Is there a rate at which it is irrational to pay off mortgag

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Frugaldude
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Is there a rate at which it is irrational to pay off mortgag

Post by Frugaldude »

I wasn't able to post my question in the subject line (it doesn't allow enough characters) but basically my question is this:

Assuming you have the money to pay off a mortgage, is there a rate at which it becomes irrational to pay it off?

If so, then what is the rate?

I mean, I assume at 0% it would be irrational, correct? If that would be irrational, then would paying off a 1% after-tax mortgage be irrational? Would 2%? 3%?

Thanks in advance for any guidance.
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Re: Is there a rate at which it is irrational to pay off mor

Post by crowd79 »

Frugaldude wrote:I wasn't able to post my question in the subject line (it doesn't allow enough characters) but basically my question is this:

Assuming you have the money to pay off a mortgage, is there a rate at which it becomes irrational to pay it off?

If so, then what is the rate?

I mean, I assume at 0% it would be irrational, correct? If that would be irrational, then would paying off a 1% after-tax mortgage be irrational? Would 2%? 3%?

Thanks in advance for any guidance.
Very irrational IMO anything below 3%! Invest whatever extra you would pay off against the mortgage by funding for your retirement needs. You'll likely get a bigger return on your money over the long haul than throwing it at the mortgage. If you've maxed out all retirement account space (max 401ks, IRA's, etc) for the year, then I suppose it would be okay to pay down the mortgage a bit faster.
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Re: Is there a rate at which it is irrational to pay off mor

Post by baw703916 »

SInce paying off a mortgage is risk-free, I'd say you should compare the interest rate of the mortgage to the rate for short-term CDs or T-bills. Say hypothetically if you had a mortgage at 3%. If you can buy a 6 month CD at 4% interest, then you wouldn't want to accelerate paying off the mortgage. But if you can only get 2% on the CD, then you are better off paying off the mortgage. Your tax bracket doesn't actually matter, because interest on the mortgage get a tax benefit at the same rate at which interest on the CD/T-bills is taxed.

I agree with the prior post that one should first max out all retirement accounts first before accelerating payment of the mortgage.
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Re: Is there a rate at which it is irrational to pay off mor

Post by grabiner »

baw703916 wrote:SInce paying off a mortgage is risk-free, I'd say you should compare the interest rate of the mortgage to the rate for short-term CDs or T-bills.
I would say you should compare it to Treasury bonds or long-term CDs of the same average duration as your mortgage.

If you have a 10-year mortgage, you will be making 120 fixed payments. You could use the mortgage payoff money to buy 120 CDs with maturities from 1 to 120 months; if that would be enough to pay off the mortgage, then you'll come out ahead by not paying it off. In practice, you wouldn't buy 120 CDs, but you might buy a Treasury bond fund with a five-year duration, which could hold Treasury bills maturing over the same period. If the yield on the five-year Treasury bond fund is higher than the mortgage rate, you would expect to come out ahead by investing in the fund with no additional risk.

If you are actually making taxable investments, the more likely alternative would be a muni fund, such as Intermediate-Term Tax-Exempt for a five-year duration. If the muni fund has the same after-tax yield, paying down the mortgage has a slight advantage because munis have some credit risk.
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Re: Is there a rate at which it is irrational to pay off mor

Post by crowd79 »

If you fill up all retirement contribution space every year and you have a 30-year mortgage at a rate less than 3%, for example, then I do not recommend paying it off with extra funds. Instead, use the extra payment you would put towards the house to buy EE Bonds every month for the next 10 years, which are guaranteed to double in value at 20 years of holding them at 3.53% interest and are federally tax-deferred and free from state income taxes. Starting in the 20th year (10 years left on the mortgage), redeem your EE's every month and you come out ahead with a little extra money to put against the mortgage starting in the 20th year of the mortgage.
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Re: Is there a rate at which it is irrational to pay off mor

Post by umfundi »

It never is irrational. It is always a tradeoff. There is no sure thing.

My choice that I made was to pay off my mortgage rather than leverage the money to invest in stocks.

I think the choice is about balancing different types of risk.

I chose to pay off my HELOC (Home Equity Line of Credit) which cost 2.25% rather than invest more in stocks last year (which yielded 15%). I remain happy with that decision. Debt = 0 is a line item on my balance sheet that makes me happy.

I suppose you can play a game where investments / debts with supposedly similar risks have marginally different interest rates. That would be your mortgage vs. online CDs, for example. I think the time and effort is not worth it.

Also, leveraging your mortgage to invest in stocks entails balancing very different risks. I have chosen not to go there.

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Re: Is there a rate at which it is irrational to pay off mor

Post by nisiprius »

Since mortgage payments are certain and steady (and do not vary with fluctuations in the market value of your house) they need to be compared to and matched with investments that are just as certain and just as steady.

Hypothetically, if you know of
  • a near-zero-fluctuation-and-other-risk investment, such as a bank "money market deposit" account (or Triple-X-Treme Prestigidious Palladium Chartreuse Enneagon savings) and
  • it throws off more than enough income to make the mortgage payments
then I feel it would be rational to take money that would otherwise have gone on prepaying some of the mortgage and to invest the money in that investment--provided you earmark the income from that investment to making the regular mortgage payments. You can then pocket the rest. For example, if you're paying 3% on the mortgage and if you knew of a bank account, money market fund, maybe even a short-term bond fund that's paying 4%.

In doing the calculation, it's certainly reasonable to add in the actual tax savings on the mortgage interest provided you are in fact itemizing and getting those tax savings. Thus, even if the mortgage payments were a hair higher than the income from the investment it might still be rational. You could make the payments out of the investment--drawing it down just a tiny bit--and then at tax time, take the actual tax savings from the interest deduction and put them back into the account, topping it up. So, yes, if your mortgage is 3% and you know of a non-fluctuating, almost-riskless investing that pays 3%, 2.95%, then, depending on whatever the math shows, it could be rational to make a slightly-lower-than-mortgage-interest investment in order to pocket the tax savings.

That is the hypothetical situation in which I think I think it would be rational. I don't think that situation has ever existed; if it has, only for instants in time and only borderline-profitable.

What in my opinion is not rational is to kid yourself into thinking you should balance a dead-certain-clockwork liability against a risky investment. And I also feel that for even the sober of us, we need to allow for the boring, unpleasant nature of paying down debt--we seek excuses for not doing it. We also need to allow for the fact that there are investment entities who would rather see you give your money to them than to the bank. You can therefore assumed that you've been well-informed of every possible argument, valid or bogus, for not paying it down. They will be glad to give you "permission."

Surely if 2006 showed us anything, it's that in real life real people really do lose real houses. And it wasn't just "them," either.

In the bogus rhetoric of "human capital" my job is a bond. Yeah, right. I have had to make mortgage payments, and I have been out of work, but I am awfully glad that I've never had the two situations occur at the same time. In the state I live in, unemployment benefits are enough to put food on the table and keep the lights on, but they are not enough to do that and make mortgage payments, too.

It would be rational to view the situation a little differently depending on whether you live in a recourse or non-recourse state, because the consequences of failing to make the mortgage payments might be different in magnitude. But not by a lot. Losing the house is still losing the house.
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Re: Is there a rate at which it is irrational to pay off mor

Post by gtwhitegold »

With things as they stand now, I believe that someone with a mortgage below 5% will be in great shape in the future, since interest rates are very likely to go up in the future and guaranteed returns such as CDs may have a rate of return above 5%. So, it would be most logical to purchase those CDs and redeem them early if necessary. (Just be sure that you don't have to sacrifice more than 3 months of interest on the CD if you cash it out.) If yields were to continue to rise, it could be advantageous to take shorter term CDs or cash out CDs and rebuy at a higher interest rate.

Some people get a psychological benefit from paying off debt, and understand that. For those people I would recommend for them to pay off their debts for that benefit, not for a financial benefit.

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Re: Is there a rate at which it is irrational to pay off mor

Post by livesoft »

nisiprius wrote:Since mortgage payments are certain and steady (and do not vary with fluctuations in the market value of your house) they need to be compared to and matched with investments that are just as certain and just as steady.
I disgreee with this statement starting with the words "they need ...."

Since a fixed rate mortgage creates payments that are certain and steady, they give one a unique opportunity or option: One can be certain when the money is needed to make the monthly payment and for how many monthly payments. One can invest the money in something more risky and not worry about needing any extra money to pay more than the monthly payment. Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage. Conversely, when one's risky investment goes way up, one can cash it in and pay off the mortgage. Thus the mortgage gives one an option and that option is worth quite a lot of money.

Now none of us would be investing in equities if there wasn't a very good chance that our investment would gain in value at least at some point in the next 15 years. So if one has money to pay off a large lengthy mortgage, I think they should invest the money and when their investment has peformed much better than the mortgage, then they can cash in the investment and pay off the mortgage.
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Re: Is there a rate at which it is irrational to pay off mor

Post by ks289 »

livesoft wrote:
nisiprius wrote:Since mortgage payments are certain and steady (and do not vary with fluctuations in the market value of your house) they need to be compared to and matched with investments that are just as certain and just as steady.
I disgreee with this statement starting with the words "they need ...."

Since a fixed rate mortgage creates payments that are certain and steady, they give one a unique opportunity or option: One can be certain when the money is needed to make the monthly payment and for how many monthly payments. One can invest the money in something more risky and not worry about needing any extra money to pay more than the monthly payment. Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage. Conversely, when one's risky investment goes way up, one can cash it in and pay off the mortgage. Thus the mortgage gives one an option and that option is worth quite a lot of money.

Now none of us would be investing in equities if there wasn't a very good chance that our investment would gain in value at least at some point in the next 15 years. So if one has money to pay off a large lengthy mortgage, I think they should invest the money and when their investment has peformed much better than the mortgage, then they can cash in the investment and pay off the mortgage.
Great points.
In addition as everyone is aware but not mentioned explicitly on this thread -tax deferral advantages of 401k contributions and potential state tax deduction of 529 contributions need to be considered also.
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Re: Is there a rate at which it is irrational to pay off mor

Post by gtwhitegold »

I agree. For most people, I would recommend maximizing their tax advantaged space before trying to pay off a very low interest loan anyways. (As mentioned elsewhere, if it was an emergency, you could cash in a Roth IRA if necessary to make payments.)

Allen
ks289 wrote:
livesoft wrote:
nisiprius wrote:Since mortgage payments are certain and steady (and do not vary with fluctuations in the market value of your house) they need to be compared to and matched with investments that are just as certain and just as steady.
I disgreee with this statement starting with the words "they need ...."

Since a fixed rate mortgage creates payments that are certain and steady, they give one a unique opportunity or option: One can be certain when the money is needed to make the monthly payment and for how many monthly payments. One can invest the money in something more risky and not worry about needing any extra money to pay more than the monthly payment. Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage. Conversely, when one's risky investment goes way up, one can cash it in and pay off the mortgage. Thus the mortgage gives one an option and that option is worth quite a lot of money.

Now none of us would be investing in equities if there wasn't a very good chance that our investment would gain in value at least at some point in the next 15 years. So if one has money to pay off a large lengthy mortgage, I think they should invest the money and when their investment has peformed much better than the mortgage, then they can cash in the investment and pay off the mortgage.
Great points.
In addition as everyone is aware but not mentioned explicitly on this thread -tax deferral advantages of 401k contributions and potential state tax deduction of 529 contributions need to be considered also.
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Re: Is there a rate at which it is irrational to pay off mor

Post by papito23 »

Reality check for the Boglerich. This question at the margin, for most Americans, is between prepaying mortgage vs maxing retirement contributions (say $10 in Roths for a married couple). We plan to be a single (moderate) income family for some time. Maxing the Roth might be manageable, but not also prepaying a house. The savers credit and eitc and tax free space seem more valuable than a ~3% liability that will slowly shrink with inflation (given that a healthy emerg fund available and a Roth acct for extreme difficulties)
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Re: Is there a rate at which it is irrational to pay off mor

Post by Call_Me_Op »

Mortgage rates are always a little higher than long-term treasury rates. So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk. This assumes you have the best available rate, or close to it (which I assume is the case for those contemplating paying-off their mortgage).

People always look at this as purely an investment decision, but it is more than that. For example, paying-off a mortgage can have important asset protection implications. In addition, it greatly reduces your monthly expenses, so you tend to feel more secure.
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Re: Is there a rate at which it is irrational to pay off mor

Post by YDNAL »

Frugaldude wrote:.... basically my question is this:

Assuming you have the money to pay off a mortgage, is there a rate at which it becomes irrational to pay it off?
If so, then what is the rate?
If "you have the money" it must be sitting somewhere (yes, even in a can in the backyard).
  1. That fact eliminates discussions about not saving, creating tax-deferred space, or the like - as we are not informed whether you do (or don't do) these things.
  2. Return OF and ON this money may (may not) be guaranteed.
  3. Return from eliminating interest expense IS guaranteed.
  4. Once there is no debt, both principal + interest are available to save.
  5. Now, then, it would be "irrational" to pay interest expense in return for zero guarantees elsewhere.
All else are just guesses (invested money returns this/that, inflation that/this, etc.).
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Re: Is there a rate at which it is irrational to pay off mor

Post by Beantown85 »

Call_Me_Op wrote:So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk. This assumes you have the best available rate, or close to it (which I assume is the case for those contemplating paying-off their mortgage).
While that may be true at the time of acquiring the mortgage, over the 15 or 30 life of the loan, I don't think that will always be true. If you have a 30 year loan @ 3.25% right now, I think you will very likely be looking at risk-free investments that offer a higher rate than that at some point during the next 30 years.
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splitting the difference?

Post by allocator »

Setting aside the not-unimportant philosophical differences, what about "splitting the difference"?

Assuming the OP is (1) maxing out his tax-advantaged accounts, and (2) that the bond portion of his portfolio is allocated, like many Bogleheads, to instruments of short to intermediate duration and LOW-YIELD, might it make sense to use the only the bond portion of the portfolio and all future cash that would flow to bond allocations to pay down the mortgage?

This requires one to "own" the fact that, if one has both a mortgage and an investment portfolio, that the portfolio is, in fact, leveraged. This would also leave you with a 100%+ equity portfolio. But if you accept that your mortgage is "negative bond" and the dollar amount of your mortgage balance is greater than the dollar amount of your bond allocation, you've already got a 100%+ equity allocation.

As I'm thinking about it (and I am a newcomer to Bogledom), the upside to this approach is that one would not be using leverage (the mortgage loan) to finance purchases that provide a negative yield (short/intermediate bonds). The potential downside is that one would be using leverage to purchase risky assets (equities) with the potential for gains that exceed mortgage rate. But if you are currently investing in equities and you have a mortgage YOU ARE ALREADY DOING THIS. At least you'd be able to maker more efficient use of the leverage you're already using.

Please correct me if my facts or reasoning are off!!!

FWIW, I'm struggling with this issue now. From a purely cold-bloodedly rational perspective, it is very difficult to get around the ideas of the "negative bond" and a mortgage as a "leverage". Yikes.
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splitting the difference?

Post by allocator »

Two more thoughts:

1) how would a rising inflation rate environment change the calculus?

2) what if the mortgagee does not wish to stay in the house "forever" - just 'til the kids are grown (let's say 15 years from now)? Does that change things?
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Re: Is there a rate at which it is irrational to pay off mor

Post by Call_Me_Op »

Beantown85 wrote:
Call_Me_Op wrote:So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk. This assumes you have the best available rate, or close to it (which I assume is the case for those contemplating paying-off their mortgage).
While that may be true at the time of acquiring the mortgage, over the 15 or 30 life of the loan, I don't think that will always be true. If you have a 30 year loan @ 3.25% right now, I think you will very likely be looking at risk-free investments that offer a higher rate than that at some point during the next 30 years.
The operative phase is "I don't think that will always be true." In effect, you are trying to outguess the bond market, which is setting the 30 year treasury at just over 3% while considering all risks. Just as it is possible that in 20 years we will be looking at a long-term treasury rate of 6%, we could also be looking at 1%. Nobody knows.
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Re: Is there a rate at which it is irrational to pay off mor

Post by momar »

nisiprius wrote: In the bogus rhetoric of "human capital" my job is a bond. Yeah, right. I have had to make mortgage payments, and I have been out of work, but I am awfully glad that I've never had the two situations occur at the same time. In the state I live in, unemployment benefits are enough to put food on the table and keep the lights on, but they are not enough to do that and make mortgage payments, too.
Call_Me_Op wrote: In addition, it greatly reduces your monthly expenses, so you tend to feel more secure.
I feel more secure with 2/3 of my mortgage balance available than with none of it and a smaller mortgage.

I might even feel more secure when I have 3/3 or 4/3 of my remaining balance.

It's easy to pay the mortgage from that. It's less easy to use the house to pay for food.
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Re: Is there a rate at which it is irrational to pay off mor

Post by midareff »

When I was able to lock 3.0% refi that was my makes no sense to pay number. IF, and that is IF, it made any sense at this moment, which to me it does not, it makes less sense as year after year of inflation eats it away. Most of my living expenses are covered by a pension with a 3% annual COLA (locked) and SS with a CPI COLA.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Beantown85 »

Call_Me_Op wrote:The operative phase is "I don't think that will always be true." In effect, you are trying to outguess the bond market, which is setting the 30 year treasury at just over 3% while considering all risks. Just as it is possible that in 20 years we will be looking at a long-term treasury rate of 6%, we could also be looking at 1%. Nobody knows.
Not quite what I was saying. What I was saying is there can often be a point where you look at the mortgage rate you have from a mortgage that is not paid off, and it compares favorably to the current risk-free rate. I agree that no one can accurately predict what rates will be in the future, but that does not mean there aren't times when one can make the decision that paying off their mortgage is clearly irrational, and doesn't require any prognosticating skill (only some luck).
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Re: Is there a rate at which it is irrational to pay off mor

Post by LFKB »

If one can lock in a 3% mortgage for 30 years I do not think it is wise to pay it off more quickly. While similar risk investments may not yield higher at the moment, I believe that at some point in the next 10 years they will. Interest rates will likely go up at some point. If they do go down, and there's not really any room for them to go down, then one could always refinance.

I feel like this is the exact opposite of the thread discussing why people didn't buy 30 year treasuries when they were yielding 10%. We are now in precisely the exact opposite environment and one day I think people will say "how did I not take out a mortgage when rates were at 3%?" or "why did I prepay my mortgage when rates were at 3%?"

Just my two cents. I realize people may say "how do you know where interest rates are going?" Well I don't but history tells us that we well below historic averages and I expect a reversion to the mean at some point, even if it is 5-10 years away.
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Re: Is there a rate at which it is irrational to pay off mor

Post by momar »

LFKB wrote:If one can lock in a 3% mortgage for 30 years I do not think it is wise to pay it off more quickly. While similar risk investments may not yield higher at the moment, I believe that at some point in the next 10 years they will. Interest rates will likely go up at some point. If they do go down, and there's not really any room for them to go down, then one could always refinance.

I feel like this is the exact opposite of the thread discussing why people didn't buy 30 year treasuries when they were yielding 10%. We are now in precisely the exact opposite environment and one day I think people will say "how did I not take out a mortgage when rates were at 3%?" or "why did I prepay my mortgage when rates were at 3%?"

Just my two cents. I realize people may say "how do you know where interest rates are going?" Well I don't but history tells us that we well below historic averages and I expect a reversion to the mean at some point, even if it is 5-10 years away.
It might not even take that long. Obviously could be a blip, but 30 year rates may have bounced off 3.1% nationally and are now back up to 3.5% in the past few months.

Source: [Members using the Chrome browser are reporting that this link is infected with malware. I can't reproduce it, but will remove the link to be sure. It's from zillow . com / current mortgage rates. The problem is from the website and is not the fault of the member posting this link. --admin LadyGeek]
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

crowd79 wrote:You'll likely get a bigger return on your money over the long haul than throwing it at the mortgage.
"Likely" is the key word.

You can never lose money paying off the mortgage. You CAN lose money investing...

Even paying off 0% DEBT may not be irrational even you consider that you could lose money by investing it.

Which is better? Paying off $100,000 that you owe at 0%, or investing $100,000 and watching it drop to $90,000? I'd rather make zero than lose $10,000..

Now what are the chances that a index fund stock investment will drop below your investment value and remain lower for 40-50 years? Not very likely. But possible.

Me, I paid off my mortgage even though it was only at 3%... I have more peace of mind with $1 million invested and no debt, than $1.3 million invested and $300,000 owed at 3%. Simple as that...
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

livesoft wrote:
nisiprius wrote:Since mortgage payments are certain and steady (and do not vary with fluctuations in the market value of your house) they need to be compared to and matched with investments that are just as certain and just as steady.
I disgreee with this statement starting with the words "they need ...."

Since a fixed rate mortgage creates payments that are certain and steady, they give one a unique opportunity or option: One can be certain when the money is needed to make the monthly payment and for how many monthly payments. One can invest the money in something more risky and not worry about needing any extra money to pay more than the monthly payment. Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage.
Assuming you don't lose your job. Which is usually MORE likely during a downturn where your stock investments are crashing. It is certainly possible that one will need to sell at a loss to pay off the mortgage...
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

papito23 wrote:Reality check for the Boglerich. This question at the margin, for most Americans, is between prepaying mortgage vs maxing retirement contributions (say $10 in Roths for a married couple). We plan to be a single (moderate) income family for some time. Maxing the Roth might be manageable, but not also prepaying a house. The savers credit and eitc and tax free space seem more valuable than a ~3% liability that will slowly shrink with inflation (given that a healthy emerg fund available and a Roth acct for extreme difficulties)
Oh I agree that one should max retirement contributions before paying off a 3% mortgage... My position is not that one should maximize mortgage repayment above all else, but I do not think it is irrational for someone to do so.
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Re: Is there a rate at which it is irrational to pay off mor

Post by tfb »

crowd79 wrote:If you fill up all retirement contribution space every year and you have a 30-year mortgage at a rate less than 3%, for example, then I do not recommend paying it off with extra funds. Instead, use the extra payment you would put towards the house to buy EE Bonds every month for the next 10 years, which are guaranteed to double in value at 20 years of holding them at 3.53% interest and are federally tax-deferred and free from state income taxes. Starting in the 20th year (10 years left on the mortgage), redeem your EE's every month and you come out ahead with a little extra money to put against the mortgage starting in the 20th year of the mortgage.
Only if you stay in that home for 30 years. If you move in year 9 and the mortgage rate is 5% at that time, you can't sell your EE bonds yet because it's not 20 years yet and selling them will give you only 0.2% return. By the time you get to year 20, you already paid 5% for another 11 years and your 3.5% won't help. If you pay off at 3% now, the paid off principal will actually earn 5% starting in year 9 when you move.
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Re: Is there a rate at which it is irrational to pay off mor

Post by momar »

HomerJ wrote: Which is better? Paying off $100,000 that you owe at 0%, or investing $100,000 and watching it drop to $90,000? I'd rather make zero than lose $10,000..
So how can you justify investing in anything except the safest assets?
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Re: Is there a rate at which it is irrational to pay off mor

Post by umfundi »

one day I think people will say "how did I not take out a mortgage when rates were at 3%?" or "why did I prepay my mortgage when rates were at 3%?"
With all due respect, that is an "irrational" comment.

This is a two-sided coin. If you could have prepaid your mortgage but did not, what did you do with the money? You can't rationally have regret while only looking at one side of the equation.

Maybe it was 2012, and you did not pay off your mortgage, but invested in stocks. Good for you. You might want to contemplate how that would have worked 2006 - 2008.

Personally, I feel that paying off the mortgage early should not be top of the list for most people, but please understand that the risk factors of most alternatives are very different.

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Re: Is there a rate at which it is irrational to pay off mor

Post by riverguy »

LFKB wrote:If one can lock in a 3% mortgage for 30 years I do not think it is wise to pay it off more quickly. While similar risk investments may not yield higher at the moment, I believe that at some point in the next 10 years they will. Interest rates will likely go up at some point. If they do go down, and there's not really any room for them to go down, then one could always refinance.

I feel like this is the exact opposite of the thread discussing why people didn't buy 30 year treasuries when they were yielding 10%. We are now in precisely the exact opposite environment and one day I think people will say "how did I not take out a mortgage when rates were at 3%?" or "why did I prepay my mortgage when rates were at 3%?"

Just my two cents. I realize people may say "how do you know where interest rates are going?" Well I don't but history tells us that we well below historic averages and I expect a reversion to the mean at some point, even if it is 5-10 years away.
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Re: Is there a rate at which it is irrational to pay off mor

Post by digit8 »

Nothing demonstrates the emphasis on "personal" in personal finance more then a mortgage. Say I could get a bank CD earning 1% more then my mortgage rate for life. Paranoia aside("gubmint insurance means nothing!"), the numbers say the CD is the smart play and choosing otherwise is strictly irrational.

But if one is of the mindset that all debt is bad, if that mortgage hangs over ones head and causes restless, sleepless nights, who can say that individual is irrational for eating 1% interest to pay off the mortgage and go to bed happy and proud instead?
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Re: Is there a rate at which it is irrational to pay off mor

Post by LadyGeek »

FYI - Several members using the Chrome browser reported that the link by momar (above) was infected with malware. I couldn't find anything wrong, but I removed the link to be sure. This is a problem from the website, not momar.

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Re: Is there a rate at which it is irrational to pay off mor

Post by baw703916 »

LadyGeek wrote:FYI - Several members using the Chrome browser reported that the link by momar (above) was infected with malware. I couldn't find anything wrong, but I removed the link to be sure. This is a problem from the website, not momar.
Thanks for doing this.
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Re: Is there a rate at which it is irrational to pay off mor

Post by livesoft »

HomerJ wrote:
livesoft wrote:Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage.
Assuming you don't lose your job. Which is usually MORE likely during a downturn where your stock investments are crashing. It is certainly possible that one will need to sell at a loss to pay off the mortgage...
Right. If I lose my job, the first thing I am going to do is sell all my investments to pay off my mortgage. Or maybe I will blow my brains out first. Both are bad things to do.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Honobob »

HomerJ wrote:
You can never lose money paying off the mortgage.

.
Bull

Plenty of ways to lose money on a paid off house. No diversity/liquidity? Why aren't people putting ALL their money in houses?
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Re: Is there a rate at which it is irrational to pay off mor

Post by Toons »

I never gave it any thought as to whether it was irrational or not ,I just paid it off. :happy
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

livesoft wrote:
HomerJ wrote:
livesoft wrote:Thus, when one's risky investment is down, one will not need to sell it at a loss to pay off the mortage.
Assuming you don't lose your job. Which is usually MORE likely during a downturn where your stock investments are crashing. It is certainly possible that one will need to sell at a loss to pay off the mortgage...
Right. If I lose my job, the first thing I am going to do is sell all my investments to pay off my mortgage. Or maybe I will blow my brains out first. Both are bad things to do.
You might need to sell some of your investments to make the MONTHLY mortgage payments... Not sure why that wasn't clear.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Call_Me_Op »

Beantown85 wrote:
Call_Me_Op wrote:So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk. This assumes you have the best available rate, or close to it (which I assume is the case for those contemplating paying-off their mortgage).
While that may be true at the time of acquiring the mortgage, over the 15 or 30 life of the loan, I don't think that will always be true. If you have a 30 year loan @ 3.25% right now, I think you will very likely be looking at risk-free investments that offer a higher rate than that at some point during the next 30 years.
But my point is you don't know. So it is not unreasonable to pay-off one's mortgage at any time - provided it will not leave you cash-poor. And as I mentioned earlier, this is not simply a question of the wisdom of doing so from an investment perspective. There are other good reasons for doing it.
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Re: Is there a rate at which it is irrational to pay off mor

Post by NorCalDad »

I don't think there's one right answer here, and much of this depends on your personal situation, risk tolerance, investing horizon and overall asset allocation. I think anyone can justify his/her decision as rational based on these factors.

I would say that younger people who prioritize paying off their mortgage are relatively risk averse. Not saying that's good or bad. My personal view is that if my investment portfolio can't return more than 3% annualized over the next 30 years, I've got bigger problems than worrying about whether I should have prepaid my mortgage.
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Re: Is there a rate at which it is irrational to pay off mor

Post by livesoft »

HomerJ wrote:You might need to sell some of your investments to make the MONTHLY mortgage payments... Not sure why that wasn't clear.
Tax-loss harvesting would then most likely give you a higher return than the interest rate on your mortgage.
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

Honobob wrote:
HomerJ wrote:
You can never lose money paying off the mortgage.

.
Bull

Plenty of ways to lose money on a paid off house. No diversity/liquidity? Why aren't people putting ALL their money in houses?

The value of a house can go down, but you'd lose that equity either way...

I agree that liquidity/diversity is an issue... I waited until I had a lot more than my mortgage saved before I paid it off.
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Re: Is there a rate at which it is irrational to pay off mor

Post by HomerJ »

livesoft wrote:
HomerJ wrote:You might need to sell some of your investments to make the MONTHLY mortgage payments... Not sure why that wasn't clear.
Tax-loss harvesting would then most likely give you a higher return than the interest rate on your mortgage.
Heh, I'd like to see that math. How does selling at a loss (even if you get SOME of it back from tax savings, but you're still negative) give you a higher return than the guarenteed 3% return on paying off the mortgage?
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Re: Is there a rate at which it is irrational to pay off mor

Post by AustenNut »

Do you still recommend this calculus for people who refinanced at their original term length? For instance, three years into a 30 year loan they refinance for a lower rate. If they kept the amounts of their monthly payments the same they are "prepaying," but otherwise they're just constantly extending the length of their loan.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Default User BR »

HomerJ wrote:"Likely" is the key word.

You can never lose money paying off the mortgage. You CAN lose money investing...

Even paying off 0% DEBT may not be irrational even you consider that you could lose money by investing it.
Then you would never invest in the market at all. After all, you can't guarantee that you'll beat CD investing, or "under the mattress", or any number of other money strategies.


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Re: Is there a rate at which it is irrational to pay off mor

Post by dharrythomas »

It is never irrational to be debt free. It lowers your monthly cash flow requirement and lowers your overall risk.

While it is true that you can lose money on a paid off house, you won't have the risk of a negative equity position that makes it harder to move. There were any number of articles the last 5 years about people who lost their job but weren't mobile because they owed too much on their house to sell it.

Bad things also happen to educated, high income, smart people who use leverage at the wrong time, ask the tax lawyer we bought our current house from in a short sell and he still had a job. (two mortgages, much leverage, bad renters, housing crash)

The less leverage I've got, the harder it is for me to totally screw up my finances. We've got a 3% mortgage that we got in 2010, we intend to finish paying it off this year. If things go right in the economy, we won't max returns, but if things go wrong, we'll be better positioned to hunker down.

Good Luck

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Re: Is there a rate at which it is irrational to pay off mor

Post by JamesSFO »

baw703916 wrote:
LadyGeek wrote:FYI - Several members using the Chrome browser reported that the link by momar (above) was infected with malware. I couldn't find anything wrong, but I removed the link to be sure. This is a problem from the website, not momar.
Thanks for doing this.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Honobob »

dharrythomas wrote:It is never irrational to be debt free. It lowers your monthly cash flow requirement and lowers your overall risk.

While it is true that you can lose money on a paid off house, you won't have the risk of a negative equity position that makes it harder to move. There were any number of articles the last 5 years about people who lost their job but weren't mobile because they owed too much on their house to sell it.

WRONG WRONG WRONG

If you kept the CASH then negative equity is not a problem. Bring some cash to the table or use your limited exposure to negotiate a short sale. Debt free? At what cost? do the math/
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Re: Rate at which it is irrational to pay off mortgage

Post by docneil88 »

Good question frugaldude.

Suppose that:
(1) Your mortgage interest is fully tax deductible.
(2) 40% of your liquid assets (outside of your emergency fund) could pay off your mortgage.
(3) Of your liquid assets (outside of your emergency fund), you have 60% in equities and 40% in bonds.
(4) A 60/40 portfolio fits your willingness, ability, and need for risk, and that if you paid off your mortgage you'd also exchange some equities for bonds in order to maintain your 60/40 allocation.
(5) Suppose the bonds are very safe and intermediate term, and they yield 1.5%, and thus have an expected nominal return of 1.5%.
(6) The equities have an expected nominal return of 7.0%.
(7) So, a 60/40 portfolio has an expected return of 4.8%.

Now, the interesting question for me is this: Should one focus primarily on the 4.8% portfolio expected portfolio return or the 1.5% expected bond return in this case when deciding at what mortgage interest rates it would be irrational to pay off one's mortgage? I'm inclined to say the 4.8% is of primary importance in this case, and that with any mortgage rate much below 4.8%, it'd be irrational to pay off the mortgage. Perhaps 3.5% would be the threshold instead of 4.8% in order to make up for the fact that you'd be taking on more overall risk to your home and your net worth by not paying off the mortgage. But I'd like to know what others think and why. Best, Neil
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Re: Is there a rate at which it is irrational to pay off mor

Post by grabiner »

Call_Me_Op wrote:Mortgage rates are always a little higher than long-term treasury rates. So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk.
Not necessarily, given the tax situation. If mortgage rates are slightly higher than Treasury rates, you get a better return by contributing more to your IRA or 401(k) and buying Treasuries than you do by paying down the mortgage with tax-deductible interest.

If you are in a high tax bracket, you may also get a better return by buying municipal bonds with tax-free interest than by paying down the mortgage, and you keep the liquidity; if rates change, you can sell the bonds and pay down the mortgage later.
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Re: Is there a rate at which it is irrational to pay off mor

Post by Call_Me_Op »

grabiner wrote:
Call_Me_Op wrote:Mortgage rates are always a little higher than long-term treasury rates. So technically, there is no rate that is better or worse than another to pay-off your mortgage. It is always a "good" investment relative to other investments with zero or near-zero credit risk.
Not necessarily, given the tax situation. If mortgage rates are slightly higher than Treasury rates, you get a better return by contributing more to your IRA or 401(k) and buying Treasuries than you do by paying down the mortgage with tax-deductible interest.

If you are in a high tax bracket, you may also get a better return by buying municipal bonds with tax-free interest than by paying down the mortgage, and you keep the liquidity; if rates change, you can sell the bonds and pay down the mortgage later.
David,

Muni's are not guaranteed, so this is not really a fair comparison.
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