Author Topic: STOP SAYING IT IS NOT MATHEMATICALLY CORRECT TO PAY OFF YOUR MORTGAGE EARLY!  (Read 54788 times)

Boofinator

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Mathematically speaking I believe your net worth will likely be higher by having a 30 year mortgage and investing any surplus.  To me it gets a bit fuzzy for a few reasons: 1) projected salary duration; 2) simplicity; and 3) stress.  If you have a mortgage that you keep for 30 years, that means you have to make payments for 30 years.  That is fine during the accumulation stage, but I'm assuming that many in the forums plan to retire early.  What do those payments look like when you are in the withdrawal phase and/or when the stock market does not have a good year? 

If you can pay off the mortgage within 5 years, I believe it makes sense to knock it out and ramp up investments after it is paid off.  If it will take longer than 5 years, it makes sense to invest the money and revisit the decision based on personal preferences after the invested amount > mortgage balance.  This is assuming that in either scenario you are investing in retirement accounts and have a sufficient emergency fund.

And what if you have a sufficient emergency fund and maxed out all retirement accounts? Would it be the same if you are investing in a taxable account? That's where I get stuck in paying down my mortgage vs. using it to invest in taxable accounts.

It depends on what your objectives are and how much risk you are willing to take.

Let's take somebody who is early in their savings journey and wants to minimize the expected (average) time to FIRE. First off, this person should try to have some liquid funds (tax-advantaged funds could be liquidated, but this isn't ideal). I am a big proponent of having this "emergency fund" in equities, unless you have unsecure employment. Additionally, since this person is near the beginning of their savings journey, this money will likely compound for decades, reducing the risk even more (reversion to the mean). Finally, this strategy minimizes the expected time to FIRE (at current mortgage interest rates and considering historical equity returns). So for this person, he or she minimizes expected time to retirement and minimizes risk by investing in a taxable account over paying off their mortgage.

As one gets older, their objectives should change, due to both a declining desire to take risk (assuming you're mustachian and have a stash that can cover your needs) and a declining ability to take risk (the pleasures of aging). At this point, one can often reduce risk by paying off the mortgage even if the expected return is less than that for equities.
« Last Edit: April 08, 2019, 09:48:48 AM by Boofinator »

the_fixer

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I believe interest rates were around 6.5% for a 30 year in 2007.

Crazy thing is how many people had 0% down payment or low down payment style loans using 80/20 loans and ARM's just so they could buy a house.

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« Last Edit: April 08, 2019, 09:47:20 AM by the_fixer »

nereo

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I believe interest rates were around 6.5% for a 30 year in 2007.
This is broadly true.  For context the 10y US treasury rate also went above 5%.  Lenders (banks) want a return that is proportional with risk, and a 30 year mortgage is considered more risky than government bonds. Also for context when my parents originally financed their home in the early 1980s they had a prime rate of over 12%, yet within a few years the 10y went as high as 15%.

Crazy thing is how many people had 0% down payment or low down payment style loans using 80/20 loans and ARM's just so they could buy a house.
NINJA loans (no income, no assets, no job) were commonplace back them, as mortgage-backed securities made all mortgages seem less risky than they really were, and people were relying on an uninterrupted rise in home values to make their leverage seem sane. 

I would say this was the most ludicrous thing the lending industry has ever undertaken, but sadly such loans are making a comeback as the deregulation push takes hold.

techwiz

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Quote
but sadly such loans are making a comeback as the deregulation push takes hold.

If true this could mean a repeat of 2008 housing crisis. I wouldn't think people in finance industry have that short of a memory?

nereo

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Quote
but sadly such loans are making a comeback as the deregulation push takes hold.

If true this could mean a repeat of 2008 housing crisis. I wouldn't think people in finance industry have that short of a memory?
Sadly you would be mistaken.
The current drumbeat is that the regulatory oversight put into place after the mortgage-backed securities fiasco of 2008 is burdensome and an unnecessary headwind on profits.  This, despite record profitability in the banking sector. https://www.washingtonpost.com/business/economy/federal-reserve-proposes-changes-to-bank-regulations/2019/04/08/48da8fa2-5a01-11e9-a00e-050dc7b82693_story.html?utm_term=.efe02bad4360

Memories are short, and a large group of people still believe that 'market forces' will ensure that banks do what is in their best long term interest.  They argue that self-regulation will be the most effective. Meanwhile, our financial system continues to evaluate publicly traded companies based on quarterly (short term) profits above all else, and rewarding risky behavior.

IMO we won't have a repeat of 2008 - the bubble will burst someplace else, with some new vulnerability clever people have exploited to avoid 'onerous' regulation.

ChpBstrd

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Quote
but sadly such loans are making a comeback as the deregulation push takes hold.

If true this could mean a repeat of 2008 housing crisis. I wouldn't think people in finance industry have that short of a memory?
Sadly you would be mistaken.
The current drumbeat is that the regulatory oversight put into place after the mortgage-backed securities fiasco of 2008 is burdensome and an unnecessary headwind on profits.  This, despite record profitability in the banking sector. https://www.washingtonpost.com/business/economy/federal-reserve-proposes-changes-to-bank-regulations/2019/04/08/48da8fa2-5a01-11e9-a00e-050dc7b82693_story.html?utm_term=.efe02bad4360

Memories are short, and a large group of people still believe that 'market forces' will ensure that banks do what is in their best long term interest.  They argue that self-regulation will be the most effective. Meanwhile, our financial system continues to evaluate publicly traded companies based on quarterly (short term) profits above all else, and rewarding risky behavior.

IMO we won't have a repeat of 2008 - the bubble will burst someplace else, with some new vulnerability clever people have exploited to avoid 'onerous' regulation.

1) Financial crisis / recession
2) Democrats elected to regulate away the causes of the recession
3) Rapid economic growth
4) Growth cycle slows
5) Republicans elected to deregulate industry and increase growth
6) Repeat

nereo

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Sadly, i don't think that's far off...

Neo

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I didn't read all the replies so someone probably already said it but if you want to pay off the mortgage early my answer is to invest in index funds instead of paying down the mortgage early each month. Then pay the mortgage off in one shot from the investment account when it reaches the appropriate amount. Seems like the least risky way to do it.

Boofinator

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I didn't read all the replies so someone probably already said it but if you want to pay off the mortgage early my answer is to invest in index funds instead of paying down the mortgage early each month. Then pay the mortgage off in one shot from the investment account when it reaches the appropriate amount. Seems like the least risky way to do it.

That's the generally recommended approach for those who want to pay off their mortgage. Given current interest rates, just about nobody should be paying off their mortgage early in their accumulation years if they are interested in FIREing as soon as possible (granted this is not everybody's objective).

nereo

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I didn't read all the replies so someone probably already said it but if you want to pay off the mortgage early my answer is to invest in index funds instead of paying down the mortgage early each month. Then pay the mortgage off in one shot from the investment account when it reaches the appropriate amount. Seems like the least risky way to do it.

That's the generally recommended approach for those who want to pay off their mortgage. Given current interest rates, just about nobody should be paying off their mortgage early in their accumulation years if they are interested in FIREing as soon as possible (granted this is not everybody's objective).

To me it seems like good advice for anyone with a low-rate fixed mortgage still in the accumulation phase, whether they intend to FIRE or not...
Question:  When would you not recommend this strategy under these parameters?

Boofinator

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I didn't read all the replies so someone probably already said it but if you want to pay off the mortgage early my answer is to invest in index funds instead of paying down the mortgage early each month. Then pay the mortgage off in one shot from the investment account when it reaches the appropriate amount. Seems like the least risky way to do it.

That's the generally recommended approach for those who want to pay off their mortgage. Given current interest rates, just about nobody should be paying off their mortgage early in their accumulation years if they are interested in FIREing as soon as possible (granted this is not everybody's objective).

To me it seems like good advice for anyone with a low-rate fixed mortgage still in the accumulation phase, whether they intend to FIRE or not...
Question:  When would you not recommend this strategy under these parameters?

I would recommend it 100% of the time. But I understand different people have different things that make them tick. Some people have a strong aversion to debt, and don't care that they're reducing expected return and increasing their risk of default by paying off the mortgage. I'm ok with that, it's certainly better than being a spendypants. So given that objective, to eliminate all debt independent of other objectives, I wouldn't object to somebody paying off their mortgage so long as they understand the risks associated with that approach relative to investing.

ender

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And what if you have a sufficient emergency fund and maxed out all retirement accounts? Would it be the same if you are investing in a taxable account? That's where I get stuck in paying down my mortgage vs. using it to invest in taxable accounts.

IMO it depends on your risk factors for:

  • Inflation
  • Income loss & mortgage payments

If inflation will not affect you as much this is less of a problem than if it can. If someone's home is 50% of their net worth, their inflation risk is higher.

Likewise, you need to have a plan for paying the mortgage/taxes/etc in the event of job loss.

Boofinator

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IMO it depends on your risk factors for:

  • Inflation
  • Income loss & mortgage payments

If inflation will not affect you as much this is less of a problem than if it can. If someone's home is 50% of their net worth, their inflation risk is higher.

Likewise, you need to have a plan for paying the mortgage/taxes/etc in the event of job loss.

Could you walk us through how inflation poses a risk here?