Why Do you do ....... AND pay off your mortgage early?

[NorthernBlitz]

So we've already touched on a few of the differences between mortgages in Canada and the USA, but one people don't bring up as much is the role of Government Sponsored Enterprises (Fannie Mae and Freddy Mac) play in the mortgage market in the USA. Because the federal government won't let these enterprises go bust, lot of the "risk" of extremely long term fixed rate mortgages isn't being carried by the US banks, but by the US taxpayers. Whether that's a good or bad thing is a debate for another time, but it is definitely another reason why mortgage interest rates in the USA are a lot lower than one would guess given the uncertainty of predicting interest rates 30 years into the future.

Thanks Maizeman. Another thing that we found different in the US was the mortgage origination fee. It seemed ridiculous to us that people had to pay the banks for the privilege of providing them with a consistent revenue stream. I suppose that this is because of the tax benefits, or maybe the long terms and the protection they offer.

I understand that it's not the ~$245k in savings that people are discussing here. But for a $200k home with a 1% origination fee, that's over $15k compounded over 30 years @ 7%. It doesn't tip the scale, but that cost isn't insignificant.

[brooklynguy]

Thanks Maizeman. Another thing that we found different in the US was the mortgage origination fee. It seemed ridiculous to us that people had to pay the banks for the privilege of providing them with a consistent revenue stream. I suppose that this is because of the tax benefits, or maybe the long terms and the protection they offer.

That's largely a function of the structure of the typical fixed-rate mortgage loan in the US (non-callability and the absence of a prepayment penalty, in particular), which effectively gives the borrower a unilateral option to reprice the loan (via refinancing) if interest rates go down (or to pay off the loan for any other reason), entirely for free other than transaction costs.  That, when combined with the artificially depressed interest rates resulting from the quasi-government-subsidization maizeman described, is what makes the 30-year fixed-rate US mortgage loan such an attractive instrument for the borrower (especially as a hedge against inflation).

[Dicey]

Another thing that we found different in the US was the mortgage origination fee. It seemed ridiculous to us that people had to pay the banks for the privilege of providing them with a consistent revenue stream. I suppose that this is because of the tax benefits, or maybe the long terms and the protection they offer.

I understand that it's not the ~$245k in savings that people are discussing here. But for a $200k home with a 1% origination fee, that's over $15k compounded over 30 years @ 7%. It doesn't tip the scale, but that cost isn't insignificant.

Origination fees are not mandatory.  Shopping around to find lenders who don't charge them is totally do-able. We've purchased at least seven homes with mortgages, never paid an Origination Fee, and always secured competitive rates. But don't get me started on title insurance...

[NorthernBlitz]

Another thing that we found different in the US was the mortgage origination fee. It seemed ridiculous to us that people had to pay the banks for the privilege of providing them with a consistent revenue stream. I suppose that this is because of the tax benefits, or maybe the long terms and the protection they offer.

I understand that it's not the ~$245k in savings that people are discussing here. But for a $200k home with a 1% origination fee, that's over $15k compounded over 30 years @ 7%. It doesn't tip the scale, but that cost isn't insignificant.

Origination fees are not mandatory.  Shopping around to find lenders who don't charge them is totally do-able. We've purchased at least seven homes with mortgages, never paid an Origination Fee, and always secured competitive rates. But don't get me started on title insurance...

That's good to know in case we ever decide to take out a mortgage and dump a bunch of cash in VTSAX.

[Goldielocks]

Perhaps because b42's in the US. A 30 year fixed rate mortgage doesn't renew, it stays constant for 30 whole years. With rates hovering around 4% for 30 freaking years, wouldn't you jump on it too?

[snipped the second part of the post with great comments]

I do know it is two different systems.  It took me a year of house and mortgage shopping in california (in 2006, no less!) to understand the US system.   

So i can say, in hindsight, no, I definitely would not jump on a 4% fixed for 30 years over a 2% variable with the constant "worry" of increasing rates.   Why?  The size of the mortgage and the value of the variable rate savings.

On a jumbo mortgage, that is a lot of cashflow in your early years, even if you have a strong income, that is restricted to paying off the mortgage.  Cash flow is important when you don't have a massive savings rate, such as when a parent is SAH for a while.

To manage the "risk" of rising rates and/ or inability to renew on future lower dollars -- save money in taxable account that can be quickly used to pay off mortgage to bring down your costs of borrowing if rates spike.   This account also grows so that you can pay cash for your home eventually also reducing risk.

As the home is gradually paid off (based on your current variable rate versus other investment returns), you can start to borrow from your HELOC.  My HELOC is sitting below 3.5% right now, and if used this way for investing, is tax deductible.  I need to review if it makes sense for us to leverage more this year.  Yes, you can't tap that last 20-25% of equity using a HELOC, but compared to 4% fixed rate, not deductible it is certainly attractive alternate route and would be up until the HELOC rate is about 6%.

TLDR -- I would not lock into a 4% 30 year rate over a variable rate.   Why? Due to the cash flow requirement to maintain it, and less flexibility in the long term, IMO lower variable rates, and a low rate HELOC is preferred for similar investment goals of keeping your money in the market.   Boarder42 is overlooking a large opportunity.

[Dicey]

Perhaps because b42's in the US. A 30 year fixed rate mortgage doesn't renew, it stays constant for 30 whole years. With rates hovering around 4% for 30 freaking years, wouldn't you jump on it too?

[snipped the second part of the post with great comments]

I do know it is two different systems.  It took me a year of house and mortgage shopping in california (in 2006, no less!) to understand the US system.   

So i can say, in hindsight, no, I definitely would not jump on a 4% fixed for 30 years over a 2% variable with the constant "worry" of increasing rates.   Why?  The size of the mortgage and the value of the variable rate savings.

On a jumbo mortgage, that is a lot of cashflow in your early years, even if you have a strong income, that is restricted to paying off the mortgage.  Cash flow is important when you don't have a massive savings rate, such as when a parent is SAH for a while.

To manage the "risk" of rising rates and/ or inability to renew on future lower dollars -- save money in taxable account that can be quickly used to pay off mortgage to bring down your costs of borrowing if rates spike.   This account also grows so that you can pay cash for your home eventually also reducing risk.

As the home is gradually paid off (based on your current variable rate versus other investment returns), you can start to borrow from your HELOC.  My HELOC is sitting below 3.5% right now, and if used this way for investing, is tax deductible.  I need to review if it makes sense for us to leverage more this year.  Yes, you can't tap that last 20-25% of equity using a HELOC, but compared to 4% fixed rate, not deductible it is certainly attractive alternate route and would be up until the HELOC rate is about 6%.

TLDR -- I would not lock into a 4% 30 year rate over a variable rate.   Why? Due to the cash flow requirement to maintain it, and less flexibility in the long term, IMO lower variable rates, and a low rate HELOC is preferred for similar investment goals of keeping your money in the market.   Boarder42 is overlooking a large opportunity.

Thanks for the kind words, GL, but in the US, HELOCs tend to have much shorter rate lock periods and limits on their tax deductibility, so b42's missed "opportunity" might not be as large as one using a different system might expect.

And you bought a house in CA in the depths of the market? Score! How long did you have it? Did it treat you well? Sorry if you've detailed that adventure elsewhere, I haven't seen it, or more likely, don't recall.

[boarder42]

Perhaps because b42's in the US. A 30 year fixed rate mortgage doesn't renew, it stays constant for 30 whole years. With rates hovering around 4% for 30 freaking years, wouldn't you jump on it too?

[snipped the second part of the post with great comments]

I do know it is two different systems.  It took me a year of house and mortgage shopping in california (in 2006, no less!) to understand the US system.   

So i can say, in hindsight, no, I definitely would not jump on a 4% fixed for 30 years over a 2% variable with the constant "worry" of increasing rates.   Why?  The size of the mortgage and the value of the variable rate savings.

On a jumbo mortgage, that is a lot of cashflow in your early years, even if you have a strong income, that is restricted to paying off the mortgage.  Cash flow is important when you don't have a massive savings rate, such as when a parent is SAH for a while.

To manage the "risk" of rising rates and/ or inability to renew on future lower dollars -- save money in taxable account that can be quickly used to pay off mortgage to bring down your costs of borrowing if rates spike.   This account also grows so that you can pay cash for your home eventually also reducing risk.

As the home is gradually paid off (based on your current variable rate versus other investment returns), you can start to borrow from your HELOC.  My HELOC is sitting below 3.5% right now, and if used this way for investing, is tax deductible.  I need to review if it makes sense for us to leverage more this year.  Yes, you can't tap that last 20-25% of equity using a HELOC, but compared to 4% fixed rate, not deductible it is certainly attractive alternate route and would be up until the HELOC rate is about 6%.

TLDR -- I would not lock into a 4% 30 year rate over a variable rate.   Why? Due to the cash flow requirement to maintain it, and less flexibility in the long term, IMO lower variable rates, and a low rate HELOC is preferred for similar investment goals of keeping your money in the market.   Boarder42 is overlooking a large opportunity.

Thanks for the kind words, GL, but in the US, HELOCs tend to have much shorter rate lock periods and limits on their tax deductibility, so b42's missed "opportunity" might not be as large as one using a different system might expect.

And you bought a house in CA in the depths of the market? Score! How long did you have it? Did it treat you well? Sorry if you've detailed that adventure elsewhere, I haven't seen it, or more likely, don't recall.

i'm locked at a 3.25.  which the variable rate has increased past at least once in the last year. and the current rate climate is rising from these historic lows i think its highly unlikely i'll be able to come out at an avg rate of 3.25% over the 30 year life cycle of the loan if you look at avg loan rates and the fact that loan rates will likely recede to the norm.  making the best 5/1 arm between 4 and 5% in the US.  we only get about a .8% drop in our rates ... many other countries actually ahve much lower 5/1 arm variable rate mortgages than the US does.

[El_Viajero]

I wanted to look at some of the things many mustachians do on the penny pinching side while they still make the huge mistake of paying down a mortgage early.

You're relying on a flawed (and kind of condescending) premise. For many people, paying off a mortgage early instead of investing that money in something more remunerative isn't a mistake at all – it's an opportunity to free themselves from the grind sooner.

I know that in your "the math works out better" world, that doesn't make much sense. Bear with me. As hard as it is to believe, a lot of us have thought this thing through and decided to annihilate the mortgage anyway. Ahem...

It is true that you will get richer by investing in an asset that returns 6% over a long enough time horizon than by using the same money to pay down a mortgage with a 3.5% interest rate. Nobody disputes that.

But paying down the mortgage early can also lower one's expenses dramatically, which allows many people to:

1. Quit a job they hate and transition into part-time work that they love in just a few years instead of several years
2. Start a business, spend more time with their kids, learn a new skill, socialize more, and see more of the world SOONER since than they would otherwise ('cuz they don't need that full-time job anymore)
3. Start doing a lot of the stuff that they want to do post-FIRE right away while they're younger and healthier. You're more likely to live 5 more years than 10 more years, you know?

These benefits are even more significant for self-employed people, who can more easily (and quickly) reduce their client load and exert more control over their lives after they no longer have to dish out, say... 1.5-2K per month on a mortgage.

As someone who would prefer to optimize his time sooner rather than later, I'll be paying off my mortgage early. I know I'm missing out on seeing a higher number next to my name in the "net worth" column. Meh. All else being equal, you're gonna get richer faster than I will.

But while you're still hacking away at your full-time job, I'll be fucking around on my bike, jamming on my guitar, having that extra beer, and reading that book you didn't have time to pick up. I'll also do some fun part-time work to keep the bills paid and pad the Vanguard account, but I won't have to say no when a buddy suggests we leave for a backpacking trip on a Wednesday.

You might think that's a "huge mistake," but I don't.

[brooklynguy]

It is true that you will get richer by investing in an asset that returns 6% over a long enough time horizon than by using the same money to pay down a mortgage with a 3.5% interest rate. Nobody disputes that.

Once you accept the premise that a leveraged-investing-via-mortgage strategy will outperform a mortgage payoff strategy over the full life of the mortgage loan (a premise which not everyone does accept, because it is not guaranteed to be true if your investment vehicle has uncertain returns, as equity investments do), your conclusion does not follow.  If you opt not to pay down your mortgage loan, then once you've reached the point of having accumulated enough to pay it off in full (which you'd have to do in order to "lower one's expenses dramatically") you can service your remaining mortgage payments using those accumulated invested funds (without needing any separate income stream to do so).  So you can retire from your job at the same point in time as you would've been able to using a mortgage payoff strategy (really, an earlier point in time, as long as you're accepting the premise that the investment returns will make the leveraged-investing-via-mortgage strategy pay off) even though you're keeping your mortgage loan.  That's why those of us in the leveraged-investing-via-mortgage camp are betting that that strategy will enable us to retire earlier.

[maizefolk]

This is a good point though that presenting numbers based on working for 30 years isn't as accessible or relevant a result for the MMM forums.

Reran the simulation with the following assumptions:

100k mortgage
4% interest on mortgage
$2k/month to either pay off the mortgage early or make regular payments with the balance invested in the stock market.
Once the early mortgage paydown scenario completes paying down the mortgage, both scenarios cut income to zero (ie FIRE). This was in month 55 (~4.5 years) given the assumptions above.*
The scenarios continue to run out to the end of the 360 month mortgage term, with mortgage payments for the "normal monthly payments" model being subtracted from the additional stock portfolio accumulated by only paying the required payment on the mortgage each month.
Final portfolio values were adjusted for cumulative inflation over the 30 year interval.


From this we can see that start months right before the start of the great depression were the only ones where paying off the mortgage before FIRE saved money over the course of 30 years. Unfortunately, these are some of the same years where a 4% withdrawal rate fails for a 100% stock portfolio, so the savvy early retiree who paid off their mortgage up front is still having a bad time of it. OTOH, times where it was really bad to be an early retiree like the late 60s actually see an increase in net worth buffer from paying down the mortgage on schedule instead of early.

However, it's hard to judge relative risk from the data displayed in this way.



From the historical data 1391 start months in 35 cases paying off the mortgage prior to FIRE was the right choice (~2.5%).

Which is exactly what BG predicted happen, but it's always nice to have the numbers in front of you.

*If someone thinks that is unrealistically fast or unrealistically slow for an MMMer to pay off their mortgage, just let me know.

[maizefolk]

Note that the exact percentages are sensitive to the ratio of the minimum monthly mortgage payment and the monthly income available to be thrown at the problem. If we instead assume only $1000 for mortgage payment + extra paydown or stock market investing, paying of the mortgage takes 122 months (~10 years), and in every single start month, putting the extra money that would have good towards extra principal payments into the stock market, and then paying the mortgage out of that pot of money each month after FIRE provides better outcomes and more resiliency than paying off the mortgage prior to FIRE.



There are a number of factors here. 10 years provides more time for your savings to compound before you start making mortgage payments out of it. It also decreases the risk that all of your stock purchases will be at extremely inflated prices right before a crash (you're more likely to have bought some of your stocks prior to the start of the bubble, or bought some at discounted prices right after the crash). And of course you're only making 20 years of mortgage payments out of the pot of money you've saved instead of 25.5 with the faster paydown scenario.

[Mika M]

1) To save money on interest in the long term, in the event that I stay in this house forever...

2) To increase equity in the event that DH and I move away to our dream life out west somewhere and use the money to buy a home there

3) In either scenario to optimize overall COL needs by working to reduce monthly housing cost

[maizefolk]

Rather than recapitulated a bunch of discussions have already happened:

For a good discussion of the arguments for and against using today's historically low interest rates vs using imputed historical rates, see the discussion that starts in this post. (h/t to Brooklyn Guy who pointed me to this thread back in February)

For back testing using imputed historical interest rates instead of a fixed 4%, see this post. (TL;DR this results in a shift from 2.5% of cases where it wouldn't have made sense to just pay the mortgage as you go to 12.6% of cases.)

For the debate about the fact that 30 year fixed interest rate mortgages didn't exist in 1871 and the response about how that's not material to the assumptions being tested, see the same thread linked above.

To paraphrase Churchill: "Indeed it has been said that democracy historical backtesting is the worst form of Government method to test retirement strategies except for all those other forms that have been tried from time to time.…"

It is also worth noting that PizzaSteve and I agreed we had different fundamental assumptions about the world, that neither of us was going to convince the other of anything, and there was really no point in the two of us continuing to talk, see yet another one of these endless mortgage threads. FWIW, if you want a retirement that is safe even if the return on owning stocks is zero or negative over the super long term I completely agree that you should definitely absolutely pay off your mortgage as soon as possible. You may also want to check out the excellent thread on some of the other implications of this world view Thoughts on Fire in a Declining Nation.



With apologies to the mods, I know lots and lots of in text links is a red flag for spamming accounts.

[Goldielocks]

Perhaps because b42's in the US. A 30 year fixed rate mortgage doesn't renew, it stays constant for 30 whole years. With rates hovering around 4% for 30 freaking years, wouldn't you jump on it too?

[snipped the second part of the post with great comments]

I do know it is two different systems.  It took me a year of house and mortgage shopping in california (in 2006, no less!) to understand the US system.   

So i can say, in hindsight, no, I definitely would not jump on a 4% fixed for 30 years over a 2% variable with the constant "worry" of increasing rates.   Why?  The size of the mortgage and the value of the variable rate savings.

On a jumbo mortgage, that is a lot of cashflow in your early years, even if you have a strong income, that is restricted to paying off the mortgage.  Cash flow is important when you don't have a massive savings rate, such as when a parent is SAH for a while.

To manage the "risk" of rising rates and/ or inability to renew on future lower dollars -- save money in taxable account that can be quickly used to pay off mortgage to bring down your costs of borrowing if rates spike.   This account also grows so that you can pay cash for your home eventually also reducing risk.

As the home is gradually paid off (based on your current variable rate versus other investment returns), you can start to borrow from your HELOC.  My HELOC is sitting below 3.5% right now, and if used this way for investing, is tax deductible.  I need to review if it makes sense for us to leverage more this year.  Yes, you can't tap that last 20-25% of equity using a HELOC, but compared to 4% fixed rate, not deductible it is certainly attractive alternate route and would be up until the HELOC rate is about 6%.

TLDR -- I would not lock into a 4% 30 year rate over a variable rate.   Why? Due to the cash flow requirement to maintain it, and less flexibility in the long term, IMO lower variable rates, and a low rate HELOC is preferred for similar investment goals of keeping your money in the market.   Boarder42 is overlooking a large opportunity.

Thanks for the kind words, GL, but in the US, HELOCs tend to have much shorter rate lock periods and limits on their tax deductibility, so b42's missed "opportunity" might not be as large as one using a different system might expect.

And you bought a house in CA in the depths of the market? Score! How long did you have it? Did it treat you well? Sorry if you've detailed that adventure elsewhere, I haven't seen it, or more likely, don't recall.

HELOCs here are 100% variable, zero lock-in rates, yet are often so much cheaper than any fixed rate term, it makes a lot of sense if you can save up money to quickly pay down mortgage in another account.

As for California -- we were smart in one sense.  We looked at about 100 homes in 2006, and could not figure out any that made financial sense to us, even with steep company mortgage incentives to buy.  The homes we would buy were near the limit of our single income family, and locked in for 30 years -- a very long time.  So many exotic options for mortgages in 2006, though!  Meanwhile, our rental cost us $400 less per month than it would have to buy.  So we did not get locked into the housing decline, but got to watch it happen, close up, while looking for a home ourselves.   

Unfortunately, as the housing market was inflating so rapidly, DH convinced me to put the proceeds of selling our other home into the stock market, so it would keep up with inflation until we were ready to buy a home again.   Put the money in in 2006, and took it out between late 2009 and 2010 to buy a home and renovate it.   Lost about $100k.   It took a while to not feel a burn about it, but now I just look at the learning i pulled from the experience.