Windfall - pay off mortage, or invest in bonds?

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cowboyinasia
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Windfall - pay off mortage, or invest in bonds?

Post by cowboyinasia » Wed Feb 27, 2013 9:25 pm

Greetings!

Over the years I’ve posed the occasional question to fellow Bogleheads to great help, so please take a look at this one (and apologies if this has been covered too many times before).

Thanks to selling something I’ve got a nice chunk of money coming soon. Nothing to retire on, but I can make a good dent in or banish my mortgage. One strategy is to simply pay it off, keep life simple.

But another strategy is to try and take advantage of the difference in low mortgage rates and invest in some laddered individual bonds, hold them until maturity, and then use the proceeds to pay off the mortgage. Once I’ve used the money to pay off the mortgage, for all intents and purposes it is trapped inside my home and I wouldn’t have the chance to try this again.


So this scenario could be something like this:
- I keep paying the mortgage month by month, over some years.
- I’ll pay X amount of mortgage per year, let’s call it $100K * 2.875 (an ARM) = $2850
- I get an interest deduction on taxes. Assume my tax rate is 25%, that would be $712.5, so I’m paying effectively $2850 (interest) - $712.5 (tax benefit) = $2137.5
- (If interest rate is 3.5%, the figure is $2625)
-
-
- I will invest the chuck of money soon to arrive in some laddered individual bonds bonds. For the first year, assume a maturity date of next July or August 2014, to be used to pay mortage for the 12 months following. Vanguard shows several with a coupon of 4% to 5%. Let’s assume I find a bond with 4.5% coupon . . .
- $100K * .045% = $4500 in income
- Taxes at 25%, or $1125
- I don’t understand how to figure out how much ‘commission’ I would pay. There are ‘bid side’ and ‘ask side’ prices, and ‘yield to worst’ comments, so I don’t know if commission is built into the either price and I’ll still get the same coupon. But I’ll assume $50 for a trade, and I’ll buy bonds once per year.
- So the money I’ll get by investing for some time would be: $4500 - $1125 (taxes) - $50 (commission) = $3325.-
-
- Now, $3325 > $2137, so I seem to be making enough money for this to be worth the effort.
- And if the mortgage is a few times $100K, and I have a decade or two left of paying it down, then playing this game could be worth $10K to $20K over the lifetime of the loan.

So, the questions for you please
- What are your thoughts about the wisdom of doing this?
- Is my math correct?
- From whom do you recommend I buy these bonds? I’m thinking of just three channels to buy bonds – (1) through Vanguard where I have mutual funds, but that’s all over the internet, and I’m not sure how comfortable I feel about that. (2) Through Edward Jones, which I’m leaning towards, because even though I’ve never done business with them, I would sit across the table from somebody who I feel is trustworthy and can help me pick good bonds and explain all the costs to me. And they have little offices all over the place including one close to where I live. (3) Merrill Lynch since my personal banking is with BofA, and I don’t want to complicate my life by opening a brokerage account at yet another institution. This is not my preferred option though, I don't see a big difference in them vs. Edward Jones (or Schwabb or whomever)

In any case, my portfolio is largely void of fixed income, so I want to bulk up probably including buying some laddered individual bonds in any case, but I think if I'm smart, careful and spend a little of my time, I might be able to squeeze out some extra money for while.

Thanks in advance!


(Edited for a typo in title)

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Watty
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Re: Windfall - pay off mortage, or invest in bonds?

Post by Watty » Wed Feb 27, 2013 10:30 pm

Vanguard shows several with a coupon of 4% to 5%. Let’s assume I find a bond with 4.5% coupon . . .
Any bond that is paying that much has a lot of risk.

2) Through Edward Jones,..... I would sit across the table from somebody who I feel is trustworthy and can help me pick good bonds and explain all the costs to me. And they have little offices all over the place including one close to where I live. (3) Merrill Lynch
Someone is paying for their offices, their salaries, their managers salary, their corporate office, etc. That would be you if you deal with them. The are very good at separating people from their money in ways that you may never even know about. To ask them for investing advice is like asking a used car salesman for car buying advice. A t best you will just pay way to much, at worst you will get taken to the cleaners. Search these boards for either of those companies names and you will find lots of horror stories.

Getting financial advice is not an inherently bad idea it is just that you need to find a fee only advisor with clearely stated costs that will not profit by putting you in expensive investments.
pay off mortage, or invest in bonds?
Invest in 100% Bonds - that is not realistic since to get a higher yield you will have to take a lot more risk. If there was not a lot of risk no one would make mortage loans at the lower rate. You might be able to make an argument that you should invest it in a mixture of assets (stocks/bonds/etc) but not all in bonds.

There is not enough informaion to really say what would be best but generally speaking for a conservative invester paying off the mortage then investing your "mortage payment" each month would be a reasonable option to look at.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by grabiner » Wed Feb 27, 2013 10:47 pm

cowboyinasia wrote:- I keep paying the mortgage month by month, over some years.
- I’ll pay X amount of mortgage per year, let’s call it $100K * 2.875 (an ARM) = $2850
- I get an interest deduction on taxes. Assume my tax rate is 25%, that would be $712.5, so I’m paying effectively $2850 (interest) - $712.5 (tax benefit) = $2137.5
- (If interest rate is 3.5%, the figure is $2625)
When does that ARM reset? That is an important consideration in the decision whether to pay down the mortgage or invest.

For example, if it resets in five years, then paying down the mortgage is effectively a five-year, risk-free bond, because your payment will earn you 2.875% (2.157% after tax) for five years and you will then be forced to pay the new balance at a market interest rate. You can't do that well on a five-year bond without taking a lot of risk. Vanguard Intermediate-Term Investment-Grade, which holds good-quality corporate with a five-year duration and relatively few defaults, yields only 2.17%. In contrast, Vanguard High-Yield Bond, which also has a duration of about five years, yields 4.57%, but that fund invests in "junk" bonds and expects some of them to default.

And if you can pay off the whole mortgage, then paying it down is effectively even better, because you start getting the benefit immediately: the money which would have gone to mortgage payments can be invested.
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Re: Windfall - pay off mortage, or invest in bonds?

Post by cowboyinasia » Thu Feb 28, 2013 12:42 am

Well, this idea isn't getting wind beneath it's wings here yet. Which may be right.

To one question . . . . The ARM resets next Sept, effectively doubling to 6%ish so I've one year of clear opportunity. I would have to refinance to a new ARM or a fixed rate loan to continue this strategy.

Note taken and appreciated on Edward Jones, but if all i'm going to do is buy a clutch of bonds from them and hold them to maturity, and not ask for investment advice, what could be so horrific in that?

Thanks again

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Re: Windfall - pay off mortage, or invest in bonds?

Post by BrandonBogle » Thu Feb 28, 2013 1:03 am

If the rate resets in September and you are relatively sure it will double for (likely) an annual reset from here out, I would seriously consider paying it off.

I'm in a situation where I'm have 28 more years fixed at 2.75% and I'm putting my extra payments into Vanguard's Long-Term Tax-Exempt fund. I do NOT have sufficient funds to pay it off in the next 6 years, so I will have rolling contributions in the fund longer than the duration. For me, it was a worthwhile risk to take to gain a greater return than paying down my mortgage faster.

But if I had the opportunity to pay it all off right away and was facing a rate increase soon, I can't say I'd honestly invest it.

And you can refi it as you suggest. If you get a good deal on the refi, that might be worthwhile. But you have to take into account the costs of the refi. I would however, if you decide to go down that route, refi it NOW instead of closer to September.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by DualIncomeNoDebt » Thu Feb 28, 2013 1:12 am

Pay off the ARM.

Buying high yield in the secondary market, via broker? At best, they'll be pocketing decent fees to execute the trade, and you'll never see the execution markup you'll be paying for individual issues; heck the bank or house may be selling you stuff the house wants to offload from their prop trading book. You won't know, and its highly likely the broker you interface with won't know either -- s/he puts in your order, and the back office fixed income desk does the trade. Good luck relying on those sharks. At worst, you're going to get your face ripped off.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by westcoast » Thu Feb 28, 2013 1:16 am

It' looks like you may be over complicating the situation. I would keep it simple and pay of the mortgage.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Raymond » Thu Feb 28, 2013 1:31 am

If I was in your situation, I would pay off the mortgage - the ARM resetting makes this even more of a no-brainer.

DualIncomeNoDebt, nice vivid image:

"...Good luck relying on those sharks. At worst, you're going to get your face ripped off."

:twisted: :shock:
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Re: Windfall - pay off mortage, or invest in bonds?

Post by Grt2bOutdoors » Thu Feb 28, 2013 9:52 am

DualIncomeNoDebt wrote:Pay off the ARM.

Buying high yield in the secondary market, via broker? At best, they'll be pocketing decent fees to execute the trade, and you'll never see the execution markup you'll be paying for individual issues; heck the bank or house may be selling you stuff the house wants to offload from their prop trading book. You won't know, and its highly likely the broker you interface with won't know either -- s/he puts in your order, and the back office fixed income desk does the trade. Good luck relying on those sharks. At worst, you're going to get your face ripped off.
Spoken like an experienced trader.

OP - Don't mess around, pay off the mortgage. Why take risk when you don't have to?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Oddlot » Thu Feb 28, 2013 11:14 am

DualIncomeNoDebt wrote:
Good luck relying on those sharks. At worst, you're going to get your face ripped off.
This statement left me wondering how badly I just got my face ripped off.

I recently rolled over (to Vanguard) an Edward Jones (EJ) IRA account consisting of five well known American funds that held an aggressive mix of US Equity, Intl Equity, and US Gov Bonds. I created the account at the end of 2001, and never touched it until now. Ultimate couch potato.

The account increased by a net 83% by the end of 2012 during the time it was at EJ. This compares to the 81% growth of the 3-fund Vanguard index portfolio during the same 11 years, roughly weighted the same as my EJ portfolio and no rebalancing.

I am NOT saying take all your money to EJ. I think that retail brokers and managed funds generally pocket the gains above what one might achieve with index funds, and the customer takes on the extra risk, but I don't think customers are having their faces ripped off, even at worst. But I have learned that Bogleheadism is better. I will be replacing most if not all of these American funds with lower cost Vanguard index funds weighted more towards fixed cost, since I am too old for all the excitement.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by cowboyinasia » Thu Feb 28, 2013 11:35 am

The consensus here is pretty clear! Thanks everyone for your inputs.

Now I'm leaning to simply paying off the mortgage. I've never lived in a place I own free and clear - probably worth trying, to see what it does for my outlook on life.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by YDNAL » Thu Feb 28, 2013 11:54 am

cowboyinasia wrote:But another strategy is to try and take advantage of the difference in low mortgage rates and invest in some laddered individual bonds, hold them until maturity, and then use the proceeds to pay off the mortgage. Once I’ve used the money to pay off the mortgage, for all intents and purposes it is trapped inside my home and I wouldn’t have the chance to try this again.
I suggest looking at the BIG [and complete] picture.
  • 1. You keep the mortgage.
    • - Added cost (interest expense), net of tax benefit (if any).
      - Potential gain/loss depending on NET return from laddered Bonds [after (1) taxes, (2) deducting interest expense].
    2. You don't keep the mortgage.
    • - Start saving the principal + interest part of payment (some have Escrow also). No change in cash flow.
      - Lost opportunity [could be a loss] from NET return from laddered Bonds.
Unless you consider both (#1, #2), you look at an incomplete picture.
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Re: Windfall - pay off mortage, or invest in bonds?

Post by Meg77 » Thu Feb 28, 2013 4:34 pm

It makes perfect sense to keep the mortgage and invest your windfall instead if (and only for as long as) you are paying an effective interest rate lower than you can earn in the market. However I don't actually think you will be able to find bonds paying 4.5% on the secondary market. If you CAN though, then I think that's more than worth it. But I would refinance to a 15 year fixed mortgage at around 2.875% and then not worry about the ARM adjusting. Honestly you should be able to earn more than that in even a savings account in just a few more years again. This assumes of course you aren't nearing retirement age, in which case you may just rather get rid of the debt and keep life simple.
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Re: Windfall - pay off mortage, or invest in bonds?

Post by reggiesimpson » Thu Feb 28, 2013 4:44 pm

Payed off mortgage? Similar to a long vacation.
"Payed"?................reggie you are losing it!
Last edited by reggiesimpson on Sat Mar 02, 2013 9:01 am, edited 1 time in total.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by FNK » Thu Feb 28, 2013 4:46 pm

cowboyinasia wrote:Vanguard shows several with a coupon of 4% to 5%. Let’s assume I find a bond with 4.5% coupon . . .
- $100K * .045% = $4500 in income
There's your mistake. Coupon is not the same as yield. If you find a bond with high coupon and high quality, it will trade at a premium. That means you'll pay more than face value for it, and your income will be less than coupon.

There's no safe investment yielding 2.875% for a year these days. Just pay down the mortgage after making sure you have a solid emergency fund.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Dandy » Thu Feb 28, 2013 5:57 pm

If your retirement savings are on track, you can fund your retirement accounts each year, you have no other expensive debt e.g. credit cards etc - then I would cancel the mortgage. You can do the math and get it checked but having extra income each month and no (or significantly less) debt is usually a winner. It gives you flexibility, greater security and usually peace of mind.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by kenyan » Thu Feb 28, 2013 6:23 pm

cowboyinasia wrote:
- I get an interest deduction on taxes. Assume my tax rate is 25%, that would be $712.5, so I’m paying effectively $2850 (interest) - $712.5 (tax benefit) = $2137.5
- (If interest rate is 3.5%, the figure is $2625)
-
-
Obviously, the winds are blowing in the direction not to pursue this, but I thought I'd chime in to make sure you do this part of the calculation right. You are assuming that you're getting 100% of the tax benefit of the interest on your mortgage. This is only the case if you would itemize deductions whether or not you have a mortgage. The standard deduction will be $6100 in 2013, $12200 for couples.

Unless you have at least $3250 single/$9350 married in other deductions, you get zero benefit on your taxes.

If you have between $3250-$6100/$9350-$12200 in other deductions, you will gain a benefit, but at a lesser percentage than 25%.

Only if you have greater than $6100/$12200 can you claim a 25% benefit.
Retirement investing is a marathon.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by DiscoBunny1979 » Thu Feb 28, 2013 6:36 pm

cowboyinasia wrote:The consensus here is pretty clear! Thanks everyone for your inputs.

Now I'm leaning to simply paying off the mortgage. I've never lived in a place I own free and clear - probably worth trying, to see what it does for my outlook on life.
----------------

An additional thing that should be taken into consideration is that if the OP does pay off the mortgage, there should be some insurance to protect the 'equity'. For instance, if the OP lived in California I would consider an earthquake policy. While such policy usually means a 15% deductible before the insurance pays a penny, it could be worth it if the unwanted earthquake shakes the house off the foundation. In my area I can obtain earthquake insurance for about $800 a year, whereas my parents that live in a different area would pay about $2,500 a year.

So there is the regular home owner's policy, earthquake coverage, and extra flood insurance (if in a flood zone or prone to flooding). An additional consideration to protect 'equity' if one pay off the mortgage would be an increase in personal liability so that if someone sues you personally for whatever reason, the 'equity' in the home can be preserved.

In preserving equtiy, I would also make sure that the state in which the OP lives has a Homestead exemption in which a portion of the home's equity can be protected from creditors and law suits. This is the case in CA whereas up to $100,000 can be protected with a Homestead exemption that is filed with the county in which one lives. Does the OP live in such place whereas can take advantage of such Homestead protection?

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Re: Windfall - pay off mortage, or invest in bonds?

Post by cowboyinasia » Fri Mar 01, 2013 12:15 pm

Meg77, FNK, Kenyan, et. al.

Thanks for the pointers. In contrast to my initial thoughts about this - before I had more data - I'm thinking the short-term period might be too challenging, getting sufficient yet safe yield on the bond side. Perhaps if I pay it down significantly, then refinance at a low, fixed rate . . . that makes it easier to get safe bonds maturing a few years out with yields higher than the loan's interest rate paid. (Especially if in some dream world interest rates rise on the bonds, and I can get much better yields.) But . . . .then there would be a few early years where I'm still subject to paying interest . . . I could set aside money to make those payments . . . but that will have to be in low yielding bank accounts and I'll lose the chance to invest in something with better yield. If instead I pay off the mortgage then that part of my life is rather secure, and I could direct the money that would have been used for mortgage payments to something relatively more risky, such as equity income, equities, real estate, or simply bond maturing a few years out giving me more yield and more safety. In the overall picture that could earn me more money over the long run.

This would be trickier than I first imagined. I'm disappointed to give up what I thought was such a clever idea, but changing to a better strategy as you learn more is better than preserving pride!

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Clearly_Irrational » Fri Mar 01, 2013 1:30 pm

For your primary residence I definitely recommend paying off the mortgage. It's a risk free trade so you need to compare the returns with "cash" which right now is returning roughly zero.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Dulocracy » Sat Mar 02, 2013 9:09 am

cowboyinasia wrote:Meg77, FNK, Kenyan, et. al.

Thanks for the pointers. In contrast to my initial thoughts about this - before I had more data - I'm thinking the short-term period might be too challenging, getting sufficient yet safe yield on the bond side. Perhaps if I pay it down significantly, then refinance at a low, fixed rate . . . that makes it easier to get safe bonds maturing a few years out with yields higher than the loan's interest rate paid. (Especially if in some dream world interest rates rise on the bonds, and I can get much better yields.) But . . . .then there would be a few early years where I'm still subject to paying interest . . . I could set aside money to make those payments . . . but that will have to be in low yielding bank accounts and I'll lose the chance to invest in something with better yield. If instead I pay off the mortgage then that part of my life is rather secure, and I could direct the money that would have been used for mortgage payments to something relatively more risky, such as equity income, equities, real estate, or simply bond maturing a few years out giving me more yield and more safety. In the overall picture that could earn me more money over the long run.

This would be trickier than I first imagined. I'm disappointed to give up what I thought was such a clever idea, but changing to a better strategy as you learn more is better than preserving pride!
Pay it off. If you pay it down and refinance when you could simply pay it off, you will need to deduct the closing costs from the refi from your overall profit from your bond investments. Use the money from your newly freed income to invest. By putting the mortgage payment into bonds instead, you have no mortgage and an accumulation of bonds.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by YDNAL » Sat Mar 02, 2013 10:38 am

Dulocracy wrote:Pay it off. If you pay it down and refinance when you could simply pay it off, you will need to deduct the closing costs from the refi from your overall profit from your bond investments. Use the money from your newly freed income to invest. By putting the mortgage payment into bonds instead, you have no mortgage and an accumulation of bonds.
This point is often omitted from discussion.
  1. A "mortgage" payment is part Principal (return of borrowed Capital) plus Interest expense (consumption item).
  2. By converting a mortgage payment into savings, we convert "consumption" (Interest expense) to savings (Asset).
  3. Of course, there is lost opportunity of return/risk from invested capital (Bonds per OP) versus return/risk* from invested capital transfered to Real Estate.
  4. Lastly, for the most part, real estate is not sold to consume in retirement as regularly as other invested capital (Bonds, per OP).
* according to Larry Swedroe, these are some figures:
http://www.cbsnews.com/8301-505123_162- ... nvestment/
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Dulocracy » Sat Mar 02, 2013 11:24 am

YDNAL wrote: * according to Larry Swedroe, these are some figures:
http://www.cbsnews.com/8301-505123_162- ... nvestment/
While that piece is an interesting evaluation of whether or not to own a home as an investment, the OP already owns a home. The cost of taxes, maintenance, and upkeep are going to exist whether or not OP has a mortgage because with or without the mortgate, the OP will own the home. The costs of having real estate and the eventual value of the real estate are irrelevant in a conversation that does not discuss whether or not the OP will own a home, but whether or not OP will pay off a debt associated with that home. That is, unless the OP is considering moving or selling, we must look at whether a home with a mortgage or without is better in this situation.

The discussion simply becomes whether or not it is better to use money to pay off a loan or invest. Paying off the loan will in this case result in better guaranteed results (if it is going up to 6%, it is a no-brainer. Even if the increase only went to a little over 4%, I would say paying off the mortgage would be best in this situation). Of course, if the OP was going to add equities to the mix, we are talking a different game again.

The article does warn against transaction costs, which does apply to the OP's thought about refinancing and then investing the rest. This leads me to the conclusion: pay off the home and invest what you have been paying in mortgage payments. Do not take on the transaction fees for a refi in this situation.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by YDNAL » Sun Mar 03, 2013 7:42 am

Dulocracy wrote:
YDNAL wrote:3.Of course, there is lost opportunity of return/risk from invested capital (Bonds per OP) versus return/risk* from invested capital transfered to Real Estate.

* according to Larry Swedroe, these are some figures:
http://www.cbsnews.com/8301-505123_162- ... nvestment/
While that piece is an interesting evaluation of whether or not to own a home as an investment, the OP already owns a home. The cost of taxes, maintenance, and upkeep are going to exist whether or not OP has a mortgage because with or without the mortgate, the OP will own the home. The costs of having real estate and the eventual value of the real estate are irrelevant in a conversation that does not discuss whether or not the OP will own a home, but whether or not OP will pay off a debt associated with that home.
You omitted the reason for the asterisk (*), so it is back in blue.

Two things:
  1. Regarding the quote in blue and "the piece" in the link, OP needs to decide investing a windfall (Capital) either in Bonds or Real Estate - via canceling Principal on a Debt (borrowed Capital).
    cowboyinasia (OP) wrote:Thanks to selling something I’ve got a nice chunk of money coming soon. Nothing to retire on, but I can make a good dent in or banish my mortgage. One strategy is to simply pay it off, keep life simple.

    But another strategy is to try and take advantage of the difference in low mortgage rates and invest in some laddered individual bonds, hold them until maturity, and then use the proceeds to pay off the mortgage.
    To make an informed decision, to the best of our ability, a historical look at Real Estate returns is most applicable.
  2. While ownership expenses simply replace paying Rent to a landlord - both are consumption and thus substitutable - one significant (most?) expense of ownership missing in your post is Interest (consumption) on a mortgage - certainly not "irrelevant" in any mortgage (debt) conversation.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Dulocracy » Sun Mar 03, 2013 10:18 am

YDNAL wrote:
Dulocracy wrote:
YDNAL wrote:3.Of course, there is lost opportunity of return/risk from invested capital (Bonds per OP) versus return/risk* from invested capital transfered to Real Estate.

* according to Larry Swedroe, these are some figures:
http://www.cbsnews.com/8301-505123_162- ... nvestment/
While that piece is an interesting evaluation of whether or not to own a home as an investment, the OP already owns a home. The cost of taxes, maintenance, and upkeep are going to exist whether or not OP has a mortgage because with or without the mortgate, the OP will own the home. The costs of having real estate and the eventual value of the real estate are irrelevant in a conversation that does not discuss whether or not the OP will own a home, but whether or not OP will pay off a debt associated with that home.
You omitted the reason for the asterisk (*), so it is back in blue.

Two things:
  1. Regarding the quote in blue and "the piece" in the link, OP needs to decide investing a windfall (Capital) either in Bonds or Real Estate - via canceling Principal on a Debt (borrowed Capital).
    cowboyinasia (OP) wrote:Thanks to selling something I’ve got a nice chunk of money coming soon. Nothing to retire on, but I can make a good dent in or banish my mortgage. One strategy is to simply pay it off, keep life simple.

    But another strategy is to try and take advantage of the difference in low mortgage rates and invest in some laddered individual bonds, hold them until maturity, and then use the proceeds to pay off the mortgage.
    To make an informed decision, to the best of our ability, a historical look at Real Estate returns is most applicable.
  2. While ownership expenses simply replace paying Rent to a landlord - both are consumption and thus substitutable - one significant (most?) expense of ownership missing in your post is Interest (consumption) on a mortgage - certainly not "irrelevant" in any mortgage (debt) conversation.
You are correct that I missed that in blue. Too much Dayquil? Lesson learned: Do not post when head is foggy due to cold medicine. I did actually read the article though! :-)

In your terms, I would say it is better to end this consumption and use the money that was going towards consumption to investing. With an upcoming increase in the OP's mortgage rate, he does not have the advantage of time, as his interest rate will not be low cost for long. Refinancing brings fees that would cut his profit if he were to invest in another strategy. Paying off the mortgage will get a better return, even after the tax deduction is taken into account.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Toons » Sun Mar 03, 2013 10:22 am

westcoast wrote:It' looks like you may be over complicating the situation. I would keep it simple and pay of the mortgage.
+1 :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Sun Mar 03, 2013 10:27 am

Watty wrote:
Vanguard shows several with a coupon of 4% to 5%. Let’s assume I find a bond with 4.5% coupon . . .
Any bond that is paying that much has a lot of risk.


[
No kidding!!! Plus, some of us (myself included) think there is a bond bubble with very little up side potential and a lot of downside potential. And if faced with the option of investing money that is not really mine (eg: if I am in debt), or getting out of debt (eg mortgage), I will, in almost all scenarios, get out of debt first (especially in this risky investment climate). But that is me, and that strategy has served me well throughout my life.

Most people here seem to be opposed to investing on margin, but many are not opposed to borrowing money for a house . In my mind there is little distinction. I have had a mortgage in the past, but only under a scenario where I was convinced I could pay it off in a short amount of time. The only other time I borrowed money was when I was able to get a home equity loan that charged less interest than I could get by investing the borrowed money in the bank...eg a sure win scenario.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by grabiner » Sun Mar 03, 2013 8:42 pm

protagonist wrote:Most people here seem to be opposed to investing on margin, but many are not opposed to borrowing money for a house . In my mind there is little distinction. I have had a mortgage in the past, but only under a scenario where I was convinced I could pay it off in a short amount of time. The only other time I borrowed money was when I was able to get a home equity loan that charged less interest than I could get by investing the borrowed money in the bank...eg a sure win scenario.
The difference is that you borrow money to buy a house that you wouldn't be able to buy otherwise; most people buying $250K houses don't have $250K in liquid assets.

Once you have bought the house, any investing that you do is investing on margin; your loan costs the same number of dollars whether it is secured by your house or your investments. This is why I normally recommend paying down a mortgage if you do not need the liquidity and cannot earn as good a rate on a bond investment. (And your last condition is fairly common with a mortgage; you can ofter earn more by contributing to a 401(k) to get tax-deferred growth and keeping the mortgage. In some tax brackets, you can earn more interest on municipal bonds than you pay after-tax on the mortgage; this is not quite a sure win because munis are allowed to default.)
Wiki David Grabiner

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Sun Mar 03, 2013 9:41 pm

grabiner wrote:
The difference is that you borrow money to buy a house that you wouldn't be able to buy otherwise; most people buying $250K houses don't have $250K in liquid assets.
I understand that, but how is buying a house you cannot afford with a mortgage different than buying cars you cannot afford with car loans, clothes you cannot afford with credit cards, equities you cannot afford on margin?

To me the distinctions are fine. Many people do all of the above, and that is their decision. Yes, cars and clothes depreciate. Equities can go either way. The house I inherited from my mom that was worth $260K when I inherited it in 2005 is now worth about $70-80K (not counting real estate commission if I wanted to sell). Fortunately it had no mortgage.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Aptenodytes » Sun Mar 03, 2013 10:07 pm

This seems weird to me.

First, get an investment plan in place that makes sense and that you can stick with for several decades.

Then invest your windfall accordingly.

Your mortgage should really not factor in at all, as I see it, especially in a time of such low interest rates.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by rr2 » Sun Mar 03, 2013 10:21 pm

protagonist wrote:
grabiner wrote:
The difference is that you borrow money to buy a house that you wouldn't be able to buy otherwise; most people buying $250K houses don't have $250K in liquid assets.
I understand that, but how is buying a house you cannot afford with a mortgage different than buying cars you cannot afford with car loans, clothes you cannot afford with credit cards, equities you cannot afford on margin?

To me the distinctions are fine. Many people do all of the above, and that is their decision. Yes, cars and clothes depreciate. Equities can go either way. The house I inherited from my mom that was worth $260K when I inherited it in 2005 is now worth about $70-80K (not counting real estate commission if I wanted to sell). Fortunately it had no mortgage.
A house costs at least 10 times the price of a new car and at least 10000 times the price of a piece of clothing. Used cars and used clothing are far cheaper.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Mon Mar 04, 2013 10:18 am

rr2 wrote:
protagonist wrote:
grabiner wrote:
The difference is that you borrow money to buy a house that you wouldn't be able to buy otherwise; most people buying $250K houses don't have $250K in liquid assets.
I understand that, but how is buying a house you cannot afford with a mortgage different than buying cars you cannot afford with car loans, clothes you cannot afford with credit cards, equities you cannot afford on margin?

To me the distinctions are fine. Many people do all of the above, and that is their decision. Yes, cars and clothes depreciate. Equities can go either way. The house I inherited from my mom that was worth $260K when I inherited it in 2005 is now worth about $70-80K (not counting real estate commission if I wanted to sell). Fortunately it had no mortgage.
A house costs at least 10 times the price of a new car and at least 10000 times the price of a piece of clothing. Used cars and used clothing are far cheaper.
The point being? One should only buy things they cannot afford if they are really expensive? Should one only buy stock on margin if buying ten times as much stock as you can afford?

Look, I know that to an extent I am playing devil's advocate here. Most homeowners I know who do not routinely borrow money for little things have mortgages...sometimes huge mortgages. But truly, I don't get the difference. If my mom had a $200K mortgage on the home that I inherited, I would be in the same position as if I had $200K in margin to pay off for stock now worth $70K.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Mon Mar 04, 2013 10:25 am

grabiner wrote: (And your last condition is fairly common with a mortgage; you can ofter earn more by contributing to a 401(k) to get tax-deferred growth and keeping the mortgage. )
This is the argument that my physician colleagues were making to me in the late 90s when I was in the top tax bracket. "You are stupid not to take a mortgage at (I forget, let's say 6% ??) , when stocks historically grow 10%/year!!!" Fortunately I didn't listen.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by rixer » Mon Mar 04, 2013 10:42 am

You never know what the future holds and it's tough to beat the security of a paid off home. I would pay off the mortgage.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by YDNAL » Mon Mar 04, 2013 10:50 am

protagonist wrote:Most people here seem to be opposed to investing on margin, but many are not opposed to borrowing money for a house . In my mind there is little distinction. (my emphasis) I have had a mortgage in the past, but only under a scenario where I was convinced I could pay it off in a short amount of time. The only other time I borrowed money was when I was able to get a home equity loan that charged less interest than I could get by investing the borrowed money in the bank...eg a sure win scenario.
Whoa... hold it a minute!

Regardless of your personal choices, you shouldn't mix apples/oranges with a simple 7 word sentence.
In my mind there is little distinction.
There is a HUGE distinction.
  • 1. To invest on margin, means that we choose to borrow capital for NO other reason than buying an Asset(s) "expecting" compensation for your decision. Some may quite easily view this decision as "a bet" (you make the call on that) with related risks.

    2. Conversely, we must live somewhere (hopefully other than in a cardboard box under a bridge).
    • a) As such, we either pay Rent to a landlord - or - pay ownership costs for the roof over our heads.
      b) The decision to "borrow money for a house" means that we chose to pay ownership costs and means that a lender is advancing Capital - secured by the Asset (house and land) - in exchange for our legal obligation to return the Capital + Interest (consumption) to them.
      c) This decision (b) may be fully substantiated once consumption items: Interest expense, taxes, insurance, etc. are compared to Rent expense (consumption).
Landy | Be yourself, everyone else is already taken -- Oscar Wilde

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Mon Mar 04, 2013 12:38 pm

YDNAL wrote:
protagonist wrote:Most people here seem to be opposed to investing on margin, but many are not opposed to borrowing money for a house . In my mind there is little distinction. (my emphasis) I have had a mortgage in the past, but only under a scenario where I was convinced I could pay it off in a short amount of time. The only other time I borrowed money was when I was able to get a home equity loan that charged less interest than I could get by investing the borrowed money in the bank...eg a sure win scenario.
Whoa... hold it a minute!

Regardless of your personal choices, you shouldn't mix apples/oranges with a simple 7 word sentence.
In my mind there is little distinction.
There is a HUGE distinction.
  • 1. To invest on margin, means that we choose to borrow capital for NO other reason than buying an Asset(s) "expecting" compensation for your decision. Some may quite easily view this decision as "a bet" (you make the call on that) with related risks.

    2. Conversely, we must live somewhere (hopefully other than in a cardboard box under a bridge).
    • a) As such, we either pay Rent to a landlord - or - pay ownership costs for the roof over our heads.
      b) The decision to "borrow money for a house" means that we chose to pay ownership costs and means that a lender is advancing Capital - secured by the Asset (house and land) - in exchange for our legal obligation to return the Capital + Interest (consumption) to them.
      c) This decision (b) may be fully substantiated once consumption items: Interest expense, taxes, insurance, etc. are compared to Rent expense (consumption).
I'm thinking about what you are saying. I see the argument. But the idea that your home will maintain its value or increase in value is as specious as the idea that your equities will do the same. Ask any resident of Florida, Las Vegas or S. Calif. Not long ago I saw an eye-opening thread here (I think it was by nisiprius but I am not sure)...a graph of home prices vs inflation since the late 19th century. Over that period, home value barely kept up with inflation, and lost over long periods as well. We have been lulled into thinking that homes are very solid investments based on a very long (possibly unprecedented) bull market in real estate during our investment lifetime. The picture from the 1920 through the 1970s was very different. Here is a copy I found: http://www.theatlantic.com/business/arc ... 890/72980/

The difference between paying the same amount of money in rent vs mortgage is that if you suddenly suffer an economic downturn (eg lose your job), if you are renting, you have the liquidity of moving somewhere cheaper, whereas if you hold a mortgage you are locked into a 30 year contract, just as if you borrowed money for anything else. In one case you have debt responsibility, which is the same as any other kind of debt. In the other case you have not. Home ownership has become a holy grail in the US. But like anything else, if you can't afford it, you shouldn't buy it.

OK, I know....nobody agrees with me... (giggle)

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Mon Mar 04, 2013 12:53 pm

Plus, I would imagine that were it not for the culture that encourages borrowing up the wazoo to fulfill the great dream of home ownership (being able to buy something with as little as 10% or less down even if your total assets cannot even cover its value), the market for homes would dictate that homes would be much more affordable, and everybody would win. More people could own homes without being indebted beyond the total value of their other assets. I would guess that this may have been the case, say, 100 years ago. No, I have no evidence to back this up, so if somebody shows me I am wrong I accept that, but as a non-economist, it makes sense to me.

If everybody bought their cars with 10% down and 30 years to pay at reasonable rates, A Civic might cost as much as a Ferrari does now.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Default User BR » Mon Mar 04, 2013 1:16 pm

grabiner wrote:Once you have bought the house, any investing that you do is investing on margin; your loan costs the same number of dollars whether it is secured by your house or your investments.
But there's a huge difference to be had by decoupling the leverage from the investments. Your mortgage isn't subject to a margin call if stocks drop precipitously. It gives you leverage and allows riding out market swings.


Brian

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Re: Windfall - pay off mortage, or invest in bonds?

Post by YDNAL » Mon Mar 04, 2013 1:30 pm

protagonist wrote:
YDNAL wrote:
protagonist wrote:In my mind there is little distinction....
There is a HUGE distinction.
  • 1. To invest on margin, means that we choose to borrow capital for NO other reason than buying an Asset(s) "expecting" compensation for your decision. Some may quite easily view this decision as "a bet" (you make the call on that) with related risks.

    2. Conversely, we must live somewhere (hopefully other than in a cardboard box under a bridge).
    • a) As such, we either pay Rent to a landlord - or - pay ownership costs for the roof over our heads.
      b) The decision to "borrow money for a house" means that we chose to pay ownership costs and means that a lender is advancing Capital - secured by the Asset (house and land) - in exchange for our legal obligation to return the Capital + Interest (consumption) to them.
      c) This decision (b) may be fully substantiated once consumption items: Interest expense, taxes, insurance, etc. are compared to Rent expense (consumption).
I'm thinking about what you are saying. I see the argument. But the idea that your home will maintain its value or increase in value is as specious as the idea that your equities will do the same. Ask any resident of Florida, Las Vegas or S. Calif. Not long ago I saw an eye-opening thread here (I think it was by nisiprius but I am not sure)...a graph of home prices vs inflation since the late 19th century. Over that period, home value barely kept up with inflation, and lost over long periods as well. We have been lulled into thinking that homes are very solid investments based on a very long (possibly unprecedented) bull market in real estate during our investment lifetime. The picture from the 1920 through the 1970s was very different. Here is a copy I found: http://www.theatlantic.com/business/arc ... 890/72980/
Protagonist,

You are mixing things again (sorry to be a pest).

You compared buying a house with a mortgage to buying investments on margin. My post challenges this idea, but has nothing to do with a house as "an investment." In that regard, you may find this link of interest.
http://www.cbsnews.com/8301-505123_162- ... nvestment/
protagonist wrote:The difference between paying the same amount of money in rent vs mortgage is that if you suddenly suffer an economic downturn (eg lose your job), if you are renting, you have the liquidity of moving somewhere cheaper, whereas if you hold a mortgage you are locked into a 30 year contract, just as if you borrowed money for anything else. In one case you have debt responsibility, which is the same as any other kind of debt. In the other case you have not. Home ownership has become a holy grail in the US. But like anything else, if you can't afford it, you shouldn't buy it.

OK, I know....nobody agrees with me... (giggle)
No one is disagreeing with (IL)liquidity in owning real estate. That said, in a free market, everything has a fair market value (like a house with a mortgage) - even if "liquidating" is not as simple a task as calling Mayflower to move in the middle of the night to leave a rented place. :)
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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Mon Mar 04, 2013 4:57 pm

YDNAL wrote: You are mixing things again (sorry to be a pest).
You are not a pest. I have a lot of respect for your ideas.
YDNAL wrote:You compared buying a house with a mortgage to buying investments on margin. My post challenges this idea, but has nothing to do with a house as "an investment."
To me, it just comes down to borrowing money to buy something you want but cannot afford outright . Whatever that "something" is...a stock, a dress, a car, a boat, a house.... it is a "thing" (I am assuming that anybody who can qualify for a mortgage can afford a roof over their head, whether it be a cheaper propertythat they have money to buy or a rental- though perhaps recent history proves otherwise). There are some tax advantages to mortgages as opposed to other investments...I get that...and you may be able to get better terms. But beyond fine points, I can see little distinction. Sure- if you can get more interest by leaving your funds in the bank or buying treasuries than you are paying on your mortgage, by all means take a mortgage. But that is rare. [/quote]

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Re: Windfall - pay off mortage, or invest in bonds?

Post by Clearly_Irrational » Mon Mar 04, 2013 5:06 pm

protagonist wrote:To me, it just comes down to borrowing money to buy something you want but cannot afford outright . Whatever that "something" is...a stock, a dress, a car, a boat, a house.... it is a "thing" (I am assuming that anybody who can qualify for a mortgage can afford a roof over their head, whether it be a cheaper property that they have money to buy or a rental- though perhaps recent history proves otherwise). There are some tax advantages to mortgages as opposed to other investments...I get that...and you may be able to get better terms. But beyond fine points, I can see little distinction. Sure- if you can get more interest by leaving your funds in the bank or buying treasuries than you are paying on your mortgage, by all means take a mortgage. But that is rare.
Without mortgages I think most people would be renters their entire lives. I do agree that prices would drop somewhat, however probably not as much as you might think because many houses would be rented out or replaced by apartment buildings.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by BrandonBogle » Mon Mar 04, 2013 9:09 pm

Protagonist, I don't look at my home itself as an investment. I looking at the mortgage as a cost of "investing" in the fact/dream that some day, I will own the house outright and my consumption cost of upkeep of the host will be minimal compared to renting. This is regardless of if my home value goes up, down, or nowhere in terms of real value (inflation-adjusted) or nominal value.

As you used borrowing money to buy clothes as an example, I use margin loans as similar to that. You are borrowing to buy something you don't have the money for and may eventually become worthless (clothes wear out). A mortgage however is borrowing to buy that short that will won't wear out in your lifetime.

While even in this case, you shouldn't go out and spend what you reasonable cant afford, borrowing to accelarate ownership that will eventually become unleveraged but continue to mitigate consumption is definitely different than borrowing on margin.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by cowboyinasia » Mon Sep 16, 2013 11:47 pm

Well, I paid off the mortgage. That was a good thing to do. Not having the mortgage brings an additional feeling of comfort and security, and the simplicity of not having to deal with it is nice too. Plus I headed off the jump in ARM which was coming around at the end of next year.

So thanks for the advice, rather than play around with bonds.

I will turn my attention to investing in local real estate though. In fact one bank pointed out by taking a mortgage on the dwelling I live in might give me the best rate!

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Re: Windfall - pay off mortage, or invest in bonds?

Post by rixer » Tue Sep 17, 2013 8:06 am

I think you made the right decision and congratulations cowboyinasia! Welcome to the club. :happy

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Re: Windfall - pay off mortage, or invest in bonds?

Post by khalestorm » Tue Sep 17, 2013 9:41 am

Clearly_Irrational wrote:
protagonist wrote:To me, it just comes down to borrowing money to buy something you want but cannot afford outright . Whatever that "something" is...a stock, a dress, a car, a boat, a house.... it is a "thing" (I am assuming that anybody who can qualify for a mortgage can afford a roof over their head, whether it be a cheaper property that they have money to buy or a rental- though perhaps recent history proves otherwise). There are some tax advantages to mortgages as opposed to other investments...I get that...and you may be able to get better terms. But beyond fine points, I can see little distinction. Sure- if you can get more interest by leaving your funds in the bank or buying treasuries than you are paying on your mortgage, by all means take a mortgage. But that is rare.
Without mortgages I think most people would be renters their entire lives. I do agree that prices would drop somewhat, however probably not as much as you might think because many houses would be rented out or replaced by apartment buildings.
That means someone has to own those properties, be it a company or individual(s). Obviously, real estate as an asset isn't high-yield and is an illiquid investment. But still, someone has to own that property. I'm in a very similar boat as OP (can pay off mortgage next year), so I'm interested to see how this turns out.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by protagonist » Tue Sep 17, 2013 8:46 pm

Without mortgages I think most people would be renters their entire lives. I do agree that prices would drop somewhat, however probably not as much as you might think because many houses would be rented out or replaced by apartment buildings.
I wonder what percentage of people owned homes, and what percentage of those took mortgages, say, 100 years ago, as compared with today.

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Re: Windfall - pay off mortage, or invest in bonds?

Post by john94549 » Tue Sep 17, 2013 10:21 pm

This is a simple question of interest arbitrage. If you are borrowing at 3.0% and reaping 4.0%, it's a simple question of math. As they say, do the math.

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