Pay off mortgage better or worse than investing in bonds?

[rai]

I’m a high saver and have a very good paying job and not too concerned with my nest egg. I’m just trying to nibble around the edges of where I should save more.

I’m at 70:30 stocks:bonds no debt except a second home which is not a rental it’s a vacation home. With the new tax law mortgage interest is less attractive than was.

I’m in a good interest rate of 2.6% 15 years which we are 30 months in.

I save in a taxable account every month as well as my 401K , HSA fully funded.

I’m typically trying to add bonds to boost my percentage and most of my new 401K is into bonds, I have rebalanced some stock as needed but just trying to consider if I’m better off saving more in my taxable or pay off my mortgage more aggressively since the interest is not fully deductible anymore.

I have heard that some say loans are like negative bonds (negative fixed income) so was thinking if I pay extra principal would be like shifting my portfolio to more bond mix.

[livesoft]

One benefit of a mortgage is that one has the option to pay it off or pay off parts of it after a big run-up in stocks or bonds. This optionality is worth something that is ignored by many of these "Should I pay off the mortgage?" threads.

For example, suppose you had a pile of cash that could be used to pay off your mortgage that you can sequester and think of differently than all your other investments. Should you invest it for 10 years in equities and use it to pay off your mortgage when it returns (after-taxes) more than 3 times your mortgage interest rate? And if is goes down in value, shouldn't you wait until it goes back up and beyond, so that it does return more than 3 times your mortgage interest rate? In other words, you don't have to cash out your investment until it succeeds.

The only issue is that you had better not invest in something that will not go up at all. Since it is pretty easy nowadays to invest in something that will go up at some point, there is never a need to pay off a mortgage until that happens.

[rai]

Thanks livesoft. I’m not talking about paying off my mortgage although you could say technically I am. I’m just talking about say adding $300-600-800 a month each month as opposed to buying more bonds or buying more stocks in a taxable account. IOW I have a lot invested in retirement and non retirement account such that I’m still going to be paying lots of taxes even when I retire. Leastways paying off a 2.6% mortgage is a guaranteed 2.6% investment. Whearas I know stocks pay that much in dividends and bonds maybe more but will be taxed on this. I do have my bonds in tax shelter but will be taxed on the income at some point.

[rai]

One point in 4-6 years plan to retire and sell both homes and buy a nicer full time home for retirement.

We’re still 12.5 years left on the mortgage and anything extra paid will lower that time to paid off closer to the 4-6 year window till retirement. I understand that’s not a big issue if the money is being used to invest or pay off mortgage it’s still being saved somewhere.

[KlangFool]

Thanks livesoft. I’m not talking about paying off my mortgage although you could say technically I am. I’m just talking about say adding $300-600-800 a month each month as opposed to buying more bonds or buying more stocks in a taxable account. IOW I have a lot invested in retirement and non retirement account such that I’m still going to be paying lots of taxes even when I retire. Leastways paying off a 2.6% mortgage is a guaranteed 2.6% investment. Whearas I know stocks pay that much in dividends and bonds maybe more but will be taxed on this. I do have my bonds in tax shelter but will be taxed on the income at some point.

rai,

1) That might not be true.

2) Even if that is true, so what? Are you saying that the after-tax return of your portfolio cannot beat 2.6%? Let's assume that the tax is 50%, your return only needs to be higher than 5.2% to beat it.

KlangFool

[smitcat]

I would not pay the mortgage off faster or earlier with any percentage near yours if the following were not already in place:
- fully funded Roth
- fully funded 401K
- fully funded college expenses
- fully funded Roth accounts for kids
- live in a non-recourse state
After those are met I would still not likely pay early and/or off any mortgage near your % if I could do these instead:
- add to after tax accounts
- invest in alternate vehicles (rentals, etc)
I would pay off a mortgage if and when I stop taking income from working as it likely will be the best trade for tax purposes.
YMMV

[JBTX]

Agree with livesoft. 2.6 is very cheap. He is correct about the optionality having value.

Looking at it another way, if rates go up, you are locked in at a lower than market rate. If rates go down you can always choose to pay it off or refinance it.

[Admiral]

Do not pay it off. Invest the extra money in a taxable account and then, if enough, pay it off when you retire.

Assuming you can take qualified distributions (from a Roth or pre-tax account) at your intended retirement age, you can take a distribution and combine it with your taxable assets to pay off the mortgage and eliminate that expense from the balance sheet.

My mortgage rate is a bit lower than your (2.25) and I buy $12k of bonds a year in my tax-deferred accounts. I am also 70/30.

Currently the yield on TBM is higher that your mortgage rate so there would be no reason for you to favor the debt over bonds.

[rai]

Thank for the advice.

[Bob B.]

I'm retired. When I was 5 years out from retirement, I pretty much eliminated my allocation to bonds and put the money instead into paying off my mortage. I wanted it paid off when I retired (didn't want the debt). Up until that time, I saw better returns (which included the tax break from the mortage) by putting money into stocks and bonds to build up my nest egg.

[DrCheese]

The tax break for mortgages is all but dead. I have a $24,000 standard deduction. I use $10,000 for state and local taxes so the first $14,000 of mortgage interest gets me nothing.

[spammagnet]

Keep it and don't pay extra. A low-cost mortgage is a good hedge against inflation.

[desiderium]

Do you have a large taxable account? If not, then investing in illiquid home equity doesn't make much sense. Also, since you are already planning to sell the house in 4-6 years, there really isn't much advantage to paying it down.

[changingtimes]

The tax break for mortgages is all but dead. I have a $24,000 standard deduction. I use $10,000 for state and local taxes so the first $14,000 of mortgage interest gets me nothing.

... "all but dead *for those married filing jointly.* "

A nice tiny bit of an advantage for singles/widows/etc.

(I hit $10k for state and local, too, but still have another $12k of deductions, including $10k for mortgage interest.)

[Que1999]

One benefit of a mortgage is that one has the option to pay it off or pay off parts of it after a big run-up in stocks or bonds. This optionality is worth something that is ignored by many of these "Should I pay off the mortgage?" threads.

For example, suppose you had a pile of cash that could be used to pay off your mortgage that you can sequester and think of differently than all your other investments. Should you invest it for 10 years in equities and use it to pay off your mortgage when it returns (after-taxes) more than 3 times your mortgage interest rate? And if is goes down in value, shouldn't you wait until it goes back up and beyond, so that it does return more than 3 times your mortgage interest rate? In other words, you don't have to cash out your investment until it succeeds.

The only issue is that you had better not invest in something that will not go up at all. Since it is pretty easy nowadays to invest in something that will go up at some point, there is never a need to pay off a mortgage until that happens.

I think this is the right answer in virtually all mortgage vs taxable account investing questions there are! I wish I knew this before plunking down $80,000 into my mortgage between 2012-2016 because the house would be paid for at this point, instead of still having 5 years left to go....

Market runs up, sell taxable at a point where you are well in the green...(think 10-20%... blow that 2-4% mortgage rate out of the water..). Market tanks, no big deal... hold the mortgage, in fact buy more shares if you can, and wait for the recovery. Then pay off the mortgage when back in the green.

Isn't this the 'right' answer to all the mortgage payoff vs taxable threads?

[majiaknight]

In other words, you don't have to cash out your investment until it succeeds.

+1 very good point.

[ThreeBears]

I would not pay off early at 2.6%. I'm at 3.65%. I pay $500 extra a month. I do this in part, as I think i'd like the mortgage to be gone when my kids go to college (not that you asked).

[Triple digit golfer]

One benefit of a mortgage is that one has the option to pay it off or pay off parts of it after a big run-up in stocks or bonds. This optionality is worth something that is ignored by many of these "Should I pay off the mortgage?" threads.

For example, suppose you had a pile of cash that could be used to pay off your mortgage that you can sequester and think of differently than all your other investments. Should you invest it for 10 years in equities and use it to pay off your mortgage when it returns (after-taxes) more than 3 times your mortgage interest rate? And if is goes down in value, shouldn't you wait until it goes back up and beyond, so that it does return more than 3 times your mortgage interest rate? In other words, you don't have to cash out your investment until it succeeds.

The only issue is that you had better not invest in something that will not go up at all. Since it is pretty easy nowadays to invest in something that will go up at some point, there is never a need to pay off a mortgage until that happens.

I think this is the right answer in virtually all mortgage vs taxable account investing questions there are! I wish I knew this before plunking down $80,000 into my mortgage between 2012-2016 because the house would be paid for at this point, instead of still having 5 years left to go....

Market runs up, sell taxable at a point where you are well in the green...(think 10-20%... blow that 2-4% mortgage rate out of the water..). Market tanks, no big deal... hold the mortgage, in fact buy more shares if you can, and wait for the recovery. Then pay off the mortgage when back in the green.

Isn't this the 'right' answer to all the mortgage payoff vs taxable threads?

How would this be executed? 10 to 20% up from what, an arbitrary point in time or from when each monthly investment is made? Or do you set a number, for example when S&P is at 3,200, I will put $X into the mortgage?

I am in a similar situation and always wonder when, if at all, I should put money into the mortgage principal. We have about 26 years remaining at 3.5%.

[Que1999]

One benefit of a mortgage is that one has the option to pay it off or pay off parts of it after a big run-up in stocks or bonds. This optionality is worth something that is ignored by many of these "Should I pay off the mortgage?" threads.

For example, suppose you had a pile of cash that could be used to pay off your mortgage that you can sequester and think of differently than all your other investments. Should you invest it for 10 years in equities and use it to pay off your mortgage when it returns (after-taxes) more than 3 times your mortgage interest rate? And if is goes down in value, shouldn't you wait until it goes back up and beyond, so that it does return more than 3 times your mortgage interest rate? In other words, you don't have to cash out your investment until it succeeds.

The only issue is that you had better not invest in something that will not go up at all. Since it is pretty easy nowadays to invest in something that will go up at some point, there is never a need to pay off a mortgage until that happens.

I think this is the right answer in virtually all mortgage vs taxable account investing questions there are! I wish I knew this before plunking down $80,000 into my mortgage between 2012-2016 because the house would be paid for at this point, instead of still having 5 years left to go....

Market runs up, sell taxable at a point where you are well in the green...(think 10-20%... blow that 2-4% mortgage rate out of the water..). Market tanks, no big deal... hold the mortgage, in fact buy more shares if you can, and wait for the recovery. Then pay off the mortgage when back in the green.

Isn't this the 'right' answer to all the mortgage payoff vs taxable threads?

How would this be executed? 10 to 20% up from what, an arbitrary point in time or from when each monthly investment is made? Or do you set a number, for example when S&P is at 3,200, I will put $X into the mortgage?

I am in a similar situation and always wonder when, if at all, I should put money into the mortgage principal. We have about 26 years remaining at 3.5%.

Let's say you invest $25,000. Market has a great year, your after-tax total return is 15%. Your mortgage rate is 4%. You sell those stocks that have returned 15% and plunk the basis and returns into your mortgage principal, locking in your 15% return rate. 15%>4%. Rinse, repeat... You can do this in increments, as livesoft said, or continue funding your taxable account until you can pay the whole thing off in one lump sum(with total after-tax returns well in excess of the mortgage rate).

[sophie1]

Here's another alternative: Buy I bonds!

Current interest rate is 2.83%, inflation protected with a fixed rate of 0.5% that is highly unlikely to increase when rates reset in May (and might even decrease), tax deferred for up to 30 years.

Plus if you buy on the last day of the month, you get interest credit for the whole month. I would definitely do this before paying down a 2.6% mortgage that is partially deductible.

[willthrill81]

One point in 4-6 years plan to retire and sell both homes and buy a nicer full time home for retirement.

We’re still 12.5 years left on the mortgage and anything extra paid will lower that time to paid off closer to the 4-6 year window till retirement. I understand that’s not a big issue if the money is being used to invest or pay off mortgage it’s still being saved somewhere.

It may be a good idea to enter retirement debt free. The reason is because guaranteed withdrawals like mortgage payments increase your sequence of returns risk (i.e. you may be forced to make withdrawals to cover your mortgage when your portfolio's performance is poor). But historically, drawing out a mortgage and investing in stocks would have resulted in higher total wealth on average, but it can increase tail risk. Basically, paying off a mortgage reduces the negative tail risk by reducing your sequence of returns risk, but it also reduces your positive tail risk by locking in historically low returns.

Keep in mind that as long as you have a mortgage, you are effectively leveraging your investments.

We recently discussed this issue in this thread.

[grabiner]

I’m a high saver and have a very good paying job and not too concerned with my nest egg. I’m just trying to nibble around the edges of where I should save more.

I’m at 70:30 stocks:bonds no debt except a second home which is not a rental it’s a vacation home. With the new tax law mortgage interest is less attractive than was.

I’m in a good interest rate of 2.6% 15 years which we are 30 months in.

Paying off the mortgage would be equivalent to buying a risk-free bond portfolio with a 2.6% yield and a 6-year duration. Paying down the mortgage would have a 12-year duration, as you would get no benefit until the mortgage is paid off. However, if you sell the home in 6 years, that gets the duration of paying it down back to 6 years, as you will get the money back with interest when you pay it off.

Is that better than taxable investing? It depends on whether the mortgage interest is deductible, and on the duration. Since you have a "very good paying job", your alternative bond investment would probably be a municipal-bond fund. A low-risk muni fund with a 6-year duration would have a 2.4% yield; you could use a 50-50 mix of Vanguard Long-Term and Intermediate-Term Tax-Exempt Admiral shares. This is higher than the after-tax yield on a deductible mortgage, but lower than the after-tax yield if you cannot deduct your mortgage interest. But if you only pay down the mortgage, a low-risk muni fund with a 12-year duration would yield more than your mortgage rate.

Therefore, I recommend paying the mortgage down if you intend to sell in 6 years and do not deduct the interest, but keeping the mortgage if you do deduct the interest. If you decide to keep the home for 12 years, don't pay down the mortgage at current rates.

I am in almost the same situation, with 2.625% interest on a mortgage with 10 years left. I can deduct all the mortgage interest from federal tax at 24% and state tax at 8.2%, so my after-tax mortgage rate is 1.79%. This is lower than the yield on 10-year munis (for paying down the mortgage), or even 5-year munis (for paying off the mortgage), so I would not even pay it off if I could do so with no tax cost. (If I wanted to pay it off now, I would have to sell stock for a large capital gain, which is another reason not to pay it off.)

[kacang]

Another data point for you to consider. We're paying down our 2.75% 15 year mortgage, for several reasons;
1. Mortgage interest is not deductible for us. SALT takes up all 24k space.
2. Our marginal tax bracket is high. If the funds were invested, TEY needs to exceed 5% to cover mortgage interest rate. I cannot find any investment of similar duration or risk giving such returns.
3. I'm retiring this month, DH will join me in a few years. We want to be mortgage-free, to manage cash flow flexibly in retirement.

[msk]

I feel that there is too much focus on trivial differences rather than on the whole forest. The interest differential between secure bonds and mortgage interest (both after tax) will always be tiny compared to stocks' probable earnings. Mortgages are always basically negative bonds, allowing leverage, but I am amazed that there is so much focus on using such leverage to buy BONDS! I can better appreciate indecision in using leverage to invest in stocks, but I am truly befuddled by all the talk in the above thread arguing in favor of leveraging bonds A portfolio consisting of a million $ stocks, 500k bonds and 500k in mortgage with nil home equity is basically an AA of 100% stocks:zero bonds. My stance to handle indecision: just increase the numbers to an absurdly high level and check whether your choice still sounds reasonable. If it makes sense to hold a mortgage of $50k within a NW at $1+ million, does it make even better sense to increase that mortgage to $1 million? No? Pay off that irritating $50k...

[grabiner]

I feel that there is too much focus on trivial differences rather than on the whole forest. The interest differential between secure bonds and mortgage interest (both after tax) will always be tiny compared to stocks' probable earnings. Mortgages are always basically negative bonds, allowing leverage, but I am amazed that there is so much focus on using such leverage to buy BONDS! I can better appreciate indecision in using leverage to invest in stocks, but I am truly befuddled by all the talk in the above thread arguing in favor of leveraging bonds

Unless you hold 100% stock, which few investors do, you are using your leverage to buy bonds, as you have the option of selling your bonds and paying down the loan. This is why comparing the mortgage to bond rates is a fair comparison.

I am not 100% stock myself, but my mortgage rate is lower than my bond rate, which is why I don't pay down the mortgage.