Author Topic: The great "pay off mortage" vs "invest in stocks" debate - possible solution  (Read 75433 times)

Bearded Man

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I am of the opinion (and practice what I preach) that one should have a paid off place to live before they invest in the stock market. A paid off place to live pays dividends for the rest of your life in that it reduces your cost of living drastically, and even with a minimum wage job you can live well in a paid off house. It's always a nice fall back position.

calivianya

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I am of the opinion (and practice what I preach) that one should have a paid off place to live before they invest in the stock market. A paid off place to live pays dividends for the rest of your life in that it reduces your cost of living drastically, and even with a minimum wage job you can live well in a paid off house. It's always a nice fall back position.
+1

This site caters to the well-off, in general. Overall income and financial solvency should be a factor when deciding to pay off a mortgage. If a person has enough in savings to pay off a house altogether, as a PP mentioned, it doesn't matter as much whether the house is paid off or not because the funds are there. For people new to their careers and/or new to saving, who have very little money to play with, making sure they have a place to live is a little more crucial.

brooklynguy

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I am of the opinion (and practice what I preach) that one should have a paid off place to live before they invest in the stock market. A paid off place to live pays dividends for the rest of your life in that it reduces your cost of living drastically, and even with a minimum wage job you can live well in a paid off house. It's always a nice fall back position.
+1

This site caters to the well-off, in general. Overall income and financial solvency should be a factor when deciding to pay off a mortgage. If a person has enough in savings to pay off a house altogether, as a PP mentioned, it doesn't matter as much whether the house is paid off or not because the funds are there. For people new to their careers and/or new to saving, who have very little money to play with, making sure they have a place to live is a little more crucial.

How exactly do you propose that a person without sufficient savings to pay off their mortgage do so?

Cheddar Stacker

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How exactly do you propose that a person without sufficient savings to pay off their mortgage do so?

Right. Let's see.

You have an extra $1,000/month. What do you do?

Option 1: Extra mortgage principal.
Option 2: 401k/or taxable brokerage account.

5 years later you lose your job and earning power. Let's see how the options look.

1: You still have 17 years of $900/month mortgage payments to make, but you have no money. The bank takes your house away within a year, you lose the normal equity you would've had, plus all those extra payments ($1,000x60=$60,000), plus now you have a foreclosure/short sale on your credit report.

2: You still have 24 years of $900/month mortgage payments to make, but you have ~$75,000 invested. You can pay the mortgage bill for 5 more years by cashing out your investments.

Which option is safer?

arebelspy

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.
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Bearded Man

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

Is this the case in most circumstances? That explains why people are walking away from houses they bought 10 years ago. If they get the equity back, it's not too bad.

forummm

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

Is this the case in most circumstances? That explains why people are walking away from houses they bought 10 years ago. If they get the equity back, it's not too bad.

I thought usually, people would just sell it themselves instead of going through foreclosure (keeps the credit healthier, lower fees, control your own destiny, etc). But the people walking away in recent years (especially during '07-'10) probably are underwater or would be after transaction costs.

forummm

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Following BrooklynGuy's method, I used cFIREsim to compare the performance of taking out a 30-year fixed-rate mortgage, investing the proceeds of that mortgage, and using only that mortgage-derived portfolio to pay your mortgage. This ignores the transaction costs of getting a mortgage, and may not equal exactly how your portfolio would be modeled because cFIREsim pulls a year's worth of spending all at once. This is based on a $100k mortgage (initial portfolio), uses a 0.05 ER, and the spending rate is not inflation adjusted (because your mortgage payments won't be either).

I thought the 30-year mortgage example would be a good way to model this because the term is sufficiently large to capture the expected long-term market returns, and if continuing to hold your mortgage and invest instead is a superior strategy, you'd want to maximize your ability to do that by refinancing right before you quit your job (and make getting a mortgage much harder). But obviously if by the time you are ready to FIRE you have 15 years left on a 3% loan and the market only offers 6% on a 30 year loan, it may not make sense to refi at that time.

The table headers don't line up exactly but I was too lazy to put it into the table code.

                  
         100% stock         
Interest rate   Monthly   Annual   Success Rate   Lowest Portfolio   Median Portfolio   Highest Portfolio
3%   422   5064   98%   ($82,039.73)   $564,271.49    $2,385,890.76
4%   477   5724   95%   ($103,240.05)   $422,969.72    $2,212,153.09
5%   537   6444   88%   ($127,727.13)   $283,518.02    $2,022,621.13
6%   600   7200   66%   ($152,246.38)   $171,800.36    $1,823,612.79
7%   665   7980   54%   ($179,631.18)   $31,882.02    $1,618,286.93
8%   734   8808   39%   ($205,557.97)   ($60,733.21)   $1,400,325.52
                  
                  
         75% stock         
Interest rate   Monthly   Annual   Success Rate   Lowest Portfolio   Median Portfolio   Highest Portfolio
3%   422   5064   98%   ($51,919.39)   $388,154.91    $1,735,055.52
4%   477   5724   96%   ($82,050.56)   $290,397.43    $1,567,618.08
5%   537   6444   82%   ($107,102.73)   $183,596.70    $1,384,959.01
6%   600   7200   63%   ($132,364.73)   $78,870.69    $1,193,167.15
7%   665   7980   46%   ($159,006.49)   ($23,592.30)   $995,286.50
8%   734   8808   28%   ($186,045.61)   ($85,508.41)   $812,400.14


There's probably some correlation between prevailing market interest rates at the time you FIRE and future market returns. Obviously the methodology I used here does not take this into account.

Bearded Man

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How exactly do you propose that a person without sufficient savings to pay off their mortgage do so?

Right. Let's see.

You have an extra $1,000/month. What do you do?

Option 1: Extra mortgage principal.
Option 2: 401k/or taxable brokerage account.

5 years later you lose your job and earning power. Let's see how the options look.

1: You still have 17 years of $900/month mortgage payments to make, but you have no money. The bank takes your house away within a year, you lose the normal equity you would've had, plus all those extra payments ($1,000x60=$60,000), plus now you have a foreclosure/short sale on your credit report.

2: You still have 24 years of $900/month mortgage payments to make, but you have ~$75,000 invested. You can pay the mortgage bill for 5 more years by cashing out your investments.

Which option is safer?

Quite the logical fallacy you created there with only two scenarios to lead people to the conclusion you want by limiting their options.

I paid cash for my first house when I was 28. It was the first house I've lived in, having moved into it from an apartment.

One is not merely forced to take out a mortgage and put every extra penny at risk by putting it toward the mortgage or invest in the stock market. There are other options.





Point is, there is an option 3, saving to pay cash for a house.

forummm

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My analysis above ignores the role of taxes too. Deductible mortgage interest and CG/Divs which may or may not be taxable, and as an income source may or may not affect eligibility for other income-related benefits.

MDM

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Quite the logical fallacy you created there with only two scenarios to lead people to the conclusion you want by limiting their options.

One man's "simplification by providing two reasonable examples out of an ~infinite number of possibilities" may be another's "logical fallacy"?

Some people may feel better owning their home.  Others may feel better having liquidity.  Once we get into feelings....

arebelspy

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

Is this the case in most circumstances? That explains why people are walking away from houses they bought 10 years ago. If they get the equity back, it's not too bad.

Of course it is.  The person owns the home, not the bank, despite people's stupid "you don't own your home if you have a mortgage..try not paying your mortgage and see what happens" -- the bank recovers what they are owed via their collateral, and you get the rest.

If a mortgage is at 10k on a 1MM home, and the bank forecloses, they don't keep that extra 900k+.

It's way better to sell yourself though if you aren't underwater--when it goes to auction, you'll get any surplus above what the bank is owed, but w/ the fees and transactional costs, it's better to sell it yourself.  And if you are underwater, obviously there is no equity.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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calivianya

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How exactly do you propose that a person without sufficient savings to pay off their mortgage do so?

Right. Let's see.

You have an extra $1,000/month. What do you do?

Option 1: Extra mortgage principal.
Option 2: 401k/or taxable brokerage account.

5 years later you lose your job and earning power. Let's see how the options look.

1: You still have 17 years of $900/month mortgage payments to make, but you have no money. The bank takes your house away within a year, you lose the normal equity you would've had, plus all those extra payments ($1,000x60=$60,000), plus now you have a foreclosure/short sale on your credit report.

2: You still have 24 years of $900/month mortgage payments to make, but you have ~$75,000 invested. You can pay the mortgage bill for 5 more years by cashing out your investments.

Which option is safer?
This is assuming several things - 1. the house is impossible to sell, 2. you can't find another job within a year, 3. you haven't paid off your house yet, and 4. you don't have an emergency fund. It's hard to imagine anyone could land himself in a situation that terrible without trying to.

I would say most people could at least find a minimum wage job at McDonald's within a year if nothing else. It would be tough, but I could pay my mortgage on minimum wage if I had to because I didn't buy more house than I needed. What's even better than having to pay a mortgage on minimum wage, though, is having a house you paid off in less than five years and not having a mortgage after you get laid off. That minimum wage job you just found looks pretty good because you can probably net at least $800/month on it. I think most people being reasonably frugal could live off of $800/month if their housing is paid for.

For the record, I am on track to pay off my house five years from now if I continue to throw my extra money at it, so it's not an unreasonable assumption that a house can be paid off in five years.

clifp

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One of the aspects of the mortgage vs investment debate that is often overlooked is the benefit of having a mortgage in the event of housing crash. One of the features of a mortgage is that comes with an implied put (i.e. the ability to send the bank the keys if the property goes severely underwater.  I and know arebelspy also bought houses in Vegas that somebody else paid 3 and 4 times as much in the mid 2000s. 

For example take  two people who retired to a sunny place like  Vegas ,Florida, California's Inland Empire, or Phoenix in say 2006.   One with a million and a paid ofF $250K house the other with $1,250K portfolio a 250K  house and a 200K mortgage.   By mid 2009 their portfolio had probably dropped by say 25% leaving them with $750K and  900K respectively.  But their 250K house might only be worth $75k.  The person with a mortgage could simply walk away from the mortgage via a short sell. Then turn around  buy virtually the same house for $75K using cash. They'd end up with an $825K portfolio and probably lower property taxes, and if they were smart a larger capital loss carry forward reducing their future tax bills.   This was an especially good strategy in this last recession since Congress pass a law forgiving the income tax due for loan forgiveness.

forummm

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One of the aspects of the mortgage vs investment debate that is often overlooked is the benefit of having a mortgage in the event of housing crash. One of the features of a mortgage is that comes with an implied put (i.e. the ability to send the bank the keys if the property goes severely underwater.  I and know arebelspy also bought houses in Vegas that somebody else paid 3 and 4 times as much in the mid 2000s. 

For example take  two people who retired to a sunny place like  Vegas ,Florida, California's Inland Empire, or Phoenix in say 2006.   One with a million and a paid ofF $250K house the other with $1,250K portfolio a 250K  house and a 200K mortgage.   By mid 2009 their portfolio had probably dropped by say 25% leaving them with $750K and  900K respectively.  But their 250K house might only be worth $75k.  The person with a mortgage could simply walk away from the mortgage via a short sell. Then turn around  buy virtually the same house for $75K using cash. They'd end up with an $825K portfolio and probably lower property taxes, and if they were smart a larger capital loss carry forward reducing their future tax bills.   This was an especially good strategy in this last recession since Congress pass a law forgiving the income tax due for loan forgiveness.

Kind of an unlikely scenario. You'd be buying a house by selling stocks that lost 50% of their prior value, so you'd have to have your house drop by more than 50%+equity (so minimum 60% decline) to even make a dollar on the overall transaction. So that's happened once in 80 years? And the further away you get from the mortgage inception date, the more equity you're paying in, so the drop has to be that much more severe.

And moving is a hassle. It wrecks your credit. It's also kind of skeezy.

clifp

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One of the aspects of the mortgage vs investment debate that is often overlooked is the benefit of having a mortgage in the event of housing crash. One of the features of a mortgage is that comes with an implied put (i.e. the ability to send the bank the keys if the property goes severely underwater.  I and know arebelspy also bought houses in Vegas that somebody else paid 3 and 4 times as much in the mid 2000s. 

For example take  two people who retired to a sunny place like  Vegas ,Florida, California's Inland Empire, or Phoenix in say 2006.   One with a million and a paid ofF $250K house the other with $1,250K portfolio a 250K  house and a 200K mortgage.   By mid 2009 their portfolio had probably dropped by say 25% leaving them with $750K and  900K respectively.  But their 250K house might only be worth $75k.  The person with a mortgage could simply walk away from the mortgage via a short sell. Then turn around  buy virtually the same house for $75K using cash. They'd end up with an $825K portfolio and probably lower property taxes, and if they were smart a larger capital loss carry forward reducing their future tax bills.   This was an especially good strategy in this last recession since Congress pass a law forgiving the income tax due for loan forgiveness.

Kind of an unlikely scenario. You'd be buying a house by selling stocks that lost 50% of their prior value, so you'd have to have your house drop by more than 50%+equity (so minimum 60% decline) to even make a dollar on the overall transaction. So that's happened once in 80 years? And the further away you get from the mortgage inception date, the more equity you're paying in, so the drop has to be that much more severe.

And moving is a hassle. It wrecks your credit. It's also kind of skeezy.

How do you to get to 50%?  From Jan 2006 to June 2009 (near the bottom of the Vegas housing market) VTI was down ~23% . During that same period total bond market was up almost 20% so even with 4% withdrawal, and reasonable >20% bond portfolio is going to leave you with as least as much as I suggested.  Back in 2006 mortgage rates were in the 6-6.5% range so a 200K mortgage was costing you $1200-1250/month. It seems me that spending $75K to get rid of $1200/month mortgage is well worth the hassle of moving.
Who cares about your credit rating you are retired and have limited need for credit?  The difference between a bad and good credit rating is what $100/year on your auto insurance.
As for a skeezy, I know some people think it is.  But plenty of people believe that owning tobacco, booze, mining, drug companies that use animals for testing, polluting oil companies, and baby killing defense contractors, is immoral also. I gave up trying to sort the morality of these things during the last recession.  You entered into a contract with a bank when you took a loan period.

One of the nice things about real estate is it isn't that highly correlated with stocks.  While I agree that collapse of housing prices we say in this last crisis is more than likely a once in a lifetime (let's hope) event.  Decline of local real estate in the range of 30-60% are actually pretty common.  My parent experienced one in So Cal in the early 80s, and Honolulu had one in the early 1990s before I move here.  Parts of Florida have them every generation, and I wouldn't be surprised if we see one in the Dakota in the next couple of years.  Certainly if you are working there is a high correlation between a  housing recessions and you losing your job.  So having a mortgage instead of paid off house makes it easier for you to pick up and move to where the jobs are which isn't a bad thing at all.

A mortgage provides a great deal of flexibility. If rates go up you can often invest the proceeds in CD or other safe fixed income investment with a higher rate than the mortgage. If rates go down you can refi, and finally if the house drops significantly below the value of the mortgage you can walk away.

brooklynguy

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Point is, there is an option 3, saving to pay cash for a house.

In the mortgage vs. payoff cost-benefit analysis, paying cash for a house can be thought of as equivalent to paying off a mortgage (before you even take it out).

I would say most people could at least find a minimum wage job at McDonald's within a year if nothing else. It would be tough, but I could pay my mortgage on minimum wage if I had to because I didn't buy more house than I needed. What's even better than having to pay a mortgage on minimum wage, though, is having a house you paid off in less than five years and not having a mortgage after you get laid off. That minimum wage job you just found looks pretty good because you can probably net at least $800/month on it. I think most people being reasonably frugal could live off of $800/month if their housing is paid for.

Don't forget that if you choose to invest in lieu of paying off the mortgage, you have a pile of investments (that you wouldn't have otherwise had) to service the mortgage for you.  And paying off the mortgage does not reduce the amount of income you need to cover your non-mortgage-related living expenses. 

Cheddar Stacker

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Quite the logical fallacy you created there with only two scenarios to lead people to the conclusion you want by limiting their options.

One man's "simplification by providing two reasonable examples out of an ~infinite number of possibilities" may be another's "logical fallacy"?

Some people may feel better owning their home.  Others may feel better having liquidity.  Once we get into feelings....

There are certainly infinite options. However, read the thread title again. 2 options there, and I like one better. I simply made a point that has been made on this forum 100 times, because some people think debt paydown is safer/conservative. I think it's riskeier for the reasons stated.

In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

True. It's possible to get all/most of your equity back. Maybe even likely. But people are irrational when it comes to their home.  Many will choose to stay far too long in dire straights when the better option is to cut your losses and sell. When backed into a corner by the bank there can be a substantial haircut. When a strong buyer like you sees foreclosure you know you aren't paying full price.

MDM

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There are certainly infinite options. However, read the thread title again. 2 options there, and I like one better. I simply made a point that has been made on this forum 100 times, because some people think debt paydown is safer/conservative. I think it's riskeier for the reasons stated.
Agreed.  I couldn't see a logical fallacy, but then I don't always see things the same way others do. ;)

Comar

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I am paying my mortage down but also putting some money into fund investments. Of the total sum I use probably about 2/3 goes for the mortage and 1/3 into fund investments. Like many say it is probably smarter to put your money into investing but...

Thing is I have something called an inflation-indexed housing loan:
http://www.landsbankinn.com/personal/loans/inflation-indexed-housing-loan/
http://www.investorwords.com/2428/indexed_loan.html

This type of loan is what the vast majority of people in my country have. Other types of loans were for a long time unattainable. Does anyone have experience with this type of loan?


Rural

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I am paying my mortage down but also putting some money into fund investments. Of the total sum I use probably about 2/3 goes for the mortage and 1/3 into fund investments. Like many say it is probably smarter to put your money into investing but...

Thing is I have something called an inflation-indexed housing loan:
http://www.landsbankinn.com/personal/loans/inflation-indexed-housing-loan/
http://www.investorwords.com/2428/indexed_loan.html

This type of loan is what the vast majority of people in my country have. Other types of loans were for a long time unattainable. Does anyone have experience with this type of loan?


There are several discussions like this on these board, and they are very much focused on conventional loans as they are structured in the US. Since your loan is very different, it's important to run the numbers yourself. It looks like you need to account for fees that don't apply here and an increasing interest rate.

SnackDog

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I would not be able to sleep well with a huge pile of cash locked up in a property, doing nothing.  I reckon we will always refinance to new loans (subject to favorable rates on the day), pull the capital out and put it to work in the market.  I also love the leverage one gets by investing 0-20% down, but getting 100% of the appreciation.  If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions).  Real estate and rents both go up, long term, just like the stock market.  The big real estate crash of 2008 is largely behind us and many markets are beyond 2007 highs.

forummm

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I would not be able to sleep well with a huge pile of cash locked up in a property, doing nothing.  I reckon we will always refinance to new loans (subject to favorable rates on the day), pull the capital out and put it to work in the market.  I also love the leverage one gets by investing 0-20% down, but getting 100% of the appreciation.  If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions).  Real estate and rents both go up, long term, just like the stock market.  The big real estate crash of 2008 is largely behind us and many markets are beyond 2007 highs.

Minor quibble: Investment properties usually require at least 25% down, so you might be able to buy 3 additional similar properties with your 80% equity stake in your residence.

But I find your idea somewhat appealing overall. I don't want to be a landlord. But this is making me reconsider doing it as a retirement gig.

sol

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If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions). 

This plan only works of you already have another cash cushion to live off of.  If your real estate appreciates by 20k/yr, you still need 20k of other assets to buy groceries every year until you sell and realize that profit.  I don't think it makes sense to cash-out refi every year and pay those fees.

And as I always do in these situations, I will here point out that paying off your mortgages early can sometimes provide additional benefits that holding investments does not, such as lowering your apparent income for ACA or FAFSA or EITC purposes.  This decision requires that you tally up all the costs and benefits, including those tax issues, rather than just comparing interest rates as if they were equivalent investments.

brooklynguy

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If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions). 

This plan only works of you already have another cash cushion to live off of.  If your real estate appreciates by 20k/yr, you still need 20k of other assets to buy groceries every year until you sell and realize that profit.  I don't think it makes sense to cash-out refi every year and pay those fees.

The alternative in SnackDog's scenario was leaving those proceeds as trapped equity in a paid-off house, so you necessarily already have another source of funds to live off of.

Quote
And as I always do in these situations, I will here point out that paying off your mortgages early can sometimes provide additional benefits that holding investments does not, such as lowering your apparent income for ACA or FAFSA or EITC purposes.

It is definitely worth factoring in this factor along with all the other costs and benefits when running the numbers, but, as I always do when this point gets brought up, I will point out that people should not fall into the trap of assuming that paying off a mortgage and eliminating monthly mortgage payments necessarily results in a dollar-for-dollar decrease in the income required to sustain your total living expenses and, generally speaking, when the math favors retaining a mortgage absent this consideration, it usually still favors retaining a mortgage after factoring in this consideration.  For anyone reading along who wants more detail, I think the best thread on this particular subtopic is sol's own "to pay off or not to pay off" mortgage thread.

K-ice

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I like to pay off the mtg on the primary residence for the warm fuzzy feeling.

But what are your strategies on rental properties?
I think this should tip the scale to slow and invest but I still need convincing.

I have 15y remaining on a rental.  I am considering refinancing for 25y and investing the difference.
Option A pay slow 25y and invest the difference
Option B pay fast 15y then invest all the equivalent mortgage payment for 10y once it is paid off.

Starting point. Owe 325K assume 3% mtg locked in for 5 years
A)   I will owe 278K in 5 years at 25y rate
B)   I will owe 233K in 5 years at 15 y rate
Difference is 45K (This makes the fast 15y payoff look more attractive)

But I am not just going to go on holidays with the extra money every month.
Invest the difference in payments quarterly ($2110) at 7% and I will have 50K in 5 years
Over a 5 year period, when I will re-evaluate, I am not sure the 5K difference is worth it.  Also, no one can guarantee 7% ROI.

But looking longer term
Over 25years I would have:
A)   563K if I go slow & invest the difference
B)   385K if I pay off in 15 y then invest my payment for 10 more years.   

This long term 268K difference is significant but so much is unknown 5-25 years from now. Again the 7% ROI is not a sure thing.  But maybe  I just need a kick in the butt to get started. 
Another perk for Option A is that I can deduct more interest from my rental income tax.


brooklynguy

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assume 3% mtg locked in for 5 years

All the leveraged-investing-via-mortgage advocacy you see on these boards assumes the debt is both long-term and fixed-rate.  Without both of these components, keeping a low-rate mortgage becomes much less of a slam dunk argument.

MDM

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All the leveraged-investing-via-mortgage advocacy you see on these boards assumes the debt is both long-term and fixed-rate

...which, for those who don't realize it, happens to be the norm for mortgages in the USA.  E.g., I didn't know about the Canadian norm until ~a year ago - and that was due to discussions here.

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All the leveraged-investing-via-mortgage advocacy you see on these boards assumes the debt is both long-term and fixed-rate.  Without both of these components, keeping a low-rate mortgage becomes much less of a slam dunk argument.

Yep. I am a Canadian. "One of the most common sources of confusion .... is the difference between a mortgage term and amortization period. A typical mortgage in Canada has a 5-year term with a 25-year amortization period." 
http://www.ratehub.ca/mortgage-term-vs-amortization


Hence the dillema, and why I am looking at the 5 year mark as well as long term.

When my BFF got a 30y locked in rate in NY I was like WHAT?


But I am telling myself with the 25y plan and investing I could slap down that 50K if needed 5y from now if the rates go up.

Do Canadians strugle more with this than Americans? 

We also can't tax deduct the interest on a primary res. mtg.  (unless you have a home based business, even then likely 10-20%.)  So I think Canadians may be more inclined to pay down the mtg than American's.




Cathy

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Do Canadians strugle more with this than Americans?

[...]

We also can't tax deduct the interest on a primary res. mtg.  (unless you have a home based business, even then likely 10-20%.)  So I think Canadians may be more inclined to pay down the mtg than American's.

There is no law that prevents a "Canadian" from obtaining a mortgage loan in the USA. Under federal law, it is unlawful for any person "or other entity" in the business of providing mortgage loans to discriminate in the provision of such loans on the basis of, among other things, "national origin": 42 USC 3605(a). Although this statute does not strictly include citizenship, state laws may be broader. Cal. Civ. Code 51(b) prohibits all arbitrary discrimination by "all business establishments of every kind whatsoever". The federal tax statute that authorises an interest deduction makes no special dispensation based on citizenship or residency: 26 USC 163. There is also no requirement that the qualified residence securing the mortgage loan be located in the USA in order for the interest thereon to be deductible: 26 USC 163(4)(A). Finally, under the Constitution of Canada, every citizen of Canada has "the right to ... leave Canada": Charter, 6(1). In conclusion, citizenship is not as relevant to the mortgage loan prepayment question as the quoted post suggests.
« Last Edit: July 20, 2015, 07:37:08 PM by Cathy »

forummm

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Do Canadians strugle more with this than Americans?

[...]

We also can't tax deduct the interest on a primary res. mtg.  (unless you have a home based business, even then likely 10-20%.)  So I think Canadians may be more inclined to pay down the mtg than American's.

There is no law that prevents a "Canadian" from obtaining a mortgage loan in the USA. Under federal law, it is unlawful for any person "or other entity" in the business of providing mortgage loans to discriminate in the provision of such loans on the basis of, among other things, "national origin": 42 USC 3605(a). Although this statute does not strictly include citizenship, state laws may be broader. Cal. Civ. Code 51(b) prohibits all arbitrary discrimination by "all business establishments of every kind whatsoever". The federal tax statute that authorises an interest deduction makes no special dispensation based on citizenship or residency: 26 USC 163. There is also no requirement that the qualified residence securing the mortgage loan be located in the USA in order for the interest thereon to be deductible: 26 USC 163(4)(A). Finally, under the Constitution of Canada, every citizen of Canada has "the right to ... leave Canada": Charter, 6(1). In conclusion, citizenship is not as relevant to the mortgage loan prepayment question as the quoted post suggests.

Whether it's illegal for a US bank to provide a loan to someone of Canadian nationality is one thing. Whether a US bank is willing to make a mortgage loan on a house in Canada. There are many policies in the US that make the 30-year fixed-rate loan on US single family homes attractive to US banks. My guess is that those policies are not as favorable when the property is located in a foreign country. It probably does not have the same federal guarantee/Fannie Mae/Freddie Mac system. As such there may not be an as attractive business case for the bank as with a piece of US real estate.

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

Good point, but Cheddar Stacker's warning is still valid.  Paying down the mortgage is not risk free.  You can, and lots of people have, lost money doing just that. 

Just from a top down standpoint, how much sense does it make to have a large portion of your net worth in an illiquid, slowly (if at all) appreciating asset?  If it was anything but a house people would say you are nuts for even thinking about it. 

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In the event of a foreclosure, you don't lose your equity. The amount you get back will be subpar due to fees and transaction costs versus selling it traditionally, but the bank doesn't just get to keep that equity.

Good point, but Cheddar Stacker's warning is still valid.  Paying down the mortgage is not risk free.  You can, and lots of people have, lost money doing just that. 

Just from a top down standpoint, how much sense does it make to have a large portion of your net worth in an illiquid, slowly (if at all) appreciating asset?  If it was anything but a house people would say you are nuts for even thinking about it.

You're preaching to the choir there Telecaster. Arebelspy wasn't trying to convince people to pay down the mortgage, he was simply clarifying correcting a statement I made that was grossly inaccurate. It needed to be said.

He is one of the biggest advocates around here for carrying a mortgage.

If you have a couple hours to fill, here's some proof. Good information in this link for those who haven't taken the time yet.
http://radicalpersonalfinance.com/early-retirement-faqs-should-i-pay-off-debt-first-or-should-i-invest-an-interview-with-joe-aka-arebelspy-rpf0095/

arebelspy

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Thanks Cheddar.  There's definitely some big drawbacks to paying down your mortgage.

Especially for those arguing it's "safer" if you lose your job--I'd definitely prefer the liquidity, myself.

I was just trying to correct that common misnomer.  Thanks for clarifying my position CS.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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Monkey Uncle

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I'll start with the disclaimer that I haven't read the entire thread.  So, pardon me if I'm covering already plowed ground.  But I thought I'd share the results of running my own situation through cFiresim.

$95k left on mortgage principal, about 12 years left on term
Interest rate 3 1/8%
Annual P+I = 9,346
Projected FIRE date = 1/1/19
current stash = 512k
Annual expenses with mortgage = 45k
Reduced expenses at payoff by entering a negative recurring expenditure
I included SS and pension benefits, as well as continued annual saving until FIRE date

Keeping the mortgage, my success rate is 97%.  Paying off the mortgage, success rate is 100%.  Not much difference, but I was flabbergasted that the probability actually went up under the payoff scenario.  So I tried a scenario that had me FIREing 1/1/16.  That difference was even bigger, with a 58% success keeping the mortgage vs. 67% paying it off.  Obviously I wouldn't FIRE at those probabilities, but the big difference was amazing to me.

EDIT:  Two things I didn't consider in this scenario:

1) Capital gains taxes that I'd have to pay on the investments I liquidate to pay off the mortgage.  I'd have to dig into it to see if I could strategically sell under-appreciated assets to limit the impact.

2) In the 2019 FIRE scenario, I didn't increase my savings during the last 3 1/2 working years to reflect the lack of a mortgage payment.  My guess is this would outweigh the capital gains taxes.

If I have some time this weekend, I might try to incorporate those two items.
« Last Edit: July 25, 2015, 05:47:34 AM by Monkey Uncle »

brooklynguy

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Reduced expenses at payoff by entering a negative recurring expenditure

In your cFIREsim simulations, did you account for the fact that your remaining mortgage payments will not rise with inflation?  Take a look at post # 25 (and the posts linked to in that post) for the cFIREsim methodology I like to use for these types of comparisons.  And also see the notes in those posts for why cFIREsim generally understates the success rate of retaining a mortgage (because, I think, it assumes withdrawing an entire year's worth of spending at the beginning of each year, rather than withdrawals that line up with a mortgage's amortization schedule).

Quote
EDIT:  Two things I didn't consider in this scenario

Don't forget to also include the benefit of deductibility of mortgage interest, if (and for so long as) you are able to utilize that benefit.

In any event, with only 12 remaining years to maturity, I wouldn't expect retaining the mortgage to provide that much benefit.  You should try running the numbers on the option of refinancing into a new 30 year mortgage.

Monkey Uncle

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Reduced expenses at payoff by entering a negative recurring expenditure

In your cFIREsim simulations, did you account for the fact that your remaining mortgage payments will not rise with inflation?  Take a look at post # 25 (and the posts linked to in that post) for the cFIREsim methodology I like to use for these types of comparisons.  And also see the notes in those posts for why cFIREsim generally understates the success rate of retaining a mortgage (because, I think, it assumes withdrawing an entire year's worth of spending at the beginning of each year, rather than withdrawals that line up with a mortgage's amortization schedule).

Quote
EDIT:  Two things I didn't consider in this scenario

Don't forget to also include the benefit of deductibility of mortgage interest, if (and for so long as) you are able to utilize that benefit.

In any event, with only 12 remaining years to maturity, I wouldn't expect retaining the mortgage to provide that much benefit.  You should try running the numbers on the option of refinancing into a new 30 year mortgage.

Yeah, I didn't think about the mortgage payments not rising with inflation.  That's a pretty easy fix in cFiresim.  The tax issues are going to be a bear to figure out, though.  I've got some number crunching to do to update my basis calculations, then I'll have to run a taxcaster simulation to see how the capital gains and the loss of the mortgage deduction work out.  Mortgage interest is declining every year as I get closer to the end of the term, so I'll have to dig into the amortization schedule to project that out for the next twelve years.  But no way am I considering refinancing for 30 years at this point in my life, so I'm not going to bother running those numbers.

I doubt that the yearly lump-sum withdrawal in cFiresim has that much impact.  That's probably closer to how I'll work my actual withdrawals than assuming the money is coming out on a monthly basis to match the mortgage payment schedule.  I doubt I would pull money out more often than quarterly.

We'll see how the adjusted numbers work out, but I'm thinking there's more going on here than just inaccuracies in the inputs.  When I look at the output graphs, all of the failure trajectories in the "keep mortgage" scenario began during the 1960s.  This suggests to me that having that mortgage payment for the first 9 years or so of the draw-down period increases sequence of return risk.  The final years of the mortgage coincide with the time period before SS and pension have fully kicked in.  So the portfolio is really getting hit hard for those first 9 years.  Having those years occur right before a falling/stagnant market is a recipe for failure. Those trajectories failed before the bull market of the '80s-90's ever got going.

But now I'm just speculating.  Gotta go run the corrected numbers.

JustGettingStarted1980

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I would not be able to sleep well with a huge pile of cash locked up in a property, doing nothing.  I reckon we will always refinance to new loans (subject to favorable rates on the day), pull the capital out and put it to work in the market.  I also love the leverage one gets by investing 0-20% down, but getting 100% of the appreciation.  If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions).  Real estate and rents both go up, long term, just like the stock market.  The big real estate crash of 2008 is largely behind us and many markets are beyond 2007 highs.


How is the above different than buying stocks on margin? Using options? I don't think many people in this forum would advocate for those techniques with their primary nest egg (as Arbelepsy says above, it may be different if you have extensive cash reserves on the side and are willing to take on more risk).

ender

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The "ideal" mortgage situation is to refinance any existing mortgage into a 30-year, low interest rate mortgage immediately prior to FIRE.

If you can't do this, run cFIREsim based on your current scenario. If your remaining mortgage term is short enough (which btw should be nearly no one in the USA right now since rates are so low, nearly everyone likely has refinanced into 15+ year mortgages) you can gain increased success rates by paying it off immediately on FIRE.

« Last Edit: July 26, 2015, 02:59:46 PM by ender »

Monkey Uncle

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The "ideal" mortgage situation is to refinance into a 30-year, low interest rate mortgage immediately prior to FIRE.

That's playing with FIRE, in my humble opinion (pun intended).  If things go bad and you need to cut expenses, you've got a big fixed expense that you can't cut, unless you want to be homeless or raid your portfolio to pay it off.

forummm

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The "ideal" mortgage situation is to refinance into a 30-year, low interest rate mortgage immediately prior to FIRE.

That's playing with FIRE, in my humble opinion (pun intended).  If things go bad and you need to cut expenses, you've got a big fixed expense that you can't cut, unless you want to be homeless or raid your portfolio to pay it off.

You're raiding just the portion that you cashed out. In my post (#57) above I showed the relationship between this strategy and interest rates and success/failures. If the fixed interest rate is low enough, it's very rare that you end up worse off after the 30 years are up.

http://forum.mrmoneymustache.com/real-estate-and-landlording/the-great-'pay-off-mortage'-vs-'invest-in-stocks'-debate-possible-solution/msg736365/#msg736365

ender

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The "ideal" mortgage situation is to refinance into a 30-year, low interest rate mortgage immediately prior to FIRE.

That's playing with FIRE, in my humble opinion (pun intended).  If things go bad and you need to cut expenses, you've got a big fixed expense that you can't cut, unless you want to be homeless or raid your portfolio to pay it off.

If your expectation is that the long term market success during the time you pay the mortgage is a higher combined return rate than your mortgage (which due to low rates is at most 4% right now for 30 years) then you should not pay it off.

If you believe in FIRE as a workable possibility (or believe in the 4% SWR idea) based on market returns then you nearly have to believe the long-term success of the market will be higher than the current mortgage rates.

However, the "edge" condition is that if your mortgage term is short and/or your rate is high, you may not have that expectation. For example if you imagine you have 5 years remaining at 5% - if the market returns less than 5%/year then you would have been better off paying this off early. Keep in mind this is again not what you expect, it's just the market has a lot of volatility and that scenario is entirely possible.

Also play with cFIREsim some and you will see the impact, historically at least, of these scenarios.
« Last Edit: July 26, 2015, 03:00:03 PM by ender »

Monkey Uncle

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Reduced expenses at payoff by entering a negative recurring expenditure

In your cFIREsim simulations, did you account for the fact that your remaining mortgage payments will not rise with inflation?  Take a look at post # 25 (and the posts linked to in that post) for the cFIREsim methodology I like to use for these types of comparisons.  And also see the notes in those posts for why cFIREsim generally understates the success rate of retaining a mortgage (because, I think, it assumes withdrawing an entire year's worth of spending at the beginning of each year, rather than withdrawals that line up with a mortgage's amortization schedule).

Quote
EDIT:  Two things I didn't consider in this scenario

Don't forget to also include the benefit of deductibility of mortgage interest, if (and for so long as) you are able to utilize that benefit.

In any event, with only 12 remaining years to maturity, I wouldn't expect retaining the mortgage to provide that much benefit.  You should try running the numbers on the option of refinancing into a new 30 year mortgage.

Yeah, I didn't think about the mortgage payments not rising with inflation.  That's a pretty easy fix in cFiresim.  The tax issues are going to be a bear to figure out, though.  I've got some number crunching to do to update my basis calculations, then I'll have to run a taxcaster simulation to see how the capital gains and the loss of the mortgage deduction work out.  Mortgage interest is declining every year as I get closer to the end of the term, so I'll have to dig into the amortization schedule to project that out for the next twelve years.  But no way am I considering refinancing for 30 years at this point in my life, so I'm not going to bother running those numbers.

I doubt that the yearly lump-sum withdrawal in cFiresim has that much impact.  That's probably closer to how I'll work my actual withdrawals than assuming the money is coming out on a monthly basis to match the mortgage payment schedule.  I doubt I would pull money out more often than quarterly.

We'll see how the adjusted numbers work out, but I'm thinking there's more going on here than just inaccuracies in the inputs.  When I look at the output graphs, all of the failure trajectories in the "keep mortgage" scenario began during the 1960s.  This suggests to me that having that mortgage payment for the first 9 years or so of the draw-down period increases sequence of return risk.  The final years of the mortgage coincide with the time period before SS and pension have fully kicked in.  So the portfolio is really getting hit hard for those first 9 years.  Having those years occur right before a falling/stagnant market is a recipe for failure. Those trajectories failed before the bull market of the '80s-90's ever got going.

But now I'm just speculating.  Gotta go run the corrected numbers.

I re-ran all the numbers for my realistic situation (FIREing 1/1/19) and...it's a wash.  Taking the inflation adjustment out of my mortgage payment was enough to boost the "keep mortgage" scenario to 100% probability of success.  And the "pay off mortgage" scenario is also still 100%.  In my situation, the capital gains taxes on the payoff money pulled from my portfolio would be minimal ($367, according to taxcaster).  And there is no mortgage deduction to lose, as I have been taking the standard deduction for two decades (duh..should have realized that before).  The only semi-interesting result left is that the "pay off mortgage" scenario reduces the severity of the lowest dips by a few 10s of thousands of dollars.  So there is some mitigation of sequence of return risk, but it does not appear to be substantial.  The average ending portfolio value is a little higher for the "keep mortgage" scenario (3.7MM vs. 3.4MM).

ETBen

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Would it make sense to calculate your intended retirement year and make extra payments based on that?  So you retire with no mortgage.  Put anything leftover into investing.  Assuming you have the means and years left to still invest some amount.

When you retire, your fixed expenses will be less.

Although, I suppose you could invest it all, then sell and retire some place cheaper to lower your fixed expenses.  So I guess it still comes down to looking at your future scenarios and expenses to calculate the best option. 

Monkey Uncle

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The "ideal" mortgage situation is to refinance into a 30-year, low interest rate mortgage immediately prior to FIRE.

That's playing with FIRE, in my humble opinion (pun intended).  If things go bad and you need to cut expenses, you've got a big fixed expense that you can't cut, unless you want to be homeless or raid your portfolio to pay it off.

You're raiding just the portion that you cashed out. In my post (#57) above I showed the relationship between this strategy and interest rates and success/failures. If the fixed interest rate is low enough, it's very rare that you end up worse off after the 30 years are up.

http://forum.mrmoneymustache.com/real-estate-and-landlording/the-great-'pay-off-mortage'-vs-'invest-in-stocks'-debate-possible-solution/msg736365/#msg736365

Assuming you are FI without mortgaging your house to boost the size of your stock portfolio, then, yes, no harm, no foul.  You're just using the leverage to make even more money, assuming average returns prevail.  However, Ender's post could be interpreted as advocating using your home equity to take out a margin loan to boost your stock portfolio so that you appear to be FI.  In that case, if the market goes down the crapper, you're in deep shit.

I may be putting words in Enders mouth here, and if so, I'm happy to be corrected.  But taken at face value, the post could be seen as advocating leveraging up to expedite FI.

ender

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Assuming you are FI without mortgaging your house to boost the size of your stock portfolio, then, yes, no harm, no foul.  You're just using the leverage to make even more money, assuming average returns prevail.  However, Ender's post could be interpreted as advocating using your home equity to take out a margin loan to boost your stock portfolio so that you appear to be FI.  In that case, if the market goes down the crapper, you're in deep shit.

I may be putting words in Enders mouth here, and if so, I'm happy to be corrected.  But taken at face value, the post could be seen as advocating leveraging up to expedite FI.

I'm saying if you have an existing mortgage you should refinance your existing loan (which would reduce your monthly housing expenses), not take out a margin loan.


Monkey Uncle

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If your expectation is that the long term market success during the time you pay the mortgage is a higher combined return rate than your mortgage (which due to low rates is at most 4% right now for 30 years) then you should not pay it off.

If you believe in FIRE as a workable possibility (or believe in the 4% SWR idea) based on market returns then you nearly have to believe the long-term success of the market will be higher than the current mortgage rates.

However, the "edge" condition is that if your mortgage term is short and/or your rate is high, you may not have that expectation. For example if you imagine you have 5 years remaining at 5% - if the market returns less than 5%/year then you would have been better off paying this off early. Keep in mind this is again not what you expect, it's just the market has a lot of volatility and that scenario is entirely possible.

Also play with cFIREsim[/ur] some and you will see the impact, historically at least, of these scenarios.

I'm not arguing against any of those points for people who are holding typical first mortgages on their homes.  But your post seemed to be advocating taking out a new 30 year mortgage on a primary residence for the purpose of generating capital to invest in stocks.  If that is indeed what you meant, I believe that is an extremely risky proposition, especially if that capital is used to create the appearance of a portfolio that is large enough to support FIRE.  If that is not what you meant, please clarify.

Monkey Uncle

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Sorry - didn't see your preceding post - thanks for clarifying.

forummm

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The "ideal" mortgage situation is to refinance into a 30-year, low interest rate mortgage immediately prior to FIRE.

That's playing with FIRE, in my humble opinion (pun intended).  If things go bad and you need to cut expenses, you've got a big fixed expense that you can't cut, unless you want to be homeless or raid your portfolio to pay it off.

You're raiding just the portion that you cashed out. In my post (#57) above I showed the relationship between this strategy and interest rates and success/failures. If the fixed interest rate is low enough, it's very rare that you end up worse off after the 30 years are up.

http://forum.mrmoneymustache.com/real-estate-and-landlording/the-great-'pay-off-mortage'-vs-'invest-in-stocks'-debate-possible-solution/msg736365/#msg736365

Assuming you are FI without mortgaging your house to boost the size of your stock portfolio, then, yes, no harm, no foul.  You're just using the leverage to make even more money, assuming average returns prevail.  However, Ender's post could be interpreted as advocating using your home equity to take out a margin loan to boost your stock portfolio so that you appear to be FI.  In that case, if the market goes down the crapper, you're in deep shit.

I may be putting words in Enders mouth here, and if so, I'm happy to be corrected.  But taken at face value, the post could be seen as advocating leveraging up to expedite FI.

Yes, I would only do this if I was FI without mortgaging my house. Because otherwise I wouldn't be FI at all (by my definition).

brooklynguy

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I would not be able to sleep well with a huge pile of cash locked up in a property, doing nothing.  I reckon we will always refinance to new loans (subject to favorable rates on the day), pull the capital out and put it to work in the market.  I also love the leverage one gets by investing 0-20% down, but getting 100% of the appreciation.  If you had a paid-off house and like real estate more than stocks, you could take out 80% and buy four more similar homes, rent them out for a profit (subject to market conditions), and pocket 100% of the market gains when you sold them (again subject to market conditions).  Real estate and rents both go up, long term, just like the stock market.  The big real estate crash of 2008 is largely behind us and many markets are beyond 2007 highs.

How is the above different than buying stocks on margin? Using options? I don't think many people in this forum would advocate for those techniques with their primary nest egg (as Arbelepsy says above, it may be different if you have extensive cash reserves on the side and are willing to take on more risk).

The difference is that this form of "margin debt" is low-rate, fixed-rate, long-term, and not mandatorily prepayable as a result of fluctuations in the value of your investments (or for any other reason, absent sale of the property).

We'll see how the adjusted numbers work out, but I'm thinking there's more going on here than just inaccuracies in the inputs.  When I look at the output graphs, all of the failure trajectories in the "keep mortgage" scenario began during the 1960s.  This suggests to me that having that mortgage payment for the first 9 years or so of the draw-down period increases sequence of return risk.  The final years of the mortgage coincide with the time period before SS and pension have fully kicked in.  So the portfolio is really getting hit hard for those first 9 years.  Having those years occur right before a falling/stagnant market is a recipe for failure. Those trajectories failed before the bull market of the '80s-90's ever got going.

Yeah, well, if investment returns are low enough or you get a bad enough sequence of returns, you will be worse off if you're leveraged.  But with a low enough mortgage rate and a long enough remaining life to maturity, the historical odds of coming out ahead can be significantly higher than the historical success rate associated with the standard 4% SWR plan that many people around here are comfortable retiring on.  It all depends on how aggressive you want to get -- leveraged-investing-via-mortgage can allow you to speed up your time to FIRE (or have money in retirement) with the same or better historical odds of success.  That is probably what you would see if you ran the numbers in your scenario for refinancing into a 30 year mortgage.  And leveraged-investing-via-mortgage mitigates other risks that are equally important, like inflation risk.

But your post seemed to be advocating taking out a new 30 year mortgage on a primary residence for the purpose of generating capital to invest in stocks.  If that is indeed what you meant, I believe that is an extremely risky proposition, especially if that capital is used to create the appearance of a portfolio that is large enough to support FIRE.

How is taking out a new 30 year mortgage for the purpose of generating capital to invest in stocks any different than choosing not to prepay an existing mortgage when you have the funds to do so but instead leave them invested in the stock market?  (I do agree with your secondary point that you should not ignore your liabilities when evaluating your net worth in order to determine whether or not you are FI, but that's a separate issue.)