## Timing mortgage pay down

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
AspireToRetire
Posts: 64
Joined: Sat Jun 10, 2017 6:35 pm

### Timing mortgage pay down

The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.

Topic Author
AspireToRetire
Posts: 64
Joined: Sat Jun 10, 2017 6:35 pm

### Re: Timing mortgage pay down

I understand that, Klangfool. But that isn’t the question.

Some people may have different comfort levels with debt or different goals altogether. For example, Retiring Russ may be retiring in 15 years and may decide to pay his mortgage off in 15 years as opposed to 30 years so he doesn’t have a mortgage in retirement (irrespective of what the market does).

So if he decides he will be putting half his extra investable money toward his mortgage to meet that goal, does it matter if he puts half every month for fifteen years vs all of it toward mortgage for the first 7.5 and then all of it toward market for the next 7.5? (Assuming market conditions are equal so as to avoid sequence of returns confounding the answer here).

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 10:11 pm
I understand that, Klangfool. But that isn’t the question.

Some people may have different comfort levels with debt or different goals altogether. For example, Retiring Russ may be retiring in 15 years and may decide to pay his mortgage off in 15 years as opposed to 30 years so he doesn’t have a mortgage in retirement (irrespective of what the market does).

So if he decides he will be putting half his extra investable money toward his mortgage to meet that goal, does it matter if he puts half every month for fifteen years vs all of it toward mortgage for the first 7.5 and then all of it toward market for the next 7.5? (Assuming market conditions are equal so as to avoid sequence of returns confounding the answer here).
If you are considering "different comfort levels with debt" (or other goals), then this is no longer a math type question.

Leaving debt concerns aside, and just considering outcome, Klangfool is correct, but perhaps didn't specify in a way directly relevant.

IF the same \$X would be spent a) all extra towards mortgage, b) all extra invested, or c) combo, then what you may not be considering is that if the mortgage has less pre-paid sooner, then that money is "invested sooner", so it has the chance to increase, possibly more than the mortgage interest savings. But it's not guaranteed.

So it's not even just a "debt aversion" concern. It's also a "known but possibly lesser advantage" vs. a "possibly higher advantage, but not known - and not *guaranteed* to be a gain".

That's sort of like investing in CD's vs stocks, etc.
It's more than just the "expected value" [i.e., "arithmetic average"] comparison of the outcomes.

RM
This signature is a placebo. You are in the control group.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 10:11 pm
I understand that, Klangfool. But that isn’t the question.

Some people may have different comfort levels with debt or different goals altogether. For example, Retiring Russ may be retiring in 15 years and may decide to pay his mortgage off in 15 years as opposed to 30 years so he doesn’t have a mortgage in retirement (irrespective of what the market does).

So if he decides he will be putting half his extra investable money toward his mortgage to meet that goal, does it matter if he puts half every month for fifteen years vs all of it toward mortgage for the first 7.5 and then all of it toward market for the next 7.5? (Assuming market conditions are equal so as to avoid sequence of returns confounding the answer here).
AspireToRetire,

As long as the market return is higher than the mortgage interest, the person could invest the money and prepay the mortgage with whatever amount that he/she wants to pay into the mortgage. In that case, the longer that the person delayed prepaying the mortgage, he/she has more money.

It is very simple math. The extreme example would be no pre-paying the mortgage until you can pay it off in one lump sum.

The person that wants to pay off the mortgage in 15 years could pay off his/her mortgage with one lump sum in less than 15 years if he/she does not pre-pay the mortgage but invest instead. It is just simple math.

KlangFool

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

ResearchMed wrote:
Thu Oct 18, 2018 10:22 pm
AspireToRetire wrote:
Thu Oct 18, 2018 10:11 pm
I understand that, Klangfool. But that isn’t the question.

Some people may have different comfort levels with debt or different goals altogether. For example, Retiring Russ may be retiring in 15 years and may decide to pay his mortgage off in 15 years as opposed to 30 years so he doesn’t have a mortgage in retirement (irrespective of what the market does).

So if he decides he will be putting half his extra investable money toward his mortgage to meet that goal, does it matter if he puts half every month for fifteen years vs all of it toward mortgage for the first 7.5 and then all of it toward market for the next 7.5? (Assuming market conditions are equal so as to avoid sequence of returns confounding the answer here).
If you are considering "different comfort levels with debt" (or other goals), then this is no longer a math type question.

Leaving debt concerns aside, and just considering outcome, Klangfool is correct, but perhaps didn't specify in a way directly relevant.

IF the same \$X would be spent a) all extra towards mortgage, b) all extra invested, or c) combo, then what you may not be considering is that if the mortgage has less pre-paid sooner, then that money is "invested sooner", so it has the chance to increase, possibly more than the mortgage interest savings. But it's not guaranteed.

So it's not even just a "debt aversion" concern. It's also a "known but possibly lesser advantage" vs. a "possibly higher advantage, but not known - and not *guaranteed* to be a gain".

That's sort of like investing in CD's vs stocks, etc.
It's more than just the "expected value" [i.e., "arithmetic average"] comparison of the outcomes.

RM
ResearchMed,

<<That's sort of like investing in CD's vs stocks, etc.>>

Except with the interest rate trending up, the CD's interest rate might be higher than my mortgage rate of 3.49%. At this moment, my money market fund is paying around 2%. The gap is closing.

KlangFool

Que1999
Posts: 162
Joined: Mon May 30, 2016 10:27 am

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?

Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..

Not sure if I'm thinking about this wrong, but it led me to pay my mortgage down so around 80% of my mortgage payment is going to principal, any extra funds goes into index funds.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?

Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..

Not sure if I'm thinking about this wrong, but it led me to pay my mortgage down so around 80% of my mortgage payment is going to principal, any extra funds goes into index funds.
Que1999,

You are wrong.

It is very simple.

If you have \$1,000 extra, the mutual fund return is 5% and the mortgage interest is 4%.

A) If you invest in the mutual fund, you earn 5% on that \$1,000.

B) If you pre-pay the mortgage, you save 4% interest on the \$1,000.

<<Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..>>

This is a very common mistake. Folks forgot to calculate the opportunity cost of not investing the extra principal payment.

4% is a joke anyhow. Do you believe that a 60/40 portfolio will return less than 4% per year in the long run?

KlangFool

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?

Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..

Not sure if I'm thinking about this wrong, but it led me to pay my mortgage down so around 80% of my mortgage payment is going to principal, any extra funds goes into index funds.
Both "scenarios" compound.

You've got either the compounding positive interest of \$X paid monthly into an investment account, or you've got the positive return from the LOWER compounding interest as the mortgage is paid off, assuming no difference in fees/etc.

So IF the interest rates are the same, it should be a wash.
But the interest rates are not going to be identical, and the mortgage payoff savings is a known savings (assuming a fixed mortgage), whereas the investment returns are possibly higher, but certainly not known or even definitely positive.

RM
This signature is a placebo. You are in the control group.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

Folks,

When the CD interest rate hit 5%, will the folks that pre-pay their mortgage of 4% or less regret their decision?

KlangFool

Nate79
Posts: 6185
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

Unfortunately most people do not understand amortization tables and misunderstand why they are paying more interest at the beginning of a mortgage. There is no magic.

A mortgage is a simple loan to understand. The amount of interest in any month of a mortgage is simply the interest rate times the remaining principle divided by 12. Therefore the higher the principle remaining means higher interest paid.

It is not because it is at the beginning of the amortization table that you pay more interest. It is because the principle is higher. Period.

Therefore, any additional principle payment at any time of the loan is equivalent to a return of simply the interest rate of the loan. No matter at the beginning or the end of the loan.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

ResearchMed wrote:
Thu Oct 18, 2018 10:40 pm
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?

Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..

Not sure if I'm thinking about this wrong, but it led me to pay my mortgage down so around 80% of my mortgage payment is going to principal, any extra funds goes into index funds.
Both "scenarios" compound.

You've got either the compounding positive interest of \$X paid monthly into an investment account, or you've got the positive return from the LOWER compounding interest as the mortgage is paid off, assuming no difference in fees/etc.

So IF the interest rates are the same, it should be a wash.
But the interest rates are not going to be identical, and the mortgage payoff savings is a known savings (assuming a fixed mortgage), whereas the investment returns are possibly higher, but certainly not known or even definitely positive.

RM
RM,

Folks could pre-pay their mortgage any time. But, once the money is in, it is harder to get it out. So, a person could pre-pay anytime if the market return no longer beat the mortgage rate.

KlangFool

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 10:45 pm
ResearchMed wrote:
Thu Oct 18, 2018 10:40 pm
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?

Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..

Not sure if I'm thinking about this wrong, but it led me to pay my mortgage down so around 80% of my mortgage payment is going to principal, any extra funds goes into index funds.
Both "scenarios" compound.

You've got either the compounding positive interest of \$X paid monthly into an investment account, or you've got the positive return from the LOWER compounding interest as the mortgage is paid off, assuming no difference in fees/etc.

So IF the interest rates are the same, it should be a wash.
But the interest rates are not going to be identical, and the mortgage payoff savings is a known savings (assuming a fixed mortgage), whereas the investment returns are possibly higher, but certainly not known or even definitely positive.

RM
RM,

Folks could pre-pay their mortgage any time. But, once the money is in, it is harder to get it out. So, a person could pre-pay anytime if the market return no longer beat the mortgage rate.

KlangFool
Well, sure. But that wasn't the question as I understood it.
Your comment perfectly reflects one of the reasons why we do NOT pay down our mortgage. (It helps that it's no longer in the range of the 17.5% of my first mortgage in 1980. Of course, my money market fund was right up there, too, back then...)

The fact that we've done much better investing in terms of returns, vs. the saved mortgage interest, makes it even easier.
But even if they were a wash, we'd prefer the flexibility of having the money accessible, rather than pre-paying the mortgage.

Note that in our case, most of our retirement money is still locked up in an unaccessible 403b plan, for a few more years until DH retires, so that is definitely a factor. So we aren't as much "house poor" as we are, relatively, temporarily "403b poor".
But unless the savings on the mortgage interest was notably higher than the likely returns on investments, we'd probably still go with not prepaying the mortgage, even once DH retires.
(We are figuring our retirement income will stay about the same as pre-retirement, so if expenses are about the same, we're fine.)

RM
This signature is a placebo. You are in the control group.

lotusflower
Posts: 289
Joined: Thu Oct 24, 2013 12:32 am

### Re: Timing mortgage pay down

Amortization is not a way to cheat you out of your money.
The 'simplest' way to pay back a 30-year loan would be to pay 1/360th of the principal each month plus whatever interest is due. I just ran the numbers for a \$1MM loan at 4%, where the amortized payment would be \$4774. With this "simple" plan, the first payment would be \$6111 and the final payment would be \$2787 (the last payment is 1/360 of the principal plus \$10 interest), and the total interest would be \$117k less.

But like the others have said if you could find an investment returning exactly the same as the mortgage rate and ignore taxes, then going back to the amortized payment and investing the rest would net you \$117k more interest.

Of course most people would find a constantly-changing payment annoying, and some people are a bit cash-strapped when a mortgage starts and don't want a bigger payment than necessary, so this kind of payment plan has two big strikes against it. Since you have to pay all the interest accrued each month, the only way to smooth this out is to pay less principal in the beginning and tack it on to the later payments. If you do this to the point where all the payments are identical, you end up with the amortization formula.

It is frustrating that this results in a very slow repayment at the beginning, and that makes it very tempting to think about prepaying, but the others are right that if you invest this money instead, the compounding is exactly equivalent if the rates are the same.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?
You have it backwards. The missing link is that inflation/compound interest/time value of money (those are basically synonyms here) mean that present dollars are worth more than future dollars. While it's easy enough to calculate the actual number of interest dollars paid, the number is nearly meaningless since the value of the dollar is not constant.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..
Well sure, the interest earned should be 5x the mortgage interest paid if the investment is 5x the mortgage. (Ignoring taxes of course)

Archimedes
Posts: 267
Joined: Wed Feb 15, 2017 11:27 am

### Re: Timing mortgage pay down

There is one thing missing from this discussion. Paying down a mortgage is a sure thing. If the mortgage is 3.5%, your return is 3.5%, done deal.

When you invest that money in the market, you will earn and lose varying amounts each year. And that amount is unpredictable and unknowable. In the past, on average, you would earn X% per year. Going forward, no one knows. Klang Fool, I am surprised that you write about the market return as if it is a known return. Clearly it is not. Have you ever heard of the statement that past performance is no guarantee of future results?

If you had invested in the Japanese market 28 years ago, you would have been so much better off paying off your mortgage that investing. The Japanese market remains in the red over that time period. If you had invested \$35,000 28 years ago, you would now have \$28,000. Ouch!

So paying off a mortgage is a risk free, known investment return. Investing in the stock market may bring greater success, or greater loss. That is an unknown. Based on past performance over a long period of time, investing would have worked out better. Going forward, no one knows. So I do some of both each month, prepay the mortgage despite the low 2.6% interest rate, and I also invest extra in my taxable account. I am hoping to finish paying off my mortgage in 2019 and then I will simply continue investing in the stock market and in CDs.

Posts: 2920
Joined: Mon Oct 27, 2014 12:35 pm

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

The underlined statement is not correct. Mortgages are highly variable and dependent on both rate and term. As an example, my mortgage is 15 years, with a rate of 2.25%. The total payment is \$2017. The FIRST payment of 180 payments was 2/3 principal and 1/3 interest (roughly \$1500 and \$500, respectively). I would not classify that ratio as one that does not "materially change the principal." In fact, it changes it very much.

Now, it's true that for longer terms, more interest is paid and that much more is paid, in relative terms, up front. But that's the price you pay for a smaller payment. Klang is correct that the comparison is what that extra money will return if invested, not when it is invested.

Posts: 2920
Joined: Mon Oct 27, 2014 12:35 pm

### Re: Timing mortgage pay down

Archimedes wrote:
Fri Oct 19, 2018 3:28 am
There is one thing missing from this discussion. Paying down a mortgage is a sure thing. If the mortgage is 3.5%, your return is 3.5%, done deal.

When you invest that money in the market, you will earn and lose varying amounts each year. And that amount is unpredictable and unknowable. In the past, on average, you would earn X% per year. Going forward, no one knows. Klang Fool, I am surprised that you write about the market return as if it is a known return. Clearly it is not. Have you ever heard of the statement that past performance is no guarantee of future results?

If you had invested in the Japanese market 28 years ago, you would have been so much better off paying off your mortgage that investing. The Japanese market remains in the red over that time period. If you had invested \$35,000 28 years ago, you would now have \$28,000. Ouch!

So paying off a mortgage is a risk free, known investment return. Investing in the stock market may bring greater success, or greater loss. That is an unknown. Based on past performance over a long period of time, investing would have worked out better. Going forward, no one knows. So I do some of both each month, prepay the mortgage despite the low 2.6% interest rate, and I also invest extra in my taxable account. I am hoping to finish paying off my mortgage in 2019 and then I will simply continue investing in the stock market and in CDs.
Underlined section is incorrect. If one invests in bonds or CDs, the return is knowable, and known in advance. Many people on the board have mortgage rates that are now lower (or nearly lower) than current yields on fixed-rate investments. I have the option of two risk-free returns, one is my mortgage, the other is bonds (yes, I know, they are not completely risk free, but let's not split hairs). I choose bonds, because the return is higher than my mortgage rate.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

Fri Oct 19, 2018 6:04 am
Archimedes wrote:
Fri Oct 19, 2018 3:28 am
There is one thing missing from this discussion. Paying down a mortgage is a sure thing. If the mortgage is 3.5%, your return is 3.5%, done deal.

When you invest that money in the market, you will earn and lose varying amounts each year. And that amount is unpredictable and unknowable. In the past, on average, you would earn X% per year. Going forward, no one knows. Klang Fool, I am surprised that you write about the market return as if it is a known return. Clearly it is not. Have you ever heard of the statement that past performance is no guarantee of future results?

If you had invested in the Japanese market 28 years ago, you would have been so much better off paying off your mortgage that investing. The Japanese market remains in the red over that time period. If you had invested \$35,000 28 years ago, you would now have \$28,000. Ouch!

So paying off a mortgage is a risk free, known investment return. Investing in the stock market may bring greater success, or greater loss. That is an unknown. Based on past performance over a long period of time, investing would have worked out better. Going forward, no one knows. So I do some of both each month, prepay the mortgage despite the low 2.6% interest rate, and I also invest extra in my taxable account. I am hoping to finish paying off my mortgage in 2019 and then I will simply continue investing in the stock market and in CDs.
Underlined section is incorrect. If one invests in bonds or CDs, the return is knowable, and known in advance. Many people on the board have mortgage rates that are now lower (or nearly lower) than current yields on fixed-rate investments. I have the option of two risk-free returns, one is my mortgage, the other is bonds (yes, I know, they are not completely risk free, but let's not split hairs). I choose bonds, because the return is higher than my mortgage rate.
+1.

I have some extra money. I could invest it any way that I want.

A) I could pre-pay my mortgage at 3.49% and lose liquidity.

B) I could keep the money in my money market fund at 2%. With the interest rate going up, this rate may exceed 3.49% in a year or two.

C) I could invest as per my portfolio of 60/40. It is diversified internationally too. It is a good bet that a 60/40 portfolio will beat 3.49% in a long run.

It is very simple. It is simple math.

KlangFool

Topic Author
AspireToRetire
Posts: 64
Joined: Sat Jun 10, 2017 6:35 pm

### Re: Timing mortgage pay down

Thank you Klangfool and others. That makes perfect sense to me. I see now that the timing throughout the life of the mortgage does not matter. A 3% mortgage means 3% interest on the remaining principal no matter where you are in the paydown. So compounding “negative” interest in the paydown is matched by compounding positive interest you would be forgoing by not investing it.

Thanks for helping me understand better and for the reminder!

Cheers!

teen persuasion
Posts: 1186
Joined: Sun Oct 25, 2015 1:43 pm

### Re: Timing mortgage pay down

Fri Oct 19, 2018 5:59 am
AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

The underlined statement is not correct. Mortgages are highly variable and dependent on both rate and term. As an example, my mortgage is 15 years, with a rate of 2.25%. The total payment is \$2017. The FIRST payment of 180 payments was 2/3 principal and 1/3 interest (roughly \$1500 and \$500, respectively). I would not classify that ratio as one that does not "materially change the principal." In fact, it changes it very much.

Now, it's true that for longer terms, more interest is paid and that much more is paid, in relative terms, up front. But that's the price you pay for a smaller payment. Klang is correct that the comparison is what that extra money will return if invested, not when it is invested.
That is interesting, how different the interest/principal breakdown is for different terms and rates.

Our 30 year 9.75% mortgage was much more heavily skewed to interest. Our first payment of \$587.66 was \$555.75 interest and \$31.91 principal, nearly 95%/5%.

I had written out an amortization schedule (in the days before we had a computer at home) to help me visualize how prepayments would affect our mortgage lifespan, and to help me plan how to attack it. I looked at things in terms of months shaved off the life of the mortgage. It was immediately clear that \$\$ applied early in the life of the mortgage shaved off more months than if I waited until I had more \$\$\$. At the beginning, an extra \$100 in principal could advance us 3 extra months in the schedule. A single lump sum of \$15k knocked 8 years off. After that, it took larger amounts to have the same effect, as yes the remaining principal was reduced which shifted our payments to a greater proportion of principal vs interest. As we approached the tail end of the mortgage payout, we slowed and then stopped prepayment, shifting the extra \$\$ to retirement.

Did we do it optimally? I don't know - we were in a time frame where mortgage rates were falling, but refinancing was costly relative to our small mortgage and it rapidly reached the point it was too small to refi. So paying it off ASAP was really the only option. We also happened to begin seriously ramping up our retirement savings around 2008, so we rode the market up DCAing in.

Posts: 493
Joined: Fri Jun 01, 2007 5:21 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Fri Oct 19, 2018 7:24 am

+1.

I have some extra money. I could invest it any way that I want.

A) I could pre-pay my mortgage at 3.49% and lose liquidity.

B) I could keep the money in my money market fund at 2%. With the interest rate going up, this rate may exceed 3.49% in a year or two.

C) I could invest as per my portfolio of 60/40. It is diversified internationally too. It is a good bet that a 60/40 portfolio will beat 3.49% in a long run.

It is very simple. It is simple math.

KlangFool
I've been hearing this for close to 10 years, in the meantime I've saved a lot by pre-paying the mortgage versus the lower rate bond returns. If things switch, I'll happily switch to buying bonds instead of pre-paying the mortgage. Although in a couple years there'll be no more mortgage payments to make so I'll definitely be buying bonds.

And there's no reason to choose between a 60/40 portfolio and paying off the mortgage. Just put 40% of my portfolio toward pre-paying my mortgage. I do keep a small fraction in bonds to potentially rebalance.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

Fri Oct 19, 2018 12:29 pm
KlangFool wrote:
Fri Oct 19, 2018 7:24 am

+1.

I have some extra money. I could invest it any way that I want.

A) I could pre-pay my mortgage at 3.49% and lose liquidity.

B) I could keep the money in my money market fund at 2%. With the interest rate going up, this rate may exceed 3.49% in a year or two.

C) I could invest as per my portfolio of 60/40. It is diversified internationally too. It is a good bet that a 60/40 portfolio will beat 3.49% in a long run.

It is very simple. It is simple math.

KlangFool
I've been hearing this for close to 10 years, in the meantime I've saved a lot by pre-paying the mortgage versus the lower rate bond returns. If things switch, I'll happily switch to buying bonds instead of pre-paying the mortgage. Although in a couple years there'll be no more mortgage payments to make so I'll definitely be buying bonds.

And there's no reason to choose between a 60/40 portfolio and paying off the mortgage. Just put 40% of my portfolio toward pre-paying my mortgage. I do keep a small fraction in bonds to potentially rebalance.

<<And there's no reason to choose between a 60/40 portfolio and paying off the mortgage.>>

I disagreed. It is just your opinion that there is no reason. You are entitled to your opinion.

<<in the meantime I've saved a lot by pre-paying the mortgage>>

By foregoing the return of a 60/40 portfolio that beat your mortgage rate substantially. It is simple math. What is the return rate of a 60/40 portfolio over the last 10 years? What is your mortgage rate?

KlangFool

LiterallyIronic
Posts: 1449
Joined: Sat Dec 05, 2015 10:36 am

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

The earlier you pay those dollars toward the mortgage, yes, the greater the amount saved in terms of interest paid. However, the earlier you pay the mortgage is just giving up investing earlier. Ergo, it doesn't matter when the timing starts. If the investment earns more than the interest rate of the mortgage, then investing comes out ahead; vice versa if the investment underperforms the mortgage rate.

That being said, my 30-year fixed mortgage is 3.875%. And I absolutely pay it off early. Especially during this early time (we've now had the mortgage for 13 months). Every month, I get the breakdown of our PITI and I pay enough extra principal so that the required principal portion of the PITI plus my extra principal payment is greater than my monthly interest payment. I am now a year ahead, after one year - that is to say, I have 28 years left instead of 29. And my outstanding principal actually gets a dent in it, rather than most of my monthly payment going to interest.

However, I could instead invest that extra \$226 (and falling) per month and possibly, even probably, beat 3.875%. The math says I shouldn't be paying extra. But I'm already investing enough to reach my retirement goal amount by my retirement age goal, assuming 7% growth and I'll feel a lot better about my mortgage when it reaches \$99,999 outstanding. It's debt aversion, not math.

deikel
Posts: 1071
Joined: Sat Jan 25, 2014 7:13 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 10:42 pm
Folks,

When the CD interest rate hit 5%, will the folks that pre-pay their mortgage of 4% or less regret their decision?

KlangFool
It should really be a question of liquidity of the asset (funds are easy to cash in - a house not so much), stability of the asset in terms of value (housing in normal markets being more stable than the up and down in markets) and cash flow (mortgage wants to be paid no matter what, market investments are 'optional'). The percentage of the mortgage is less interesting IMO.

However the comparison should be 4% mortgage vs 9% market (CAGR not considering inflation) since you keep out inflation for both of them. For the mortgage, inflation works in your favor....I hope I got that right
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.

Posts: 2920
Joined: Mon Oct 27, 2014 12:35 pm

### Re: Timing mortgage pay down

LiterallyIronic wrote:
Fri Oct 19, 2018 1:55 pm
AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

The earlier you pay those dollars toward the mortgage, yes, the greater the amount saved in terms of interest paid. However, the earlier you pay the mortgage is just giving up investing earlier. Ergo, it doesn't matter when the timing starts. If the investment earns more than the interest rate of the mortgage, then investing comes out ahead; vice versa if the investment underperforms the mortgage rate.

That being said, my 30-year fixed mortgage is 3.875%. And I absolutely pay it off early. Especially during this early time (we've now had the mortgage for 13 months). Every month, I get the breakdown of our PITI and I pay enough extra principal so that the required principal portion of the PITI plus my extra principal payment is greater than my monthly interest payment. I am now a year ahead, after one year - that is to say, I have 28 years left instead of 29. And my outstanding principal actually gets a dent in it, rather than most of my monthly payment going to interest.

However, I could instead invest that extra \$226 (and falling) per month and possibly, even probably, beat 3.875%. The math says I shouldn't be paying extra. But I'm already investing enough to reach my retirement goal amount by my retirement age goal, assuming 7% growth and I'll feel a lot better about my mortgage when it reaches \$99,999 outstanding. It's debt aversion, not math.
You may be averse to debt, and that's fine. But your post indicates a common misperception of the savings attributed to an early pay down strategy, because those savings are in future dollars.

Owing to inflation, current dollars are worth more than future dollars. How much more is based on the inflation rates over time. But even with 2% inflation, a dollar has lost much of its purchasing power in 10 years. When you pre-pay a mortgage, you don't realize any savings until such time in the future (10 years, 20 years, whatever) when you no longer have a payment. The savings that you've realized are worth less, because (for example) the \$20,000 you've saved in interest doesn't have the same purchasing power as \$20,000 today.

Contrast this with investing, where the opposite is true. Over time--as long as your investment beats inflation--the value goes up due to the magic of compounding. So, each dollar you save today will be worth much more in 10 or 20 years. Investing that extra \$500 each month today will have likely reaped huge gains in the 10 or 20 years when you actually realize the interest savings in your now inflated dollars. Let's also now consider that by pre-paying today, versus sticking to your payment plan, you're paying with more valuable dollars (to you) than you will be in the future. In 10 or 15 years, a low-rate fixed mortgage will take up a smaller and smaller slice of your expenses. So by pre-paying, those valuable dollars are gone. So, yes, you've saved your \$2,000 per month (or whatever your payment is) once the note is paid off in 7, 10, 12 years. But now that \$2000 that you've freed up does not buy as much as it did.

Does this make sense?

On top of all that, what happens if you pre-pay and then must sell before the mortgage is paid off? You've realized some gains because whatever principal you owe will be less than it would have been. But suppose the house falls in value? Then you've pre-paid, lost the option to invest that money, and STILL you've come out behind.

There is a psychological/emotion satisfaction that comes with pre-paying debt. But don't confuse that with a financially sound decision.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

deikel wrote:
Fri Oct 19, 2018 2:27 pm
KlangFool wrote:
Thu Oct 18, 2018 10:42 pm
Folks,

When the CD interest rate hit 5%, will the folks that pre-pay their mortgage of 4% or less regret their decision?

KlangFool
It should really be a question of liquidity of the asset (funds are easy to cash in - a house not so much), stability of the asset in terms of value (housing in normal markets being more stable than the up and down in markets) and cash flow (mortgage wants to be paid no matter what, market investments are 'optional'). The percentage of the mortgage is less interesting IMO.

However the comparison should be 4% mortgage vs 9% market (CAGR not considering inflation) since you keep out inflation for both of them. For the mortgage, inflation works in your favor....I hope I got that right
deikel,

My statement referred to when the guaranteed return rate like CD and money market fund beat the mortgage rate that someone prepays or payoff. It has nothing to do with the market return. At our current rate of interest rate increase, we may get there in a year or two.

KlangFool

Minderbinder
Posts: 44
Joined: Wed Feb 14, 2018 3:41 pm

### Re: Timing mortgage pay down

I would add one should not ignore taxes in this scenario... post tax-reform its likely that the high standard deduction for joint-filers with low to average value houses may inherently mean there is no tax deduction for the mortgage.

In which case, the 'return' from paying down the mortgage is effectively after-tax return.

Posts: 2682
Joined: Thu Jun 27, 2013 2:15 pm

### Re: Timing mortgage pay down

AspireToRetire wrote:
Thu Oct 18, 2018 10:11 pm
I understand that, Klangfool. But that isn’t the question.

Some people may have different comfort levels with debt or different goals altogether. For example, Retiring Russ may be retiring in 15 years and may decide to pay his mortgage off in 15 years as opposed to 30 years so he doesn’t have a mortgage in retirement (irrespective of what the market does).

So if he decides he will be putting half his extra investable money toward his mortgage to meet that goal, does it matter if he puts half every month for fifteen years vs all of it toward mortgage for the first 7.5 and then all of it toward market for the next 7.5? (Assuming market conditions are equal so as to avoid sequence of returns confounding the answer here).
Investing (and the stock market) is a crapshoot!

Let's just take Optimizing Olivia (from your original post) and play different scenarios:

- Scenario 1: the stock market keeps going down all the time while she's working on paying off 50% of her mortgage.

- Scenario 2: the stock market keeps going up all the time (at a higher rate than her mortgage) while she's working on paying off 50% of her mortgage.

- Scenario 3: the stock market keeps going up all the time (at a lower rate than her mortgage) while she's working on paying off 50% of her mortgage.

- Scenario 4: the stock market has had huge gains and huge losses and, but the time she's paid off 50% of her mortgage, it is right back where it originally was when she got her mortgage.

Even with these four scenarios, we cannot conclusively say whether Olivia or Sally will have a higher nest egg when both have finally paid off their mortgages. Why? Because there will be the same four scenarios from when Olivia pays off 50% of her mortgage until when both have paid off their mortgages. Therefore, there are now in total 16 different scenarios at play (at least - I am sure there are other scenarios that one can think of, such as ... what if both got an identical inheritance somewhere along the line ... and so on).

Bottom line, unless you can predict the market into the future, there is no way I - or anyone else - can give you a precise answer as to who will be better off.

We could, if you want, answer that question if you say this comparison started in 1988 or some such time in the past

LiterallyIronic
Posts: 1449
Joined: Sat Dec 05, 2015 10:36 am

### Re: Timing mortgage pay down

Fri Oct 19, 2018 2:33 pm
LiterallyIronic wrote:
Fri Oct 19, 2018 1:55 pm
AspireToRetire wrote:
Thu Oct 18, 2018 9:51 pm
The one topic that seems to be discussed to no end on this forum is whether to pay down your mortgage or invest.

This got me thinking whether the optimal answer depends on timing.

Traditional amortization schedules heavily weigh interest in the early life of the mortgage. Your monthly payment doesn’t start to materially change the principal until halfway into the mortgage. So if you pay X additional dollars early on, it avoids you so much more interest over the lifetime of the loan than paying X dollars at the end of the loan.

If one has extra money laying around each month then let’s compare these two scenarios:

1) Optimizing Olivia puts all extra money toward the mortgage until it’s 50% paid off (knocking out the bulk of the interest on the amortization schedule), and then changes her strategy to put all extra money into the market from that point forward.
2) Simple Sally puts half of her extra money into the market and the other half toward her mortgage principal from day one until the mortgage is paid off.

Are both of these characters coming out the same or is Optimizing Olivia ending up ahead in any way?

I’m not great with math so curious if wiser minds would know the answer here.

The earlier you pay those dollars toward the mortgage, yes, the greater the amount saved in terms of interest paid. However, the earlier you pay the mortgage is just giving up investing earlier. Ergo, it doesn't matter when the timing starts. If the investment earns more than the interest rate of the mortgage, then investing comes out ahead; vice versa if the investment underperforms the mortgage rate.

That being said, my 30-year fixed mortgage is 3.875%. And I absolutely pay it off early. Especially during this early time (we've now had the mortgage for 13 months). Every month, I get the breakdown of our PITI and I pay enough extra principal so that the required principal portion of the PITI plus my extra principal payment is greater than my monthly interest payment. I am now a year ahead, after one year - that is to say, I have 28 years left instead of 29. And my outstanding principal actually gets a dent in it, rather than most of my monthly payment going to interest.

However, I could instead invest that extra \$226 (and falling) per month and possibly, even probably, beat 3.875%. The math says I shouldn't be paying extra. But I'm already investing enough to reach my retirement goal amount by my retirement age goal, assuming 7% growth and I'll feel a lot better about my mortgage when it reaches \$99,999 outstanding. It's debt aversion, not math.
You may be averse to debt, and that's fine. But your post indicates a common misperception of the savings attributed to an early pay down strategy, because those savings are in future dollars.

Owing to inflation, current dollars are worth more than future dollars. How much more is based on the inflation rates over time. But even with 2% inflation, a dollar has lost much of its purchasing power in 10 years. When you pre-pay a mortgage, you don't realize any savings until such time in the future (10 years, 20 years, whatever) when you no longer have a payment. The savings that you've realized are worth less, because (for example) the \$20,000 you've saved in interest doesn't have the same purchasing power as \$20,000 today.

Contrast this with investing, where the opposite is true. Over time--as long as your investment beats inflation--the value goes up due to the magic of compounding. So, each dollar you save today will be worth much more in 10 or 20 years. Investing that extra \$500 each month today will have likely reaped huge gains in the 10 or 20 years when you actually realize the interest savings in your now inflated dollars. Let's also now consider that by pre-paying today, versus sticking to your payment plan, you're paying with more valuable dollars (to you) than you will be in the future. In 10 or 15 years, a low-rate fixed mortgage will take up a smaller and smaller slice of your expenses. So by pre-paying, those valuable dollars are gone. So, yes, you've saved your \$2,000 per month (or whatever your payment is) once the note is paid off in 7, 10, 12 years. But now that \$2000 that you've freed up does not buy as much as it did.

Does this make sense?

On top of all that, what happens if you pre-pay and then must sell before the mortgage is paid off? You've realized some gains because whatever principal you owe will be less than it would have been. But suppose the house falls in value? Then you've pre-paid, lost the option to invest that money, and STILL you've come out behind.

There is a psychological/emotion satisfaction that comes with pre-paying debt. But don't confuse that with a financially sound decision.
I disregard inflation. I assume my income will never increase from what it is now; I assume that all expenses will remain unchanged (and therefore my fixed-rate mortgage will stay the exact same percentage of my income). Multiplying my 2018 expenses (plus a buffer for fun) by 25 results in \$600,000. So I intend to retire 15 years from now on \$600,000. I live a simple life in which I don't worry about inflation, or "chasing yield," or what-have-you. I just simply invest \$1,324 every month and pay Interest minus Principal in extra principal payments every month. And beyond that, I just let it ride. Life's too short for me to be wringing my hands about whether or not everything is optimized.

And I never claimed that pre-paying comes out "ahead" financially speaking. In fact, I specifically said otherwise.

moghopper
Posts: 140
Joined: Fri Oct 18, 2013 10:07 am

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 9:57 pm

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

Stock Return = X.

Bond return = Y.

If Y > X, sell all stocks and buy bonds

If X > Y, sell all bonds and buy stocks

Simple.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

moghopper wrote:
Fri Oct 19, 2018 4:17 pm
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

Stock Return = X.

Bond return = Y.

If Y > X, sell all stocks and buy bonds

If X > Y, sell all bonds and buy stocks

Simple.
30 years fixed rate mortgage is not the same as a normal bond or a bond fund.

KlangFool

moghopper
Posts: 140
Joined: Fri Oct 18, 2013 10:07 am

### Re: Timing mortgage pay down

KlangFool wrote:
Fri Oct 19, 2018 4:26 pm

30 years fixed rate mortgage is not the same as a normal bond or a bond fund.

KlangFool
So you say - but my point is that this subject is more nuanced than you care to consider. You have a very black and white view that is generally at odds with my experience.

I don't believe that it makes any difference if you pay down the mortgage early or late. But it can be a valid decision for some to make to reduce a source of risk over the long term. Best of course, if this is a complete paydown, or combined with a recast that will reduce the payment.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

moghopper wrote:
Fri Oct 19, 2018 4:29 pm
KlangFool wrote:
Fri Oct 19, 2018 4:26 pm

30 years fixed rate mortgage is not the same as a normal bond or a bond fund.

KlangFool
So you say - but my point is that this subject is more nuanced than you care to consider. You have a very black and white view that is generally at odds with my experience.

I don't believe that it makes any difference if you pay down the mortgage early or late. But it can be a valid decision for some to make to reduce a source of risk over the long term. Best of course, if this is a complete paydown, or combined with a recast that will reduce the payment.
moghopper,

<<I don't believe that it makes any difference if you pay down the mortgage early or late. >>

That is your opinion. It is not supported by the actual math.

<<You have a very black and white view that is generally at odds with my experience.>>

My view is supported by basic math. If you disagree, you can mathematically prove it wrong. No experience is required.

KlangFool

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

moghopper wrote:
Fri Oct 19, 2018 4:29 pm
KlangFool wrote:
Fri Oct 19, 2018 4:26 pm

30 years fixed rate mortgage is not the same as a normal bond or a bond fund.

KlangFool
So you say - but my point is that this subject is more nuanced than you care to consider. You have a very black and white view that is generally at odds with my experience.

I don't believe that it makes any difference if you pay down the mortgage early or late. But it can be a valid decision for some to make to reduce a source of risk over the long term. Best of course, if this is a complete paydown, or combined with a recast that will reduce the payment.
You wrote "But it can be a valid decision for some to make to reduce a source of risk over the long term."

That may well be a valid decision, for you or others, about reducing risk.

However, that is not at all the same as whether the actual expected or actual outcomes (depending upon choice of alternative investment) are mathematically "better" (meaning, "more money").

RM
This signature is a placebo. You are in the control group.

Posts: 493
Joined: Fri Jun 01, 2007 5:21 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Fri Oct 19, 2018 1:38 pm
Fri Oct 19, 2018 12:29 pm
KlangFool wrote:
Fri Oct 19, 2018 7:24 am

+1.

I have some extra money. I could invest it any way that I want.

A) I could pre-pay my mortgage at 3.49% and lose liquidity.

B) I could keep the money in my money market fund at 2%. With the interest rate going up, this rate may exceed 3.49% in a year or two.

C) I could invest as per my portfolio of 60/40. It is diversified internationally too. It is a good bet that a 60/40 portfolio will beat 3.49% in a long run.

It is very simple. It is simple math.

KlangFool
I've been hearing this for close to 10 years, in the meantime I've saved a lot by pre-paying the mortgage versus the lower rate bond returns. If things switch, I'll happily switch to buying bonds instead of pre-paying the mortgage. Although in a couple years there'll be no more mortgage payments to make so I'll definitely be buying bonds.

And there's no reason to choose between a 60/40 portfolio and paying off the mortgage. Just put 40% of my portfolio toward pre-paying my mortgage. I do keep a small fraction in bonds to potentially rebalance.

<<And there's no reason to choose between a 60/40 portfolio and paying off the mortgage.>>

I disagreed. It is just your opinion that there is no reason. You are entitled to your opinion.

<<in the meantime I've saved a lot by pre-paying the mortgage>>

By foregoing the return of a 60/40 portfolio that beat your mortgage rate substantially. It is simple math. What is the return rate of a 60/40 portfolio over the last 10 years? What is your mortgage rate?

KlangFool
But I have not had a 60/40 portfolio because I can take on more risk by paying down my mortgage. A mortgage is just a negative bond. I have about a 90/10 portfolio that has performed great over the last 10 years and I have a nearly paid off mortgage that has a 4.25% interest rate. What I haven't held is bonds that haven't performed great, especially the last 5 years.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

Fri Oct 19, 2018 4:49 pm
KlangFool wrote:
Fri Oct 19, 2018 1:38 pm
Fri Oct 19, 2018 12:29 pm
KlangFool wrote:
Fri Oct 19, 2018 7:24 am

+1.

I have some extra money. I could invest it any way that I want.

A) I could pre-pay my mortgage at 3.49% and lose liquidity.

B) I could keep the money in my money market fund at 2%. With the interest rate going up, this rate may exceed 3.49% in a year or two.

C) I could invest as per my portfolio of 60/40. It is diversified internationally too. It is a good bet that a 60/40 portfolio will beat 3.49% in a long run.

It is very simple. It is simple math.

KlangFool
I've been hearing this for close to 10 years, in the meantime I've saved a lot by pre-paying the mortgage versus the lower rate bond returns. If things switch, I'll happily switch to buying bonds instead of pre-paying the mortgage. Although in a couple years there'll be no more mortgage payments to make so I'll definitely be buying bonds.

And there's no reason to choose between a 60/40 portfolio and paying off the mortgage. Just put 40% of my portfolio toward pre-paying my mortgage. I do keep a small fraction in bonds to potentially rebalance.

<<And there's no reason to choose between a 60/40 portfolio and paying off the mortgage.>>

I disagreed. It is just your opinion that there is no reason. You are entitled to your opinion.

<<in the meantime I've saved a lot by pre-paying the mortgage>>

By foregoing the return of a 60/40 portfolio that beat your mortgage rate substantially. It is simple math. What is the return rate of a 60/40 portfolio over the last 10 years? What is your mortgage rate?

KlangFool
But I have not had a 60/40 portfolio because I can take on more risk by paying down my mortgage. A mortgage is just a negative bond. I have about a 90/10 portfolio that has performed great over the last 10 years and I have a nearly paid off mortgage that has a 4.25% interest rate. What I haven't held is bonds that haven't performed great, especially the last 5 years.

That does not change the comparison.

1) You choose to believe that the mortgage is a negative bond.

2) You choose to compare the mortgage rate with a bond.

3) Then, you decide to pay down the mortgage based on (1) and (2).

Somebody else could

1) Do not believe that the mortgage is a negative bond.

2) Compare the mortgage rate with their portfolio return.

3) Decide not to pay down the mortgage.

<< But I have not had a 60/40 portfolio because I can take on more risk by paying down my mortgage. A mortgage is just a negative bond. >>

I wish you the best of luck. This does not make any sense for me. You had just increase your liquidity risk and market risk at the same time.

KlangFool

Posts: 493
Joined: Fri Jun 01, 2007 5:21 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Fri Oct 19, 2018 5:12 pm

...
I wish you the best of luck. This does not make any sense for me. You had just increase your liquidity risk and market risk at the same time.

KlangFool
I agree with you that I have increased my liquidity risk. I don't believe I've increased my market risk. The amount I have in stocks in the same and I would lose the same either way in a market crash. The only difference is bonds versus paying mortgage. It's 60/40 vs. 60/10 and 30% towards paying down the mortgage.

The key is to make sure you haven't overextended and bought too much house so you can handle the liquidity risk. And an emergency fund that matches your employment risk.

grabiner
Posts: 27463
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

### Re: Timing mortgage pay down

Timing actually works slightly in the other direction; it is more attractive to pay down a shorter-term mortgage.

If you make an extra payment on a 3% mortgage, your return is 3%, regardless of the remaining time on the mortgage; your balance will be \$10,300 less next year, and \$10,609 less in two years.

But if you have a shorter-term mortgage, you are locking in the rate for a shorter time, as if you bought a shorter-term bond. If you can buy a three-year bond at 2.75% or a 10-year bond at 3.25%, then you should buy a bond in preference to paying down a 10-year mortgage at 3%, but pay down a 3-year mortgage at 3% in preference to buying a bond.

For this purpose, the term of an ARM is the time to the next reset, since you will be forced to refinance the mortgage at the then-current rate when it resets.
David Grabiner

Archimedes
Posts: 267
Joined: Wed Feb 15, 2017 11:27 am

### Re: Timing mortgage pay down

After maxing out the tax deferred accounts, each month I put 75% of extra funds into an 80/20 taxable account, and 25% of extra funds towards mortgage principal. I do this despite a 2.625% mortgage rate.

I am hoping to finish paying off this mortgage in early 2019. Once there is no more mortgage to pay each month, I will have major extra cash each month on top of what I already have. This is going to make my cash flow look great, and I am going to feel so happy not to owe any money to anyone.

I will have plenty in retirement accounts, in taxable accounts, in real estate investments and plenty of extra cash flow to boot. This is going to make me feel so much more comfortable than having those extra funds in treasury bills or CD investments, so that is what I plan to do. To each his own....

Posts: 2920
Joined: Mon Oct 27, 2014 12:35 pm

### Re: Timing mortgage pay down

Archimedes wrote:
Sun Oct 21, 2018 7:17 pm
After maxing out the tax deferred accounts, each month I put 75% of extra funds into an 80/20 taxable account, and 25% of extra funds towards mortgage principal. I do this despite a 2.625% mortgage rate.

I am hoping to finish paying off this mortgage in early 2019. Once there is no more mortgage to pay each month, I will have major extra cash each month on top of what I already have. This is going to make my cash flow look great, and I am going to feel so happy not to owe any money to anyone.

I will have plenty in retirement accounts, in taxable accounts, in real estate investments and plenty of extra cash flow to boot. This is going to make me feel so much more comfortable than having those extra funds in treasury bills or CD investments, so that is what I plan to do. To each his own....
Anyone except your insurance company, your local r.e. tax collector, etc. Not to make light of your feelings but, while having no mortgage may feel great, the housing bills must still be paid.

balbrec2
Posts: 290
Joined: Mon Nov 13, 2017 3:03 pm

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
While your rate on your mortgage is knowable, the future return of the stock market is not.
I would not be in a hurry to prepay a 3.49% note. Keep the note and DCA into stocks. Keep in mind, if you are
deducting mortgage interest it becomes a 2.61% note in the 25% bracket.

KlangFool
Posts: 16992
Joined: Sat Oct 11, 2008 12:35 pm

### Re: Timing mortgage pay down

balbrec2 wrote:
Mon Oct 22, 2018 7:24 am
KlangFool wrote:
Thu Oct 18, 2018 9:57 pm
OP,

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.

If you have \$500 extra, mortgage interest = 3% and market return = 7%, investing the \$500 always win since 7% is greater than 3%.

KlangFool

P.S.: My mortgage interest is 3.49%. I am not prepaying my mortgage.
While your rate on your mortgage is knowable, the future return of the stock market is not.
I would not be in a hurry to prepay a 3.49% note. Keep the note and DCA into stocks. Keep in mind, if you are
deducting mortgage interest it becomes a 2.61% note in the 25% bracket.
balbrec2,

1) It does not have to be the future stock market return. The person could make this into an annual decision or change his/her mind at any time.

2) The interest rate is going up. So, the risk-free return of money market fund or CD may beat 3.49% in one or two years too.

KlangFool

unclescrooge
Posts: 5072
Joined: Thu Jun 07, 2012 7:00 pm

### Re: Timing mortgage pay down

lotusflower wrote:
Fri Oct 19, 2018 1:36 am
Amortization is not a way to cheat you out of your money.
The 'simplest' way to pay back a 30-year loan would be to pay 1/360th of the principal each month plus whatever interest is due. I just ran the numbers for a \$1MM loan at 4%, where the amortized payment would be \$4774. With this "simple" plan, the first payment would be \$6111 and the final payment would be \$2787 (the last payment is 1/360 of the principal plus \$10 interest), and the total interest would be \$117k less.

But like the others have said if you could find an investment returning exactly the same as the mortgage rate and ignore taxes, then going back to the amortized payment and investing the rest would net you \$117k more interest.

Of course most people would find a constantly-changing payment annoying, and some people are a bit cash-strapped when a mortgage starts and don't want a bigger payment than necessary, so this kind of payment plan has two big strikes against it. Since you have to pay all the interest accrued each month, the only way to smooth this out is to pay less principal in the beginning and tack it on to the later payments. If you do this to the point where all the payments are identical, you end up with the amortization formula.

It is frustrating that this results in a very slow repayment at the beginning, and that makes it very tempting to think about prepaying, but the others are right that if you invest this money instead, the compounding is exactly equivalent if the rates are the same.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?
You have it backwards. The missing link is that inflation/compound interest/time value of money (those are basically synonyms here) mean that present dollars are worth more than future dollars. While it's easy enough to calculate the actual number of interest dollars paid, the number is nearly meaningless since the value of the dollar is not constant.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..
Well sure, the interest earned should be 5x the mortgage interest paid if the investment is 5x the mortgage. (Ignoring taxes of course)
This is a great summary.

It's why I've chosen to get an ARM. In the initial years the amount going towards principal reduction is considerably higher than with a 30 year loan.

Of course, stability of wife's job was also a factor. If in case, rates went up 200% she could still make the payments on her income alone.

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

unclescrooge wrote:
Mon Oct 22, 2018 3:53 pm
lotusflower wrote:
Fri Oct 19, 2018 1:36 am
Amortization is not a way to cheat you out of your money.
The 'simplest' way to pay back a 30-year loan would be to pay 1/360th of the principal each month plus whatever interest is due. I just ran the numbers for a \$1MM loan at 4%, where the amortized payment would be \$4774. With this "simple" plan, the first payment would be \$6111 and the final payment would be \$2787 (the last payment is 1/360 of the principal plus \$10 interest), and the total interest would be \$117k less.

But like the others have said if you could find an investment returning exactly the same as the mortgage rate and ignore taxes, then going back to the amortized payment and investing the rest would net you \$117k more interest.

Of course most people would find a constantly-changing payment annoying, and some people are a bit cash-strapped when a mortgage starts and don't want a bigger payment than necessary, so this kind of payment plan has two big strikes against it. Since you have to pay all the interest accrued each month, the only way to smooth this out is to pay less principal in the beginning and tack it on to the later payments. If you do this to the point where all the payments are identical, you end up with the amortization formula.

It is frustrating that this results in a very slow repayment at the beginning, and that makes it very tempting to think about prepaying, but the others are right that if you invest this money instead, the compounding is exactly equivalent if the rates are the same.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
I actually have been thinking along the lines of what the OP is saying. The % on a mortgage isn't as important as the actual number of interest dollars paid? Is it? And similarly, the % of interest on an investment isn't as important as the actual # earned on that interest?
You have it backwards. The missing link is that inflation/compound interest/time value of money (those are basically synonyms here) mean that present dollars are worth more than future dollars. While it's easy enough to calculate the actual number of interest dollars paid, the number is nearly meaningless since the value of the dollar is not constant.
Que1999 wrote:
Thu Oct 18, 2018 10:31 pm
Just as an extreme example 4% interest earned on a \$500k mutual fund investment isn't equivalent to 4% interest paid on a \$100k mortgage. Those 'real' numbers will be very different..
Well sure, the interest earned should be 5x the mortgage interest paid if the investment is 5x the mortgage. (Ignoring taxes of course)
This is a great summary.

It's why I've chosen to get an ARM. In the initial years the amount going towards principal reduction is considerably higher than with a 30 year loan.

Of course, stability of wife's job was also a factor. If in case, rates went up 200% she could still make the payments on her income alone.
Did you mean a 15 year mortgage vs. a 30 yr mortgage?

The comparison with an ARM and "30 year loan" (assuming here that it is not adjustable) would depend upon the comparative rates and the terms. An ARM of similar rate and term as a conventional mortgage will have the *same* amortization, at least until there is a re-set.

RM
This signature is a placebo. You are in the control group.

unclescrooge
Posts: 5072
Joined: Thu Jun 07, 2012 7:00 pm

### Re: Timing mortgage pay down

ResearchMed wrote:
Mon Oct 22, 2018 4:22 pm
unclescrooge wrote:
Mon Oct 22, 2018 3:53 pm

This is a great summary.

It's why I've chosen to get an ARM. In the initial years the amount going towards principal reduction is considerably higher than with a 30 year loan.

Of course, stability of wife's job was also a factor. If in case, rates went up 200% she could still make the payments on her income alone.
Did you mean a 15 year mortgage vs. a 30 yr mortgage?

The comparison with an ARM and "30 year loan" (assuming here that it is not adjustable) would depend upon the comparative rates and the terms. An ARM of similar rate and term as a conventional mortgage will have the *same* amortization, at least until there is a re-set.

RM
I'm comparing a 7 year ARM at 2.625% vs a 30 year at 4.25%.

ResearchMed
Posts: 10413
Joined: Fri Dec 26, 2008 11:25 pm

### Re: Timing mortgage pay down

unclescrooge wrote:
Mon Oct 22, 2018 5:24 pm
ResearchMed wrote:
Mon Oct 22, 2018 4:22 pm
unclescrooge wrote:
Mon Oct 22, 2018 3:53 pm

This is a great summary.

It's why I've chosen to get an ARM. In the initial years the amount going towards principal reduction is considerably higher than with a 30 year loan.

Of course, stability of wife's job was also a factor. If in case, rates went up 200% she could still make the payments on her income alone.
Did you mean a 15 year mortgage vs. a 30 yr mortgage?

The comparison with an ARM and "30 year loan" (assuming here that it is not adjustable) would depend upon the comparative rates and the terms. An ARM of similar rate and term as a conventional mortgage will have the *same* amortization, at least until there is a re-set.

RM
I'm comparing a 7 year ARM at 2.625% vs a 30 year at 4.25%.
Then you should have mentioned the difference in the rates, because the big difference in the case you are describing is in the difference in the two interest rates.
The fact that one is an ARM and one is conventional is not the reason for the difference in the amount of principal/amount of interest paid that you mention.
(Also the amortization time for your ARM; is it still amortized over 30 years, albeit the *rate* adjusts after 7?)

There may be people here who have not yet spent much time looking into mortgages (most of us who have done so, were at one point not particularly familiar with all of this). So it helps to write correctly which 'factors' affect the aspects of paying down the mortgage.
(Yes, ARM's usually start out at lower interest rates, so of course more is paid in principal during those years. But that may reverse if the ARM eventually adjusts to significantly higher than the fixed, etc. There are various ways to structure a mortgage, including shortening - or lengthening - the number of years used to amortize, and they'll all affect the ratio of interest to principal paid, to differing degrees.)

RM
This signature is a placebo. You are in the control group.

Ron Scott
Posts: 1090
Joined: Tue Apr 05, 2016 5:38 am

### Re: Timing mortgage pay down

KlangFool wrote:
Thu Oct 18, 2018 9:57 pm

It is very simple.

Mortgage interest rate = X.

Market return = Y.

If Y > X, investing win.

If X > Y, pay extra win.

It has nothing to do with timing.
On the other hand...

Mortgage Interest Rate = X GUARANTEED
Market return = Y YESTERDAY. TOMORROW? WHO KNOWS?
If Y > X LONG ENOUGH investing win
If X > Y pay extra MAY win, DEPENDING ON MARKET RETURNS

Timing is everything.

PS: Paid off mortgage early, many years ago. Happy.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

unclescrooge
Posts: 5072
Joined: Thu Jun 07, 2012 7:00 pm

### Re: Timing mortgage pay down

ResearchMed wrote:
Mon Oct 22, 2018 5:36 pm
unclescrooge wrote:
Mon Oct 22, 2018 5:24 pm
ResearchMed wrote:
Mon Oct 22, 2018 4:22 pm
unclescrooge wrote:
Mon Oct 22, 2018 3:53 pm

This is a great summary.

It's why I've chosen to get an ARM. In the initial years the amount going towards principal reduction is considerably higher than with a 30 year loan.

Of course, stability of wife's job was also a factor. If in case, rates went up 200% she could still make the payments on her income alone.
Did you mean a 15 year mortgage vs. a 30 yr mortgage?

The comparison with an ARM and "30 year loan" (assuming here that it is not adjustable) would depend upon the comparative rates and the terms. An ARM of similar rate and term as a conventional mortgage will have the *same* amortization, at least until there is a re-set.

RM
I'm comparing a 7 year ARM at 2.625% vs a 30 year at 4.25%.
Then you should have mentioned the difference in the rates, because the big difference in the case you are describing is in the difference in the two interest rates.
The fact that one is an ARM and one is conventional is not the reason for the difference in the amount of principal/amount of interest paid that you mention.
(Also the amortization time for your ARM; is it still amortized over 30 years, albeit the *rate* adjusts after 7?)

There may be people here who have not yet spent much time looking into mortgages (most of us who have done so, were at one point not particularly familiar with all of this). So it helps to write correctly which 'factors' affect the aspects of paying down the mortgage.
(Yes, ARM's usually start out at lower interest rates, so of course more is paid in principal during those years. But that may reverse if the ARM eventually adjusts to significantly higher than the fixed, etc. There are various ways to structure a mortgage, including shortening - or lengthening - the number of years used to amortize, and they'll all affect the ratio of interest to principal paid, to differing degrees.)

RM
I didn't mention it for 2 reasons...I think I had mentioned it earlier in this thread, and it wasn't the most important lesson to take away.

Most people don't actively realize that a lower rate results in a larger principal payment. They only think that the interest paid is lower, and assume that the principal paid down is the same. It is not. And that is important.

Even if the interest rate goes up, depending on how much it goes up, how much extra principal you've paid down through regular mortgage payments (no extras), and how much inflation we've seen, you still come out ahead.... But of course carries a risk, which is why you want to consider the stability and growth of your job, which I did mention.

majiaknight
Posts: 133
Joined: Tue Jan 26, 2016 2:55 pm

### Re: Timing mortgage pay down

Besides all the good discussion above on the theory, I'd suggest OP run the following mortgage payoff calculator (Extra Monthly Payments) to compare difference scenarios:
http://www.mtgprofessor.com/calculators ... tor2a.html

You could look at the extra payment benefits and loan schedule to compare different timings of extra payment.

CMD1
Posts: 128
Joined: Tue Nov 28, 2017 8:10 pm

### Re: Timing mortgage pay down

A lot of analytical answers and a lot of truth BUT a lot of good can come from having no house payment. The lower you are on the income scale the more this really shows -- the freedom of no payment and choices that allows you to make and the sleep well at night factor are real for many. You can try to be the smartest guy in the room and most on here are but the reality is most Americans are more likely to spend it eventually if it's not in the house and thus end up with a mortgage into retirement years, again doesn't really apply to most here but is a factor for much of the population.