Author Topic: DONT Payoff your Mortgage Club  (Read 358135 times)

AlexMar

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Re: DONT Payoff your Mortgage Club
« Reply #1000 on: December 23, 2018, 07:33:02 PM »
With the standard deduction being so high, the tax breaks on mortgage interest is probably irrelevant to most people here.

"putting it into the market and building a diversified portfolio is the way to go."

So the author thinks "diversified" means having all of your money in the stock market?  To this day I don't really know anyone who says "Gosh, I sure wish my house wasn't paid off" nor do I know anyone taking out huge equity lines on their homes to throw it all in to the stock market.


I think the Motley Fool author has Captain Hindsight syndrome.  Though they do admit the stock market will "likely" have better returns....  Compared to your guaranteed return on your mortgage.

Dicey

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Re: DONT Payoff your Mortgage Club
« Reply #1001 on: December 24, 2018, 12:10:02 AM »
With the standard deduction being so high, the tax breaks on mortgage interest is probably irrelevant to most people here.

"putting it into the market and building a diversified portfolio is the way to go."

So the author thinks "diversified" means having all of your money in the stock market?  To this day I don't really know anyone who says "Gosh, I sure wish my house wasn't paid off" nor do I know anyone taking out huge equity lines on their homes to throw it all in to the stock market.


I think the Motley Fool author has Captain Hindsight syndrome.  Though they do admit the stock market will "likely" have better returns....  Compared to your guaranteed return on your mortgage.
Thanks for sharing your insights, @AlexMar.

Not quite sure how you concluded that the author's recommendation of a diversified portfolio means having all your money in the stock market. Diversified means, well, diversified.

And yes, yes, you have "met" someone who wishes she had a pre-December 15, 2017 mortgage. [Insert big sigh here.]

This article was deliberately posted on the "Don't..." thread. If you have another opinion, there's a more appropriate place for it. If we can't go there to discuss this concept, then sorry, you can't naysay it here. FWIW, no one is forcing anyone to do anything. Rather, we are open to learning all the angles so as to make the most informed decision possible. Because the goal is to reach FIRE as expediently as possible.

If you come, learn, and chose to do something different, that is your decision, but at least you will be fully informed, which is the Mustachian way. But you don't to get to stay here and attempt to dissuade others, you have to go to the other side. Kinda sucks, but that's what the mods asked us to do. We're abiding by their request and we will be mighty obliged if the folks with other opinions will kindly do the same.


nereo

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Re: DONT Payoff your Mortgage Club
« Reply #1002 on: December 24, 2018, 10:02:49 AM »
Quote
So the author thinks "diversified" means having all of your money in the stock market?  To this day I don't really know anyone who says "Gosh, I sure wish my house wasn't paid off" nor do I know anyone taking out huge equity lines on their homes to throw it all in to the stock market.

Among the financially affluent, I think these people are more common than you realize. My parents like to joke that they are 40 years into their 30 year mortgage, nad they Ďonlyí have another 12 to go.  Refinancing a home to pull out equity is a rather common strategy - unfortunately itís gotten a bad rap lately when countless spends-pants consumers used the equity in their homes unintellegently, like for exotic vacations or installing a pool instead of increasing their wealth.  Ultimately thatís what refinancing is - transferring equity from one asset class into another.  In this case itís pulling it from a rather illiquid asset with an historically low rate of return into something else.  If that something else allows for something like increased contributions into oneís 401(k) itís likely a smart move.  If itís to buy a luxury SUV, thatís not so intelligent use of money.

Finally, a key reason why you donít hear a lot of people say ďgosh, i wish I had never paid down my houseĒ  or hear people talking about using tons of equity to throw it all into the market iis because these people never let it get to that point.  Theyíve realized they can carry a mortgage for decades, and allow inflation to eat away at their payments while bulking up the rest of their financial buckets. Itís been an intentional, gradual process where each month they chose saving and investing more over reducing manageable low-interest debt.  Some - like my parents - carry their mortgages deep into retirement, and by that point their Principle and Interest payments pale in comparison to Taxes and Insurance (which never go away).

Dicey

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Re: DONT Payoff your Mortgage Club
« Reply #1003 on: December 24, 2018, 11:40:52 AM »
Quote
So the author thinks "diversified" means having all of your money in the stock market?  To this day I don't really know anyone who says "Gosh, I sure wish my house wasn't paid off" nor do I know anyone taking out huge equity lines on their homes to throw it all in to the stock market.

Among the financially affluent, I think these people are more common than you realize. My parents like to joke that they are 40 years into their 30 year mortgage, nad they Ďonlyí have another 12 to go.  Refinancing a home to pull out equity is a rather common strategy - unfortunately itís gotten a bad rap lately when countless spends-pants consumers used the equity in their homes unintellegently, like for exotic vacations or installing a pool instead of increasing their wealth.  Ultimately thatís what refinancing is - transferring equity from one asset class into another.  In this case itís pulling it from a rather illiquid asset with an historically low rate of return into something else.  If that something else allows for something like increased contributions into oneís 401(k) itís likely a smart move.  If itís to buy a luxury SUV, thatís not so intelligent use of money.

Finally, a key reason why you donít hear a lot of people say ďgosh, i wish I had never paid down my houseĒ  or hear people talking about using tons of equity to throw it all into the market iis because these people never let it get to that point.  Theyíve realized they can carry a mortgage for decades, and allow inflation to eat away at their payments while bulking up the rest of their financial buckets. Itís been an intentional, gradual process where each month they chose saving and investing more over reducing manageable low-interest debt.  Some - like my parents - carry their mortgages deep into retirement, and by that point their Principle and Interest payments pale in comparison to Taxes and Insurance (which never go away).
OMG - You've triggered a memory, nereo. I can hear (and see in my mind) exactly where we were standing in my parent's house when my dad was griping about how much their utility bills were. Even then, my smart-ass self told him he was lucky to be facing such a "big" problem. My taxes for a month were more than he paid in a year, and after 30+ years, they had no mortgage, so the utilities loomed large in comparison. It was a pretty funny conversation.

Which reminds me of another vignette, years later, with my mom. They had a new (paid-for) house in a Senior Community, a late model paid-cash-for Camry, no debt and a government pension, with incredible healthcare, plus SS for both. She was worrying about money, so I went through the finance dance with her and reviewed their numbers. I said, "You do realize that you have children who work full-time who don't earn this much?" She looked me straight in the eye and said, "Yes, but we can't go out and earn more." OMG, mom, you don't need to! In fact, after I backed out my HCOLA mortgage payment, they were netting more that I was. Scarcity mindset is real, especially for seniors.

Awesome that your parents set such a good example @nereo!

TomTX

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Re: DONT Payoff your Mortgage Club
« Reply #1004 on: December 24, 2018, 12:33:12 PM »
So the author thinks "diversified" means having all of your money in the stock market?  To this day I don't really know anyone who says "Gosh, I sure wish my house wasn't paid off" nor do I know anyone taking out huge equity lines on their homes to throw it all in to the stock market.

With the recent market dip, we are seriously discussing a cashout refi to put more into the stock market and to reset to a 30 year fixed rate mortgage. Tentative trigger is 40% drop. Consider it "rebalancing asset classes" if you like.

Any good tips on lenders to shop? Have top Preferred Rewards status with BoA, which saves a bit on their closing costs.

Telecaster

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Re: DONT Payoff your Mortgage Club
« Reply #1005 on: December 24, 2018, 01:10:14 PM »

I think the Motley Fool author has Captain Hindsight syndrome.  Though they do admit the stock market will "likely" have better returns....  Compared to your guaranteed return on your mortgage.

Imagine an investment where you don't see the returns for 10-20 years.   Oh, and the rate of return is only a point or so above the current inflation rate.  In you were trying to sell people on such an investment they would say you were barking mad.   

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1006 on: December 25, 2018, 04:32:07 PM »
In a perfect world, I would be posting this elsewhere on this forum, but the mods have spoken, so here I am, sharing these golden eggs with the enlightened. At least it's good confirmation. Feel free to share it far and wide, if you find a place that seems appropriate and not inflammatory. After all, the people celebrating their payoffs don't want to hear from the Debbie Downers like us, lol.

I'll be the Debbie Downer here, at least as far as #3 goes (others have touched on the few Mustachians qualifying for the mortgage deduction these days).

(Though I sense I might offend sensibilities here, this isn't a post telling people to pay off their mortgage. I just want everyone to have the right information to make the properly informed decision.)


3. Inflation offsets savings in interest

Despite the fact you can earn better returns by investing than by paying off your mortgage early, some people still prefer to prepay their mortgage. This may be because of an aversion to debt, or a belief it's better to get the guaranteed return that comes from mortgage prepayment, since there's no guarantee invested money will grow.

The problem is, you need to factor in inflation when deciding if this strategy makes sense. Due to inflation, your mortgage effectively becomes cheaper to pay over time since the value of your money erodes but your mortgage payment stays the same (assuming you have a fixed-rate loan). If you have a monthly payment of $1,500 today, in 25 years, the $1,500 you'll pay toward your mortgage would be the equivalent of around $942 of today's dollars -- assuming inflation of 2% annually.

Since your mortgage payment is continually getting cheaper over time, it seldom makes sense to prepay it. Don't forget that all the interest savings you net from paying off the mortgage early are also reduced by inflation, making this even less of a good deal over time. If you save around $80,000 in interest by paying off a $300,000 4.5% mortgage in 21.5 years instead of 30 years, you've actually saved less than $50,000 when accounting for the fact you don't benefit from the interest savings for more than two decades.


Inflation with regards to mortgages is a huge red herring for Mustachians. (Inflation may pay a role if you're living paycheck to paycheck, where the reduced inflation-adjusted mortgage payment may result in transitioning from high-cost debt to investment savings or to allow for more tax-deferred savings.) If you're already maxing all tax-advantaged accounts, inflation is irrelevant*.

A mortgage is a debt instrument. And it happens to be amortized, though it could have been structured as a percentage of the debt that covers interest and some of the principle (or in any other matter). This has nothing to do with inflation. In fact, a debt instrument could be structured to increase with some pre-calculated inflation rate (say, 2%), and still the amount you pay would be the same (whatever the interest rate is). In fact, from a long-term investment strategy, an inflation-adjusted amortization schedule would be the ideal approach since you can invest more money early in the accumulation phase (note that the time horizon here is relevant, not the inflation rate).

Generally speaking, inflation is irrelevant when comparing your investment and debt alternatives. If you have doubts, use a spreadsheet to compare paying off a mortgage (at say, 5%) with investing in a fixed income instrument at the same interest rate (feel free to use any inflation rate). The outcome will be identical.

I know I'm going to get blow-back on this, but I think this is one of the huge myths a lot of people cling to to not pay off their mortgage. If there is something I'm not properly considering, I'd love to be corrected otherwise.

*The obvious exception would be if you're considering investing in TIPS.

p.s. Merry Season of Family Gathering.

YttriumNitrate

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Re: DONT Payoff your Mortgage Club
« Reply #1007 on: December 25, 2018, 04:49:26 PM »
With interest rates continuing to rise, sometime in 2019 we could see risk-free FDIC insured savings accounts offering interest rates that are equivalent to the mortgage rates that many of us are paying. I'm looking forward to see how that changes the tone of the "should I pay off my mortgage" debate. I'm guessing the pay-off your mortgage camp will focus more on the emotional aspects of paying off debt.

mrmoonymartian

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Re: DONT Payoff your Mortgage Club
« Reply #1008 on: December 25, 2018, 05:01:13 PM »
I think the case for not paying off your mortgage is about 20% stronger now than it was a couple of months ago.

FIreDrill

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Re: DONT Payoff your Mortgage Club
« Reply #1009 on: December 25, 2018, 05:08:14 PM »
Hahaha!

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Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1010 on: December 25, 2018, 05:18:56 PM »
Hahaha!

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Not sure if any of these comments were in response to mine, but still waiting to see some analysis showing that inflation is relevant.

SwordGuy

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Re: DONT Payoff your Mortgage Club
« Reply #1011 on: December 25, 2018, 07:47:58 PM »
Not sure if any of these comments were in response to mine, but still waiting to see some analysis showing that inflation is relevant.
Inflation is completely relevant to whether one should pay off one's mortgage early, assuming a fixed rate mortgage.  The higher the inflation the less one should pay early.   Much better to pay off a fixed rate mortgage with highly inflated dollars.










Dicey

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Re: DONT Payoff your Mortgage Club
« Reply #1012 on: December 25, 2018, 09:19:38 PM »
Hahaha!

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Not sure if any of these comments were in response to mine, but still waiting to see some analysis showing that inflation is relevant.
See point 3 on post #1014 above.

Telecaster

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Re: DONT Payoff your Mortgage Club
« Reply #1013 on: December 26, 2018, 11:54:24 AM »
Hahaha!

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Not sure if any of these comments were in response to mine, but still waiting to see some analysis showing that inflation is relevant.
See point 3 on post #1014 above.

To expand on that point...you assumed only 2% inflation.  The historical average is something like 3.5%.    So if inflation is something like average, your effective mortgage payment will be cut in half in just twenty years.   If inflation was say, 4.5%, then that $1,500 payment will be the equivalent of just $620.   

To put it another way, you are spending fully valued dollars today to save puny inflation-ravaged dollars in the future.   FWIW, from 1970 to 1999, inflation averaged 5.5%.   

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1014 on: December 26, 2018, 12:47:03 PM »
I understand how inflation affects buying power, but regardless of inflation, you are still and always being charged your interest rate on the remaining value of the mortgage. So you can factor in inflation, but you have to then compare this inflation-adjusted rate to all other inflation-adjusted options for where to put that money. For example, if you are looking at buying bonds (I know not everyone here believes they are a good investment), and they are paying 3%, does that make them a bad investment because they are probably not keeping up with inflation? The right answer would be: compared to what other investment?

Another way to look at this: Let's assume the government controls prices and has regulated 0% inflation, guaranteed for the next 30 years (you even have a crystal ball that confirms this is the case). How would that affect your investment strategy (to include paying off debt)?

nereo

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Re: DONT Payoff your Mortgage Club
« Reply #1015 on: December 26, 2018, 01:13:48 PM »
Another way to look at this: Let's assume the government controls prices and has regulated 0% inflation, guaranteed for the next 30 years (you even have a crystal ball that confirms this is the case). How would that affect your investment strategy (to include paying off debt)?
Can I have a unicorn in this magical scenario?

If not, could I also know what the returns will be on equities (and specific stocks preferably) during the same time frame?  I'm guessing no - because that's always 'unknowable', as are future inflation rates and future bond rates and unemployment rates and all the other various financial conditions. Which is kind of the point.  We can't know what the exact conditions will be over thirty year time periods, so we do the next best thing, we look at what has happened in the past, and we evaluate whether that's reasonable for the future. In which case I go with what is most likely, while doing what is practical to guard against what may be most detrimental.

Rufus.T.Firefly

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Re: DONT Payoff your Mortgage Club
« Reply #1016 on: December 27, 2018, 07:02:51 AM »
To answer Boofinator's question and for future readers wondering the same thing, here is the mathematical reasoning on how inflation relates to mortgage pre-payment decisions: a low interest mortgage acts as a hedge against high inflation.

The real interest rate = nominal interest rate - rate of inflation.

Let's apply this to two scenarios. One in which there is 0% inflation for 30 years and one in which there is 4% inflation for 30 years and compare the differences in pre-paying a mortgage. You can run these numbers for yourself using a mortgage pre-payment calculator.

(I'm using 200K mortgage, 4% interest, 30 year loan, $1,000/month additional mortgage payment)

Scenario 1: inflation is 0% (making the real interest rate 4%) - By paying off the mortgage early, you will save $98,732

Scenario 2: inflation is 4% (making the real interest rate 0%) - By paying off the mortgage early, you will save $0

And if inflation is ever higher than your nominal interest rate, the bank is in fact paying YOU to hold the loan.

nereo

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Re: DONT Payoff your Mortgage Club
« Reply #1017 on: December 27, 2018, 08:07:25 AM »
To answer Boofinator's question and for future readers wondering the same thing, here is the mathematical reasoning on how inflation relates to mortgage pre-payment decisions: a low interest mortgage acts as a hedge against high inflation.

The real interest rate = nominal interest rate - rate of inflation.


This is also why one must treat claims that "paying off your mortgage gives you a guaranteed X% return [with 'X' being the mortgage rate]" with a hefty dose of salt.  What you are getting is a nominal return, and the real return will be quite a bit less (and possibly negative).

The same logic is applied to market returns; annualized returns over the last 30 years has been 10%, but 'real' returns have averaged 7.2%.  We used real returns because we want to compare apples to apples (we want to equate spending power in 1987 to spending power in 2018). 
It makes no sense to use inflation adjusted numbers for market returns but not use inflation adjusted numbers for your mortgage payments.
« Last Edit: December 27, 2018, 02:25:18 PM by nereo »

talltexan

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Re: DONT Payoff your Mortgage Club
« Reply #1018 on: December 27, 2018, 11:41:01 AM »
Inflation is relevant because the conditions that produce it also produce higher (nominal) incomes via wages or via stock market returns. So you have more income relative to your debt (and debt payments).

And, yes, more of that income is sucked away by other expenses, too. But your debt payments have stayed fixed with a 30-year fixed mortgage.

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1019 on: December 27, 2018, 03:55:50 PM »
To answer Boofinator's question and for future readers wondering the same thing, here is the mathematical reasoning on how inflation relates to mortgage pre-payment decisions: a low interest mortgage acts as a hedge against high inflation.

The real interest rate = nominal interest rate - rate of inflation.

Let's apply this to two scenarios. One in which there is 0% inflation for 30 years and one in which there is 4% inflation for 30 years and compare the differences in pre-paying a mortgage. You can run these numbers for yourself using a mortgage pre-payment calculator.

(I'm using 200K mortgage, 4% interest, 30 year loan, $1,000/month additional mortgage payment)

Scenario 1: inflation is 0% (making the real interest rate 4%) - By paying off the mortgage early, you will save $98,732

Scenario 2: inflation is 4% (making the real interest rate 0%) - By paying off the mortgage early, you will save $0

And if inflation is ever higher than your nominal interest rate, the bank is in fact paying YOU to hold the loan.

Actually, you save the exact same amount of money in both scenarios. The purchasing power of that money is just going to decrease faster in Scenario 2.

Let's look at scenario 2 from the bank's perspective. They are getting 4% interest, and they expect 4% inflation. Yes, their purchasing power isn't going to increase at the end of the loan's term, so why would they make such a loan? Well, the answer is that they are making the optimal decision given the investment choices they have. What are they going to do, hold onto the cash? Are they going to burn it on a flashy new bank? (And of course they are getting leverage on their loans, so their profits tend to be higher than the return.)

Let's look at your "Scenario 3", where the bank is lending you money at 3%, and you know inflation is going to be 4%. Meanwhile, your best investment option is going to return 2%. Would you keep the loan since the bank is "in fact paying you to hold the loan"?

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1020 on: December 27, 2018, 04:01:58 PM »
Inflation is relevant because the conditions that produce it also produce higher (nominal) incomes via wages or via stock market returns. So you have more income relative to your debt (and debt payments).

And, yes, more of that income is sucked away by other expenses, too. But your debt payments have stayed fixed with a 30-year fixed mortgage.

From what I've read, stock market real returns have little to no correlation with inflation.

https://pensionpartners.com/inflation-deflation-and-stock-market-returns/

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1021 on: December 27, 2018, 04:14:08 PM »
To answer Boofinator's question and for future readers wondering the same thing, here is the mathematical reasoning on how inflation relates to mortgage pre-payment decisions: a low interest mortgage acts as a hedge against high inflation.

The real interest rate = nominal interest rate - rate of inflation.


This is also why one must treat claims that "paying off your mortgage gives you a guaranteed X% return [with 'X' being the mortgage rate]" with a hefty dose of salt.  What you are getting is a nominal return, and the real return will be quite a bit less (and possibly negative).

The same logic is applied to market returns; annualized returns over the last 30 years has been 10%, but 'real' returns have averaged 7.2%.  We used real returns because we want to compare apples to apples (we want to equate spending power in 1987 to spending power in 2018). 
It makes no sense to use inflation adjusted numbers for market returns but not use inflation adjusted numbers for your mortgage payments.

I disagree with your first paragraph. The return is guaranteed; it is the purchasing power that is not guaranteed.

Your second paragraph is spot on. You need to compare investments (which include debt payments) using the same inflation criteria (either adjusted or not adjusted). So if people say "hold your mortgage because inflation", by that logic they should also say "dump stocks because inflation". Because you want that dollar today, right? What if inflation was at double digits and forecasted stock returns were single digits; would you sell all your stock, because theoretically you're paying those companies to hold your money, right? (Or would gold start coming into the conversation?)

Yes, I know these are theoreticals, but the important thing is that investments are relative, and inflation shouldn't really be considered when comparing two different investment strategies since all investments are subject to inflation (except TIPS (and some say gold)).

Rufus.T.Firefly

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Re: DONT Payoff your Mortgage Club
« Reply #1022 on: December 27, 2018, 05:32:50 PM »
To answer Boofinator's question and for future readers wondering the same thing, here is the mathematical reasoning on how inflation relates to mortgage pre-payment decisions: a low interest mortgage acts as a hedge against high inflation.

The real interest rate = nominal interest rate - rate of inflation.

Let's apply this to two scenarios. One in which there is 0% inflation for 30 years and one in which there is 4% inflation for 30 years and compare the differences in pre-paying a mortgage. You can run these numbers for yourself using a mortgage pre-payment calculator.

(I'm using 200K mortgage, 4% interest, 30 year loan, $1,000/month additional mortgage payment)

Scenario 1: inflation is 0% (making the real interest rate 4%) - By paying off the mortgage early, you will save $98,732

Scenario 2: inflation is 4% (making the real interest rate 0%) - By paying off the mortgage early, you will save $0

And if inflation is ever higher than your nominal interest rate, the bank is in fact paying YOU to hold the loan.
Actually, you save the exact same amount of money in both scenarios. The purchasing power of that money is just going to decrease faster in Scenario 2.

In nominal terms, you save the same amount of money. But in real terms, factoring in inflation, the amount saved is different. This is prior to considering any opportunity cost of investing the money.

I believe your examples have been too nebulous to understand because you were trying to evaluate both how inflation relates to mortgage pre-payment and how it relates to investments. Investments in stocks are not the same as fixed interest loan or bonds.

In the long-term, stocks act as excellent hedges against inflation because the revenue, expenses, and net profit of corporations will rise with the inflation and so will their subsequent dividends and valuations.

Telecaster

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Re: DONT Payoff your Mortgage Club
« Reply #1023 on: December 27, 2018, 07:24:56 PM »

Your second paragraph is spot on. You need to compare investments (which include debt payments) using the same inflation criteria (either adjusted or not adjusted). So if people say "hold your mortgage because inflation", by that logic they should also say "dump stocks because inflation". Because you want that dollar today, right? What if inflation was at double digits and forecasted stock returns were single digits; would you sell all your stock, because theoretically you're paying those companies to hold your money, right? (Or would gold start coming into the conversation?)


I think you might be conflating two different arguments.  One involves inflation, one doesn't.  Over any long period of time (like say, the length of a typical mortgage), stocks have returned about 7% after inflation.  If you got a mortgage in the last few years, the mortgage rate is likely around 4%.   If the future is anything like the past, you can expect your return of paying down the mortgage after inflation to be around 0.5-1%.  Something like that.  Since ~7% is greater than about 1% the decision is pretty easy.   

Strictly speaking paying down the mortgage is not a return.   It is a future savings.   Nothing wrong with a future savings!  But many people don't realize they are paying a dollar now to save 75 cents or like even less in the future, and therefore tend to overestimate the benefits of paying down the mortgage. 

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Re: DONT Payoff your Mortgage Club
« Reply #1024 on: December 27, 2018, 09:31:14 PM »
Inflation is relevant because the conditions that produce it also produce higher (nominal) incomes via wages or via stock market returns. So you have more income relative to your debt (and debt payments).

And, yes, more of that income is sucked away by other expenses, too. But your debt payments have stayed fixed with a 30-year fixed mortgage.
This hit the nail on the head. If you own or produce real goods, then by definition the value of your remaining mortgage will become relatively smaller because of inflation. If you own nothing and produce nothing, then it won't matter either way.

and inflation shouldn't really be considered when comparing two different investment strategies since all investments are subject to inflation (except TIPS (and some say gold)).
Honestly it doesn't really matter. Use real returns for both, or nominal returns for both, just don't mix them together.

Radagast

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Re: DONT Payoff your Mortgage Club
« Reply #1025 on: December 27, 2018, 09:35:07 PM »
What is the rate range where you would switch from long term minimum payments to lump sum payoff and why?
I would pay off the mortgage as a lump sum if 1) its rate was greater than 1/PE10 + expected inflation, and 2) I had enough money (edit: in taxable accounts) to pay it off as a lump sum.

I would also pay it off as a lump sum if 1) its rate was higher than that of my bond allocation, and 2) my bond allocation was big enough to pay it off as a lump sum.
« Last Edit: December 27, 2018, 09:48:51 PM by Radagast »

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1026 on: December 28, 2018, 12:31:36 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

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Re: DONT Payoff your Mortgage Club
« Reply #1027 on: December 28, 2018, 02:32:27 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

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Re: DONT Payoff your Mortgage Club
« Reply #1028 on: December 28, 2018, 03:19:59 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

Mortgage A is a standard mortgage.

Mortgage B is amortized to increase by 4% annually (to account for inflation), pay 4% interest, and the loan will be completely paid off in 30 years.

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Re: DONT Payoff your Mortgage Club
« Reply #1029 on: December 28, 2018, 03:33:14 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

Mortgage A is a standard mortgage.

Mortgage B is amortized to increase by 4% annually (to account for inflation), pay 4% interest, and the loan will be completely paid off in 30 years.

that still doesn't compute. If they start the same Mortgage B will just increase every year while Mortgage A won't.  Where's the logic in that?

AnswerIs42

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Re: DONT Payoff your Mortgage Club
« Reply #1030 on: December 28, 2018, 05:52:13 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

Mortgage A is a standard mortgage.

Mortgage B is amortized to increase by 4% annually (to account for inflation), pay 4% interest, and the loan will be completely paid off in 30 years.

that still doesn't compute. If they start the same Mortgage B will just increase every year while Mortgage A won't.  Where's the logic in that?
Sure it does make sense... the starting payments *wouldn't* be the same - the payments would be lower to start with under mortgage B, but increase over time so they eventually overtake the original mortgage A payments. The maths can be made to work if you juggle the figures enough.

In theory, mortgage B would be better if you're investing the difference because your money would be invested for longer.

FIreDrill

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Re: DONT Payoff your Mortgage Club
« Reply #1031 on: December 28, 2018, 06:53:13 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

Mortgage A is a standard mortgage.

Mortgage B is amortized to increase by 4% annually (to account for inflation), pay 4% interest, and the loan will be completely paid off in 30 years.

that still doesn't compute. If they start the same Mortgage B will just increase every year while Mortgage A won't.  Where's the logic in that?
Sure it does make sense... the starting payments *wouldn't* be the same - the payments would be lower to start with under mortgage B, but increase over time so they eventually overtake the original mortgage A payments. The maths can be made to work if you juggle the figures enough.

In theory, mortgage B would be better if you're investing the difference because your money would be invested for longer.
Yeah I don't get this at all.... Why would you ever want a mortgage that is adjustable and increases as inflation occurs over time.  Mortgage B make no sense.

If you are trying to demonstrate how inflation actually decreases a fixed rate mortgage over time then a good example would be below.  This assumes 2.6% inflation over a 30 year term.

YearPI Inflation Adjusted
20003000
20012922
20022846.028
20032772.031272
20042699.958459
20052629.759539
20062561.385791
20072494.78976
20082429.925227
20092366.747171
20102305.211744
20112245.276239
20122186.899057
20132130.039681
20142074.65865
20152020.717525
20161968.178869
20171917.006218
20181867.164057
20191818.617791
20201771.333729
20211725.279052
20221680.421796
20231636.73083
20241594.175828
20251552.727257
20261512.356348
20271473.035083
20281434.736171
20291397.43303


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nereo

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Re: DONT Payoff your Mortgage Club
« Reply #1032 on: December 28, 2018, 07:50:13 PM »
Iíve never seen a mortgage structured this way.

Radagast

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Re: DONT Payoff your Mortgage Club
« Reply #1033 on: December 29, 2018, 11:11:14 AM »
A: 12/28/2018 30 Year Treasury Bond Yield: 3.045%
B: 12/28/2018 30 Year Treasury Inflation Protected Bond Yield: 1.212%

I would love to see an explanation of why the A yield should be the same as the B yield.

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Re: DONT Payoff your Mortgage Club
« Reply #1034 on: December 29, 2018, 06:41:29 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

I'm not sure I understand.  If they are both 30 year mortgage loans, how can you have payments that increase by 4% every year, and another that is fixed? You can't have both the term and the loan amount stay the same under these conditions.

Mortgage A is a standard mortgage.

Mortgage B is amortized to increase by 4% annually (to account for inflation), pay 4% interest, and the loan will be completely paid off in 30 years.

that still doesn't compute. If they start the same Mortgage B will just increase every year while Mortgage A won't.  Where's the logic in that?
Sure it does make sense... the starting payments *wouldn't* be the same - the payments would be lower to start with under mortgage B, but increase over time so they eventually overtake the original mortgage A payments. The maths can be made to work if you juggle the figures enough.

In theory, mortgage B would be better if you're investing the difference because your money would be invested for longer.

Exactly. I and I hope most others on this board would love to see a mortgage amortized to increase with inflation (as long as the interest rate is the same).

Let's see if the google sheets attachment works, otherwise I'll summarize in another post. In addition to the monthly figure and statistics, I've also included a theoretical investment using leftover money ($500 per month total) to show that B is far superior to A.

The point of the whole exercise here is that an inflation-adjusted mortgage would be a good thing, assuming you are paying the same interest rate. But such a thing is not available, so we have to take the best option we have. That being said, when we are comparing the investment options for our money, unless stocks can be shown to be an inflation hedge (and the jury is out as mentioned in an earlier post), then all the talk about mortgages being an inflation hedge is irrelevant. What is relevant is expected returns, which for mortgages are essentially guaranteed but for stocks, well, we are aware of the risks and rewards.

p.s. A mortgage is an inflation hedge if you're comparing your living arrangements to renting.

AnswerIs42

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Re: DONT Payoff your Mortgage Club
« Reply #1035 on: December 29, 2018, 07:07:34 PM »
Yeah I don't get this at all.... Why would you ever want a mortgage that is adjustable and increases as inflation occurs over time.  Mortgage B make no sense.
Turning this on its head for a minute - why would you want a mortgage that costs more in real terms at the beginning, when you're younger and your wages are presumably lower, and the money could be invested earlier to work longer for you instead; and costs less in real terms later in the mortgage, when you're earning so much you have lots of spare money but if you invest it instead it has less time to grow?

I couldn't get Boofinator's attachment to work, but I had a go too (see attachment). Mine's pretty simplified, assuming you pay the mortgage yearly rather than monthly. Note that my figures are not inflation adjusted.

The initial payments for mortgage B are way less than mortgage A - about 40% less. They don't even cover the interest during the first five years. I also added a couple of columns for what could happen if you invested the difference (later on withdrawing the difference from the investments to make up the difference once mortgage B's payments overtook mortgage A's), assuming 7% above-inflation stock-market returns (big assumption, I know).

I understand why the banks would be reluctant to offer this - the main risks to the bank with mortgages are in the early stages when LTV is high, so it's in the bank's interest to reduce the LTV ASAP in case something goes wrong and the property has to be sold at a loss. That said, the banks used to like offering interest-only mortgages, which is pretty risky for the banks in the early years too.

And I also get why borrowers would be a bit wary about mortgage payments that rise with inflation... but then again, rent rises with inflation too, and renters have to just deal with it.

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1036 on: December 29, 2018, 08:03:29 PM »
The google sheets attachment appeared to be a flop. Here's a summary of the statistics:

                        Principle   Interest   Payment                                   Principle   Interest   Payment
Mortgage A:   100000   71867.99   171867.99   Mortgage B:       100000   93434.24   193434.24

Investment Returns A    Investment Returns B
51257.71                     210065.73

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1037 on: December 29, 2018, 09:13:07 PM »
Inflation is relevant because the conditions that produce it also produce higher (nominal) incomes via wages or via stock market returns. So you have more income relative to your debt (and debt payments).

And, yes, more of that income is sucked away by other expenses, too. But your debt payments have stayed fixed with a 30-year fixed mortgage.

This (bolding mine) is intuitive, but from what I have read is not the historic case. There is some correlation of stocks with inflation at lower inflation values (at which time a mortgage could be considered a deflation hedge and stocks an inflation hedge, as someone else has noted), but the stock market tends to tank even in nominal terms with high inflation (presumably because wages do not rise as fast, and thus consumerism suffers). So overall, there appears to be generally little to no correlation between stocks and inflation. If you have data to the contrary I am open to being educated otherwise.

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Re: DONT Payoff your Mortgage Club
« Reply #1038 on: December 31, 2018, 12:15:13 PM »
As we've veered away from the purpose of this thread and into the realm of hypothetical loan structures, I'd ask those who want to continue that line line of analysis to start a new thread and post a link to it below.

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Re: DONT Payoff your Mortgage Club
« Reply #1039 on: December 31, 2018, 12:35:51 PM »
As we've veered away from the purpose of this thread and into the realm of hypothetical loan structures, I'd ask those who want to continue that line line of analysis to start a new thread and post a link to it below.

Since a very common refrain to not pay off the mortgage is because of "inflation", and since it was brought up yet again in this very thread, it is an appropriate topic of communication. The inflation communicants seem to fall into one of two (or sometimes both) camps:

1) Mortgages are an inflation hedge, since the price is locked in upon purchase. This can be a valid argument when comparing purchasing a house to purchasing things that rise with inflation (or renting). However, historical stock returns appear to be relatively independent from inflation (certainly there's a correlation, since both are generally rising, but if both metrics are transformed than the correlation is minimal).

2) Mortgages are great because payments don't rise with inflation.

The hypothetical mortgage was meant to show the fallacy in argument #2.

I don't think our thread originator B42 was a fan of the echo chamber, so in some small way I think he'd appreciate the comments here.

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Re: DONT Payoff your Mortgage Club
« Reply #1040 on: December 31, 2018, 12:56:59 PM »
I thought it was pretty well accepted that inflation depresses real stock returns.   

A somewhat dense paper exploring inflation on stock returns in ten countries here:

https://www.federalreserve.gov/pubs/ifdp/1994/464/ifdp464.pdf

A less dense explanation from Warren Buffet why inflation depresses real stock returns here:

http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/


Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1041 on: December 31, 2018, 01:49:06 PM »
I thought it was pretty well accepted that inflation depresses real stock returns.   

A somewhat dense paper exploring inflation on stock returns in ten countries here:

https://www.federalreserve.gov/pubs/ifdp/1994/464/ifdp464.pdf

A less dense explanation from Warren Buffet why inflation depresses real stock returns here:

http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/

Thanks for the two papers.

I think we all agree that inflation depresses real stock returns, but what we really want to compare is nominal returns of equities to a fixed-return investment (such as a mortgage). I haven't yet dug deep on the federal reserve paper, but Warren argues that the nominal returns act like a fixed-return bond (and hence are not an inflation hedge).

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Re: DONT Payoff your Mortgage Club
« Reply #1042 on: January 01, 2019, 08:35:22 PM »
1) Mortgages are an inflation hedge, since the price is locked in upon purchase. This can be a valid argument when comparing purchasing a house to purchasing things that rise with inflation (or renting). However, historical stock returns appear to be relatively independent from inflation (certainly there's a correlation, since both are generally rising, but if both metrics are transformed than the correlation is minimal).
In the long run stock values are tied to real prices and the economy, plus expectations. If the economy and expectations are tanking while inflation soars then they will not do well in real terms, but that is because of those other two factors. All else being equal, they correlate to inflation. Another issue is choosing too short a period to test for correlation. The idea is that stocks compensate for inflation over say ten years or more, so checking one year rolling correlations is a poor test of this. It is like the people a couple years ago who were saying "US and international stocks are almost perfectly correlated. Besides, international returns are negative over the past ten years while US stocks are positive!" You can tell from the statement that something is wrong, and the something is checking short term correlations and incorrectly extending them to longer terms despite that obviously being incorrect.

In any case inflation is apparently good for stock returns up to about 4%, and generally bad at some point after that. But I am confused. The idea that inflation shocks are bad for stock returns in the short term is exactly why I would consider keeping a mortgage if I had the option to pay it off. You seem to be saying that inflation is bad for the returns of stocks (and presumably bonds), and so that makes an inflation hedge pointless? It seems like that is what makes it valuable.

Quote
2) Mortgages are great because payments don't rise with inflation.

The hypothetical mortgage was meant to show the fallacy in argument #2.
There is nothing inherently great about mortgages. But they don't rise with inflation, so if you are considering one, that is something to include in the consideration.

Inflation is relevant because the conditions that produce it also produce higher (nominal) incomes via wages or via stock market returns. So you have more income relative to your debt (and debt payments).

And, yes, more of that income is sucked away by other expenses, too. But your debt payments have stayed fixed with a 30-year fixed mortgage.

This (bolding mine) is intuitive, but from what I have read is not the historic case. There is some correlation of stocks with inflation at lower inflation values (at which time a mortgage could be considered a deflation hedge and stocks an inflation hedge, as someone else has noted), but the stock market tends to tank even in nominal terms with high inflation (presumably because wages do not rise as fast, and thus consumerism suffers). So overall, there appears to be generally little to no correlation between stocks and inflation. If you have data to the contrary I am open to being educated otherwise.
Read "Deep Risk" by William Bernstein.

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Re: DONT Payoff your Mortgage Club
« Reply #1043 on: January 02, 2019, 12:52:35 PM »
So for everyone who likes that mortgage payments do not rise with inflation: If the bank offered you two thirty-year mortgage loans, both at the same interest rate (say 4%), with the first being a standard mortgage, but the second amortized so that the payments increase for inflation every year by 4%, which would you take?

(I'll post my answer and math in a little while.)

So I read up until this post, and--while I'm fascinated by the idea--I do not think this product would ever become popular with banks. I built a spreadsheet and started tinkering around, and it looks like the bank would actually have to offer negative amortization over the first few years to get something like this. In my example, a mortgage of $300,000 with 4.875 APR and 3% assumed annual inflation had an initial monthly payment of $1,090, while the initial monthly interest was $1,219. It wasn't until the middle of year 5 that the payments had risen to the point that they were more than offsetting interest on the loan.

Now that I've typed this, I'm going to scroll down and read the rest of your posts, it looks like a really neat math exercise.

talltexan

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Re: DONT Payoff your Mortgage Club
« Reply #1044 on: January 02, 2019, 12:56:51 PM »
PS I think a mortgage product that starts low and increases over time is...a lot like the one I have.

My 5/1 ARM included sixty payments at a rate of 3.0%, now it's just reset up to 5.0%. It's chunkier than the escalating payments, but my lender gave me a premium, which was five years at that teaser rate.

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Re: DONT Payoff your Mortgage Club
« Reply #1045 on: January 02, 2019, 01:50:08 PM »
Another month, another minimum payment on our 3.125% mortgage.

Boofinator

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Re: DONT Payoff your Mortgage Club
« Reply #1046 on: January 02, 2019, 04:52:21 PM »
PS I think a mortgage product that starts low and increases over time is...a lot like the one I have.

My 5/1 ARM included sixty payments at a rate of 3.0%, now it's just reset up to 5.0%. It's chunkier than the escalating payments, but my lender gave me a premium, which was five years at that teaser rate.

That is very true. I personally like ARMs, and got one on my previous house (I think I have had the tendency to move enough that ten years in a home may never actually happen, let alone thirty years). I recently moved to a new house, and unfortunately the interest rates being offered for ARMs were no better than fixed long-term mortgages, so I went with the latter.

EDIT: Actually, now that I think of it a bit more, there is a big difference between an ARM and the hypothetical "inflation-adjusted" mortgage in that your interest rate has increased (versus the hypothetical mortgage where the interest rate is constant). In my opinion, the big factors to consider for which investment to send your little green soldiers are investment time horizon, volatility, and expected return. As the interest rate increases, you need a longer time horizon to make stocks a good bet over the fixed-rate debt. I think your interest rate of 5% still favors investments over paying off the debt as long as you have a very long time horizon.
« Last Edit: January 02, 2019, 05:03:51 PM by Boofinator »

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Re: DONT Payoff your Mortgage Club
« Reply #1047 on: January 02, 2019, 11:34:17 PM »
Another month, another minimum payment on our 3.125% mortgage.
What a thrill!

nereo

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Re: DONT Payoff your Mortgage Club
« Reply #1048 on: January 03, 2019, 06:21:58 AM »
Another month, another minimum payment on our 3.125% mortgage.
What a thrill!
I feel pretty damn lucky to have a 2.6% mortgage :-)

Dicey

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Re: DONT Payoff your Mortgage Club
« Reply #1049 on: January 03, 2019, 06:52:15 AM »
Another month, another minimum payment on our 3.125% mortgage.
What a thrill!
I feel pretty damn lucky to have a 2.6% mortgage :-)
Thirty year? OMG!