,  fees on the sale alone would eat up 15k-20k on a 250k house sale.

It really boils down to diversifying assets in order to ride out the storm when it comes and the reason for the diversification comes from the risk you take on when shoving all your money towards a mortgage.  Take the following scenarios..

A. 250k house with 75% equity and no savings.
B. 250k house with 50% equity and 62K in savings.
C. 250k house with 25% equity, 42k in savings, and 100k in retirement accounts (increased amount due to tax savings on retirement contributions)

I personally lean towards scenario C for these reasons.

1. Instant 20% return on investments into pre-tax accounts.
2. Higher expected growth rate in retirement accounts than principal pay down. (Assuming 9% long term market return compared to 3-4% mortgage pay down)
3. MUCH more flexibility if we hit hard times by accessing taxable investments/saving accounts.

Really, the instant 20% return for pre-tax accounts is just way too good to pass up for a measly 4% return on our mortgage.

Everyones situation is going to be different though.  Some may not have access to tax advantaged accounts, others may make so much money that they don't care if they miss out on a couple percent returns.

In my case.

Mathematically - Option C is the obvious winner.

Emotionally      - Loaded question....





« Last Edit: January 10, 2017, 02:23:31 PM by FrozenBits »

Fishindude

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Analyze the numbers any way you want but no mortgage payment means I've got a whole lot more money each month to invest or do as I please with. 

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I personally lean towards scenario C for these reasons.

1. Instant 20% return on investments into pre-tax accounts.
2. Higher expected growth rate in retirement accounts than principal pay down. (Assuming 9% long term market return compared to 3-4% mortgage pay down)
3. MUCH more flexibility if we hit hard times by accessing taxable investments/saving accounts.

Reason 3, for me at least is what really puts me in the other column. I would much rather be in a paid off house with an emergency fund in the event we fall on hard times financially. Really, both are good options. However, for our family it would be a lot easier to leave the nest egg untouched and go earn $1k per month to get by, than to worry about the additional $700 to $1k needed to continue to pay the mortgage or pay rent.

No job with no house payment or rent = no worries in my opinion.


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Analyze the numbers any way you want but no mortgage payment means I've got a whole lot more money each month to invest or do as I please with. 
+1 and that is true for the rest of your life.

Retire-Canada

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Mathematically - Option C is the obvious winner.

Yes it is.

If you really are keen on being mortgage free invest the extra payments into index funds and once you have accumulated enough to kill the mortgage in one go - do it. Of course just keeping your money invested and keeping the mortgage is a better idea from the stand point of risk and wealth building. However, if living in paid off home is worth many thousands of lost $$ in wealth than go for it. It's your money.
« Last Edit: January 10, 2017, 02:36:32 PM by Retire-Canada »

Midwest

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The one thing I would point out is that shoving money towards a mortgage does come with risk itself.  If you shove 100k at your mortgage and then get foreclosed on (for whatever reason),  you lose that entire sum.  This may be an extreme example that may not apply to most mustachians, because we have safeguards in place like emergency funds and other investments, but it should be taken into consideration regarding risk of early principal payments on your mortgage.  Principal payoff only gauntness a "risk" free rate of return when assuming there is no risk of foreclosure.

This is not correct. If you are foreclosed on the mortgage company sells your house. The net proceeds are used to pay off the mortgage. If there is any money left over the mortgage company mails you a check for the difference. If the net proceeds don't cover the mortgage they can sue you for the difference. If they sue you there really is no difference on being foreclosed on with equity of -10% or 99%.

Laws differ from state to state, but regardless of that - if a bank has to foreclose on a property it is in their best interest to do so as quickly as possible, unloading the property at a steep discount and without any of the normal improvements homeowners might do to fetch the best price.  why?  Because what they want is to get their money back, not to make YOU money or protect YOUR equity.
An example:  suppose you've paid off 50% of $250k mortgage when 'bad stuff' happens and it goes into foreclosure.  You still owe the bank $125k.  The bank may sell very well list the property at $175k (30% below market) for a quick sell.  They get their money back, subtract closing costs and fees, and you may be lucky to get $30k of the $125k in equity you've put into the home.

That's risk.

If you have substantial equity, you are going to have a better chance of avoiding the foreclosure process.  If I lose my job with no equity and mostly retirement assets, tough for me to sell the house or avoid foreclosure.  If I lose my job with substantial equity, much easier to sell the house.  I'm much more motivated than the bank to save money and my credit.

If your selling the house at "retail" it really doesn't matter if you have 80% equity or 10% equity, buyers aren't going to give a crap.

I'm assuming you're saying selling the house would be easier with equity because you could discount the sale in order to move it quicker.  In that case, you are still losing money by selling the asset at a discount,  fees on the sale alone would eat up 15k-20k on a 250k house sale.


Banks don't sell houses at retail in the foreclosure process.  They unload them at a substantial discount.

I'm assuming that a) owner with equity could choose to discount, but still discount less than a foreclosure b) owner could choose to avoid hiring a seller's agent c) owner occupied home in good repair will generate a higher price than a bank owned property d) bank will have more fees in foreclosure than an owner sale and e) owner with 1 house to sell might be more motivated to get the best price than a large agency with hundreds of thousands of homes.

If you have liquid non-retirement assets, you could employ a similar strategy.  However, if your money is all (or nearly all) tied up in retirement accounts in that scenario, you are much more at the mercy of the bank.
« Last Edit: January 10, 2017, 02:35:26 PM by Midwest »

FIreDrill

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Analyze the numbers any way you want but no mortgage payment means I've got a whole lot more money each month to invest or do as I please with.

You do realize the title of this post implies analyzing the numbers, right? lol

bacchi

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One reason I'm accelerating my mortgage payoff is that payment is a barrier to FI.

How is that possible if you had saved the difference in investment accounts?

bacchi

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All or a portion of the equity in a primary residence is subject to a homestead exemption in most states which protects it from lawsuits and bankruptcy, treasuries and bank accounts don't have these protections.

From my understanding, this is only true in 2 states, Florida and Texas.*

This is why OJ Simpson bought a house in Florida rather than stay in California. His Florida house is not subject to civil lawsuit forfeiture.


* Eta: 44 states have homestead protection to some extent. California's protection is $75k for individuals below the age of 65.
« Last Edit: January 10, 2017, 03:09:49 PM by bacchi »

CmFtns

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I disagree with you... call me silly or any names you want to

We are talking about the difference between over-prepared and over-prepared... There is not much difference in risk here... whether you are dumping money into stocks, mortgage, or a mix of the two you are doing a million times better than 99% of the world and to me none of these options are risky. Now when I see two non-risky options and historically one option has performed better every single time guess which one I would be picking.

Now all these talks about coin flipping and 10 million dollar loans at 9.99% or whatever are completely different stories because there is huge risk in all these things and are not comparable.

TL;DR
When i see two scenarios with equal or minimal risk between them I go with the better returns
I would absolutely not pay down a sub 4% mortgage... it makes zero sense to me


ysette9

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As someone in a HCOL area (where can I get a $750k SF condo?? What a deal!) it probably does make a big difference how much the mortgage is total. When I run cFIREsim scenarios with house prices in the $800-1000k range, there is a noticeable difference in success probability between carrying a 30 year mortgage versus paying all cash or even putting 50% down. Keeping the mortgage for as long as possible wins. Then again, there is the emotional aspect of it. Will I actually feel comfortable enough to keep the mortgage while living off of investments? Back in the era when we had a car loan, that sucker didn't live its full natural life because seeing that balance bugged me.

Landlady

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One reason I'm accelerating my mortgage payoff is that payment is a barrier to FI. 
I'm in the same boat. The minute I pay off my property my net rental income shoots up to an amount which takes me to FI.
I could have chosen to put the money in stocks, but my timeline to FI gets longer because I already have a big chunk of the mortgage paid down and will still have payments. Diversification hurts me here for the short term I guess.
If I sell the house and immediately put the money in stocks, I miss out on tons of passive income from the rental property in future years so that's not good either. Currently, the returns are better than the stock market on this house.
So my decision for FI is to pay off the property and then use the surplus income to then invest in the market.

I'm never sure if it's the right thing to do, but it's certainly the path that gets me to FIRE the quickest.

RichMoose

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Are you making a fair comparison that is in line with the argument many have about early mortgage payoff on this site?

We generally compare mortgage paydown vs. index investing, not mortgage paydown vs. T-bills. Big difference.

That being said, the second highlighted part is key here. After maxing out tax-advantaged accounts, mortgage payoff becomes increasingly attractive. But it's important not to concentrate your net worth in one asset - your house. While mortgage rates might be a steady 3.18% for 15 years, your house will go up and down in value similar to stocks or bonds. If your house is your only asset, it becomes more than just a roof over your head.

It is realistic in the long term to expect a 80/20 stock bond index fund to return 9% a year (Vanguard said 9.4%). Your house on the other hand will appreciate a little more than the rate of inflation over the long term (Case-Shiller says around 3.4%). Would you rather focus on growing an asset that returns 9%, or paying down a possibly tax-deductible loan on an asset that returns 3.4%?

I also believe cash flow is important, but not when you sacrifice growth and diversification.

Paying down a mortgage does not increase the amount of real-estate you have on your balance sheet. Paying down the mortgage reduces the debt on an individuals balance sheet which means the appreciation on the house is irreverent to this decision.

Partially true, but my point is concentration of assets in your house. So it paying down a mortgage fast might not increase the amount of real estate on your balance sheet, but it will increase the net value of real estate on your balance sheet.

For example, let's say my real estate is valued at $500,000. If I put $100,000 down and pay it off in 15 years that's a monthly payment of about $2900. Compared to about $1900 if I pay off in 30 years.

Scen. A: If I only pay off my mortgage, in 15 years I have a house worth about $825,000 at the 3.4% return. If I run stuck and need some cash, I have to obtain a loan, probably against the house. That means an appraisal, legal fees, and interest costs.

Scen. B: If I invest that extra $1000 at 9%, in 15 years I have about $375,000 in the bank, plus a $825,000 house - $255,000 mortgage for equity of $570,000. That's a total networth of $945,000. Also, if needed the $375,000 in investments could toss off $15,000 a year at the 4% rule. If I run stuck somewhere and need a bit of cash, I can sell some of my investments at virtually no cost.

In 30 years, when the mortgage is paid off in Scenario B, the difference is even bigger because of the compounding factor on your investments. Scen. A gives you a paid off house and $1.08 million in investments (if you divert the $2900 to investing). Scen. B gives you a paid off house and $1.77 million in investments. That's a difference of three-quarters a million dollars.

It's a personal decision, but I'll take the extra $700,000 for no extra effort. Added bonus: I have the security of diversification the whole 30 year journey.

FIreDrill

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Mathematically - Option C is the obvious winner.

Yes it is.

If you really are keen on being mortgage free invest the extra payments into index funds and once you have accumulated enough to kill the mortgage in one go - do it. Of course just keeping your money invested and keeping the mortgage is a better idea from the stand point of risk and wealth building. However, if living in paid off home is worth many thousands of lost $$ in wealth than go for it. It's your money.

It depends on the time period. Over some historical periods paying off the house early results in a higher net worth over the long-term.

You would really have to cherry pick the data in order to support your argument over a 30 year investment timeframe.  And remember, you have to front load the investment side with an instant 20% gain due to tax savings by contributing to pre-tax accounts...


Retire-Canada

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You would really have to cherry pick the data in order to support your argument over a 30 year investment timeframe.  And remember, you have to front load the investment side with an instant 20% gain due to tax savings by contributing to pre-tax accounts...

And factor in the diversification risk of having all your NW tied up in one asset.

theolympians

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My argument is not strictly mathematical. Paying off your mortgage early allows for FIRE and stability/peace of mind.

Volatility is risk. A home owned free and clear is safety.

SwordGuy

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One reason I'm accelerating my mortgage payoff is that payment is a barrier to FI.

How is that possible if you had saved the difference in investment accounts?

Let's say I have a $1000 a month mortgage payment on a $100,000 mortgage balance.

Using the 4% "rule", I will need $25,000 invested to make one month's payment.   To make 12 payments I'll need $250,000 invested.

Or, I can just save up $100,000 and pay the damn thing off, and retire $150,000 quicker.

That's how. :)


The important thing to remember is that pre-paying the mortgage is NOT a guaranteed return.  It is only a return if we make all the mortgage payments.  If, for some reason we can't, the bank will sell the house for a price that gives them the money we owe them.  They don't care about our portion of the equity in the house.   The more we've pre-payed the mortgage in this situation, the easier it is for the bank to sell our old house cheaply - because they only need to sell it for enough to clear our debt to them.  If we're foreclosed and the bank sells the property for cheap, we get zero return on those extra payments.

That's why pre-paying a lot on the mortgage is risky if you have inadequate reserves to handle a loss of income for a lengthy period.   Major illnesses or accidents that prevent people from working are, if I remember correctly,  one of the leading reason for foreclosures.  The other is job loss due to economic downturns.


bacchi

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One reason I'm accelerating my mortgage payoff is that payment is a barrier to FI.

How is that possible if you had saved the difference in investment accounts?

Let's say I have a $1000 a month mortgage payment on a $100,000 mortgage balance.

Using the 4% "rule", I will need $25,000 invested to make one month's payment.   To make 12 payments I'll need $250,000 invested.

Or, I can just save up $100,000 and pay the damn thing off, and retire $150,000 quicker.

That's how. :)

Noooo. The $1000/mth payment includes principal payment. You can't use the 4% rule on mortgage-invested money because some of it is trading one investment (stocks) for another (real estate).


Mattzlaff

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Regardless of the math I prefer to pay off the mortgage quicker too. I do invest all I can into tax advantaged accounts, and I'm not paying off my mortgage in 5 years, but I do maybe put 6-8k a year towards the principal. I'm happy with that.

30 years of debt doesn't sit well here with me. The way I see it, is that this place preaches debt free living, so why not pay off the mortgage, faster than normal but not dump everything into it? If I can cut my mortgage to 20 years I'm happy(I'll be 43 by then). I've still invested into the market and I've gotten 10 years of debt free living.

Retire-Canada

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The way I see it, is that this place preaches debt free living, so why not pay off the mortgage, faster than normal but not dump everything into it?

The reasons have all been listed in this thread already.

Livewell

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In my decision analysis classes we first learned the concept of an expected value, which is simply the expected payout multiplied by the probability of getting it. I think most people understand that concept, especially when we talk about the lottery. As an example, I'll offer you a $1 wager that when I flip a coin if it is heads I'll give you $2 and if it is tails I'll give you nothing. The expected value of this is exactly the cost of the wager. HOWEVER, this does not take into account risk tolerance.

Once you take into effect risk tolerance, you start multiplying these expectations by another factor (how to determine your own risk tolerance is another topic entirely). Pretend I am risk intolerant so I will multiply my expected values by 0.9. Suddenly the wager above is unattractive to me because I would pay $1 for a $0.90 expected value. Conversely, my friend might love risk and get a little thrill out of this wager, and have a risk tolerance factor of 1.1. That means for my friend, the expected value of the above wager is above $1, so it is worth it to him/her to flip the coin.

I say all of this as a preface to the debate on paying off the mortgage or not. We can run the strict numbers for probabilities and expected value, but that ignores each person's individual risk tolerance. This is real and important and influences decision making. It doesn't matter if the numbers say that holding the mortgage for 30 years is the best option if my second friend can't sleep at night and would rather take the lower, less volatile return. It isn't WRONG or RIGHT, it is one's individual risk tolerance. The important thing is to understand that and factor it in accordingly.

I think this is absolutely the answer here - it is your own risk tolerance that determines the right choice for your decision.  For us, we had a healthy portfolio and no other debt before we started tackling the mortgage.  At first we used a bonus to pay down and refinance - which reduced our monthly payment by 40%. A few years later we used another bonus to pay it off.  Could we have made more in the market with that money?  Absolutely, however we still had a portfolio of index stocks too.  End of the day it just felt right to be 40 and not have to worry about a mortgage.  My advice would be to trust your gut.

nereo

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I'd like to compliment Virtus on a fine piece of trolling.  He/she titled the thread as a shouted command, and has since proceeded to deny points made in discussion criticizing the central premise or simply redefined concepts like risk to better fit the premise.

The all-caps subject was a nice touch, using every single character allowed (perhaps that's why there was only one exclamation mark?)
A few suggestions for future threads:

STOP RELYING ON THE 4% RULE, IT WON'T WORK!!!
MMM LIES, HE'S NOT REALLY RETIRED AT ALL
TAXATION IS THEFT, TO SAY OTHERWISE IS DISHONEST!

what others topics can we yell at each other about?

nereo

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If you just started a 30-year mortgage the 4% rule is a great guideline for determining how much you would need to have saved to cover the mortgage payment. Using cFIREsim you would need a portfolio of $330,000 to cover a $1,000 per month principle and interest payment in every historical scenario which is a withdrawal rate of 3.6%.

The statement which led to your response (made by SwordGuy) was a joke, indicated by the smiley emoticon at the end.  Clearly if you have a mortgage balance of $100,000, you do not need $250,000 or $330,000 to cover it.  That's absurd. 
What you would need is to factor in an additional $1,000/mo to your anticipated expenses for the duration of the mortgage.  When you do that you'll notice that you need substantially less than you would putting that money towards your mortgage, in part because it is a fixed amount and the real value decreases with inflation (and yes, also because the market's average returns exceed current fixed mortgage rates).

(edited for clarity)
« Last Edit: January 11, 2017, 09:51:57 AM by nereo »

Retire-Canada

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what others topics can we yell at each other about?

Before we move on to something else can I just say -  IT IS NOT MATHEMATICALLY CORRECT TO PAY OFF YOUR MORTGAGE EARLY! ;)

soupcxan

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the actual risk of losing money in the market over that length of time [30 years] is effectively zero. 

This is such a gross misunderstanding of risk, I don't even know where to start. SMH

thepokercab

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I for one am excited about ALL CAPS proclamations taking their rightful place as a sign of truth.  For too long Caps Lock has been mocked and ignored in this country, by the ELITE with their semi colons, and commas and punctuation in general, trying to tell the rest of us how to live. 

nereo

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I for one am excited about ALL CAPS proclamations taking their rightful place as a sign of truth.  For too long Caps Lock has been mocked and ignored in this country, by the ELITE with their semi colons, and commas and punctuation in general, trying to tell the rest of us how to live.

For someone who disparages punctuation, you certainly have used quite a lot of it in your post.
:-P