Author Topic: Requesting input on mortgage options  (Read 847 times)

Swamp Chomp

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Requesting input on mortgage options
« on: April 22, 2018, 07:13:31 PM »
Hello, thanks for reading our post.  My wife and I write to you requesting input.  We started reading MMM a few years ago and over time have gone lean on our home budget, started investing into VTSAX, changed over cell phones to Republic Wireless, and are now closing on our house June 1 so we can move into a less expensive home and accellerate our path to financial independence. 

We're wrestling with taking out a 15-year mortgage or a 30-year and investing the difference in the monthly payment into VTSAX... I know, a common topic in the MMM community.

A little backstory, I am 33 and our goal is for me to retire in 15 years. We bought a 30+ year old business a year ago March and things there are starting to get on-track (the prior owner had wound it down quite a bit).  We draw $4,000/month for living expeneses and take another $500/month to put toward our VTSAX.  Once we build the business up, we're hoping to get to where we can put 50% of our income toward VTSAX.

When we retire, we would like to continue our current way of life, which costs about $48K per year (including the mortgage), so using the 4% SWR, that's $1,200,000 needed to retire.  If we were to do the 15-year mortgage and have that expense eliminated, our monthly budget needs would drop to around $35K per year, so $875,000 needed in the bank to retire. 

On our new place, we're looking at borrowing about $150,000 at 4.5%.  With the 15-year, the monthly payment would be $1,147 and at 30-years it would be $760. If we took the difference ($388) and invested that monthly, that would be worth about $121,000 at the 15-year mark, assuming a 7% return. 

I've read the arguements saying it is more profitable to take the 30-year and invest (ignoring the peace of mind aspect), but looking at my math here (which could be missing something), comparing the investment growth going the 30-year route  ($121,000) to the 15-year route with the decreased savings needed to be able to retire morgage free ($325,000), doesn't it make clear sense to do the 15-year and pay off that mortgage?  I've read many of the discussions in the forum about this topic but haven't seen this approach to it, which seems like the best way to look at the situation for my wife and I.

I would be grateful to hear input about this.  Many thanks.  - Ben

Dicey

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Re: Requesting input on mortgage options
« Reply #1 on: April 22, 2018, 10:11:15 PM »
You can always take out a 30 year mortgage and pay it off on a 15 year amortization schedule for maximum flexibility. Also, an accurate comparison of 15 vs 30 year loans needs to include consideration for inflation. The longer the mortgage, the better the hedge against the inevitable inflation. Of course, we are only speaking of affordable, low-interest, fixed rate mortgages, right?

Another option is to take the 30 year loan, invest the difference plus everything else you can and just let it grow to the point that you can pay off your mortgage in a single payment. It will happen, but when it does, many, many people notice that they really like watching their money grow with virtually no effort. Then they are happy to just let the mortgage ride. Knowing you could pay it off whenever you wanted is pretty darn cool.

Fishindude

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Re: Requesting input on mortgage options
« Reply #2 on: April 23, 2018, 07:17:33 AM »
Go with a 15 year fixed rate mortgage with no penalty for early pay off.
If you're really hard core, pay the 15 year mortgage off early.

I think a lot of people talk the talk of going with the 30 year mortgage and investing the rest, but I'm betting most just spend it instead of investing.
The short term mortgage forces a short term pay off so long as you don't borrow more.   Living mortgage free is a real luxury.

waltworks

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Re: Requesting input on mortgage options
« Reply #3 on: April 23, 2018, 11:57:15 AM »
Here's a slightly easier way to see why this is a bad idea.

Let's say you're doing a 4% 15 year vs 4.5% 30 year. $150k principal. Invest the difference.

15 year is paid off at the end of the term, and indeed your annual spend drops a bunch. Awesome.

On the other hand, if you look at your amortization schedule for the 30 year, sometime around year 13 your investment earnings exceed the amount left on the mortgage. So you pay it off (if you want to), and you've got the same decreased annual spend/paid off house, but a couple of years ahead of where you'd be with the 15 year option.

The even simpler way to think about it: Your money is working harder at 7% than 4.5%, whether it's paying off debt or earning dividends/capital gains.

Now, your equities investment is far from guaranteed to get you 7% returns, of course. And there are some tax advantages (for some people) to carrying a mortgage. So there are certainly subtleties not captured here that will vary from situation to situation.

-W

boarder42

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Re: Requesting input on mortgage options
« Reply #4 on: April 23, 2018, 12:34:38 PM »
http://michaelbluejay.com/house/15vs30.html

this is a great calculator to determine what will mathmatically be optimal based on historical market assumptions - which if you're investing in VTSAX you're assuming we'll see typical market returns.

The calculator usually spits out that if you plan to stay in the house 6-7 years or more you're better with the 30 year and investing the difference.

The easy emotional decision is to run from debt and pay down the mortgage - kinda like its easy to go to taco bell on the way home from work and get dinner - the bad ass thing to do that actually requires no extra life effort and historically leads to a faster timeline to FIRE is to take which ever mortgage is best from the above scenario based on the time you expect to live there and pay it down as slowly as possible and invest the rest- one by product of this method is its safer and lower risk than paying extra towards your mortgage. 

A few things are incorrect in your OP though about you assumptions around your mortgage and afew othe comments here are incorrect.

1. 7% market returns vs 4.5% mortgage - mortgages dont index to inflation so if we're going to assume a 7% market return - this removes inflation we should remove it from our mortgage rate of return as well so you can compare 7% to 1.5% or 10% to 4.5% either way not paying down the house looks better.

2. your assumption that less is needed in the bank to retire without a mortgage vs with - when looked at in a vacuum yes the mortgage today is spending today and that adds to your withdrawal.  But when we use a tool like cFIREsim and we make assumptions of 1MM dollar nest egg and 40k spending and have one person with a 200k - 30 year mortgage and 1.2MM at 4% the person with the mortgage actually becomes more successful to the tune of around 5% in FIRE - so if you were to retire in 15 years you would need the 875k plus the remaining balance of your mortgage and you'd have better odds of surving a long FIRE time line of withdrawals than without the mortgage. 

2a. the other thing to point out here is your dollar can go into your mortgage or be invested so if you choose to invest that money the historical odds are you will reach the point at which you have 4% plus the remaining balance on your house much faster than if you went with the 15 year just to be mortgage free at time of FIRE. 

3. mentioned above but the security of not paying down a mortgage and investing the money is often stated in the wrong way by the pay down the mortgage crowd.  until your house is 100% paid off youre more secure with a bunch of money invested in equities than extra money having been pumped into your house.

waltworks

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Re: Requesting input on mortgage options
« Reply #5 on: April 23, 2018, 12:51:34 PM »
Boarder, I was assuming OP was being conservative (ie 4% real/7% w/inflation) about market returns. If that wasn't their intent, then yes, inflation adjusting the equities and not the mortgage is a little wacky.

-W

boarder42

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Re: Requesting input on mortgage options
« Reply #6 on: April 23, 2018, 01:01:50 PM »
Also OP the putting money towards a mortgage needs to ONLY be considered after you've maximized your tax situation which as a business owner there are many ways to defer taxes.  So i'd make sure you're looking into that first before you add an extra dollar towards the house above the mortgage.  (even after that it wont make sense, but its exponentially wrong doing it prior)

cchrissyy

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Re: Requesting input on mortgage options
« Reply #7 on: April 23, 2018, 11:20:34 PM »
Quote
When we retire, we would like to continue our current way of life, which costs about $48K per year (including the mortgage), so using the 4% SWR, that's $1,200,000 needed to retire.  If we were to do the 15-year mortgage and have that expense eliminated, our monthly budget needs would drop to around $35K per year, so $875,000 needed in the bank to retire. 

that's not quite right, as the mortgage doesn't last throughout your retirement even if you pick the 30 year plan and never pay ahead. Cfiresim can account for this much better than the simplified multiplication above.

as far as what to do, I would want the 30 year note, pay extra when I felt like it, and invest the monthly difference until it became enough to pay the mortgage in full, and then decide if I prefer to pay it off or if I feel better keeping money invested and paying the mortgage from that account.

Swamp Chomp

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Re: Requesting input on mortgage options
« Reply #8 on: April 26, 2018, 06:11:46 PM »
Hello all,

First, thank you all for taking the time to read and write your input.  My wife and I value it all.  I knew it wasn't a clear decision but you helped me learn about more nuances than I was initially aware of.  What a great community.

We have decided to go the 30-year and invest in VTSAX.  Some of the bigger things that tipped the scale for were:

- Inflation hedge
- Flexibility if times got tough
- Overall greater long-term return
- Interest write-off
- Ability to minimize taxes via the biz

Thank a bunch all.

Ben

boarder42

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Re: Requesting input on mortgage options
« Reply #9 on: April 26, 2018, 08:07:22 PM »
You made a great choice  but FYI You likely won't be writing off interest the new tax law changed that. Unless your mortgage interest is over 14k. And your state and local taxes are over 10k. Any interest over 14k will be deducted.