Low cost index fund Vs Mortgage

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moneymatters281
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Low cost index fund Vs Mortgage

Post by moneymatters281 »

Hello everyone,

I recently joined Bogleheads and amazed to see ocean of valuable information. Here is my delima.

I have around 100K sitting in TD Ameritrade from last few months. People are saying market will fall down soon but I am not sure how long it will take. I do not want to wait to time the market. I do have primary home mortgage with 3% interest rate. I need experts advise on this - should I use amount to pay towards mortgage or invest in low cost index fund ? I am inclining towards low cost index fund. If this what experts thinks, please suggest me low cost index funds. I am open for any other ideas too.

Appreciate your help and thanks in advance.
delamer
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Re: Low cost index fund Vs Mortgage

Post by delamer »

Where did the $100K come from? Is it new money or did it come from a bonus, selling property, etc.?

A lot depends on how much liquidity you have, in addition to the $100K. You don’t want to put all of your available cash into your house.

Of course, you could put some into the mortgage and some into an index fund. Which index fund depends on your ultimate purpose for the money.

If you decide to put it toward your mortgage, you should look into a recast: https://www.lendingtree.com/home/mortga ... recasting/
lakpr
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Re: Low cost index fund Vs Mortgage

Post by lakpr »

what is your tax bracket, what is the mortgage balance, what is your tax filing stratus? This information is required before being able to answer which is a better option

The TCJA law has made mortgage interest effectively non-deductible. Only if the mortgage interest exceeds $24,600 (standard deduction) - $10,000 (SALT cap) = $14,600 you will get any benefit on mortgage interest deduction. That is equivalent to having an outstanding mortgage balance of $14,600/3% = $487k approximately

If you don’t own a mansion with more than $500k mortgage balance, your mortgage is costing you 3% after tax

If you are in a 22% tax bracket, you need to earn 3%/(1 - 0.22) = 3.84% in your investments for investing to make sense than paying off mortgage.

It s possible to get 3.84% returns, but that return is NOT GUARANTEED like it is with paying down the mortgage. If you invest in stocks or any blended fund or Target Date fund or a 3-fund portfolio, you ARE taking risk. It is up to you to decide whether the risk is worth it, and if by taking a risk you will out-earn 3.84%.
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Wiggums
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Re: Low cost index fund Vs Mortgage

Post by Wiggums »

You are right in not wanting the time the market. The market goes up and down. Even if it dropped a little, is that enough to invest the money?

There are reasons to pay down the mortgage and reasons to invest. the other contributors raised the pertinent questions. I personally don’t think you can go wrong investing or paying down the mortgage or a combination of both. Assuming you have some cash, if invest in index funds and let the money compound over many years.

Good luck to you...
djheini
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Re: Low cost index fund Vs Mortgage

Post by djheini »

lakpr wrote: Mon Jul 15, 2019 2:20 pm The TCJA law has made mortgage interest effectively non-deductible. Only if the mortgage interest exceeds $24,600 (standard deduction) - $10,000 (SALT cap) = $14,600 you will get any benefit on mortgage interest deduction. That is equivalent to having an outstanding mortgage balance of $14,600/3% = $487k approximately
Only if you're married. As a single filer you only get $12,200 standard deduction but still have the $10,000 SALT cap, so you only need $2,200 of other deductions to make itemizing worth it.
Shael_AT
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Re: Low cost index fund Vs Mortgage

Post by Shael_AT »

There is a real, strategic posture you can lock into when paying off mortgage early versus throwing into equities.

For example, lets say you pay an extra ~10,000 through 20,000 a year on a 600,000 loan, on top of your current payments. You are in your first 10 years of ownership and the regular payment is mostly interest anyways.

During an downturn, either in the economy, at your job specifically or in your personal/familial life, or in general if you need to hold a reduced income unexpectedly late into that first 10 years (years 7-10), you now have enough equity build up in the house from your extra payments that could truly mean saving your house.

Let me explain.

Most likely, a significant income hit will come from a layoff, business restructuring or something similar. There is a fair chance your equities will be 20-50% lower than they were a month(s) before. You can use the equity built up in the home to re-finance and re-structure your debt agreement with the bank, while potentially benefiting from a near-0 rate environment (sound familiar?). Suddenly, your term is no longer 20 years until payoff, but back to a full 30 term. You pay some fee's and taxes on the new structuring. But, your recurring payment is lower and more manageable than it was before.

This is a pretty niche case, BTW, but this is the kind of strategy you need to consider as a pro when paying additional into the home. I've seen this deployed successfully during the last two crashes from family and colleagues. "Better than losing our kids school/our family home/etc".
TravelforFun
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Re: Low cost index fund Vs Mortgage

Post by TravelforFun »

Are the $100k being invested right now or are they sitting in a saving account. If the money is in a saving account and you have another sources of funds for emergency fund, then apply the $100k towards your mortgage.

TravelforFun
lakpr
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Re: Low cost index fund Vs Mortgage

Post by lakpr »

djheini wrote: Mon Jul 15, 2019 3:12 pm Only if you're married. As a single filer you only get $12,200 standard deduction but still have the $10,000 SALT cap, so you only need $2,200 of other deductions to make itemizing worth it.
True. If you are single, and even if you don’t have anything else but mortgage interest as your only deduction, your mortgage balance can be as little as $2200/3% = $73k. Any mortgage balance above that makes your mortgage interest partially deductible.
lakpr
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Re: Low cost index fund Vs Mortgage

Post by lakpr »

Shael_AT wrote: Mon Jul 15, 2019 3:21 pm There is a real, strategic posture you can lock into when paying off mortgage early versus throwing into equities.

For example, lets say you pay an extra ~10,000 through 20,000 a year on a 600,000 loan, on top of your current payments. You are in your first 10 years of ownership and the regular payment is mostly interest anyways.

During an downturn, either in the economy, at your job specifically or in your personal/familial life, or in general if you need to hold a reduced income unexpectedly late into that first 10 years (years 7-10), you now have enough equity build up in the house from your extra payments that could truly mean saving your house.

Let me explain.

Most likely, a significant income hit will come from a layoff, business restructuring or something similar. There is a fair chance your equities will be 20-50% lower than they were a month(s) before. You can use the equity built up in the home to re-finance and re-structure your debt agreement with the bank, while potentially benefiting from a near-0 rate environment (sound familiar?). Suddenly, your term is no longer 20 years until payoff, but back to a full 30 term. You pay some fee's and taxes on the new structuring. But, your recurring payment is lower and more manageable than it was before.

This is a pretty niche case, BTW, but this is the kind of strategy you need to consider as a pro when paying additional into the home. I've seen this deployed successfully during the last two crashes from family and colleagues. "Better than losing our kids school/our family home/etc".
This is called mortgage recasting and there is a Wiki entry on that term. Discussed plenty of times in this forum, not a “pro” secret. However, the mortgage note holder /servicer will need to agree for recasting, it is not a given. It also assumes that you will have paid additional principal early in the mortgage term to build up enough equity more than the original amortization tables indicate.
Shael_AT
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Re: Low cost index fund Vs Mortgage

Post by Shael_AT »

100% agree'd, not saying its a professional "pro" move, but a single use case. I meant pro in the context of "Pros vs Cons". Sorry for the confusion!
lakpr
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Re: Low cost index fund Vs Mortgage

Post by lakpr »

Shael_AT wrote: Mon Jul 15, 2019 3:39 pm 100% agree'd, not saying its a professional "pro" move, but a single use case. I meant pro in the context of "Pros vs Cons". Sorry for the confusion!
On this, yes we are in agreement!
delamer
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Re: Low cost index fund Vs Mortgage

Post by delamer »

lakpr wrote: Mon Jul 15, 2019 3:36 pm
Shael_AT wrote: Mon Jul 15, 2019 3:21 pm There is a real, strategic posture you can lock into when paying off mortgage early versus throwing into equities.

For example, lets say you pay an extra ~10,000 through 20,000 a year on a 600,000 loan, on top of your current payments. You are in your first 10 years of ownership and the regular payment is mostly interest anyways.

During an downturn, either in the economy, at your job specifically or in your personal/familial life, or in general if you need to hold a reduced income unexpectedly late into that first 10 years (years 7-10), you now have enough equity build up in the house from your extra payments that could truly mean saving your house.

Let me explain.

Most likely, a significant income hit will come from a layoff, business restructuring or something similar. There is a fair chance your equities will be 20-50% lower than they were a month(s) before. You can use the equity built up in the home to re-finance and re-structure your debt agreement with the bank, while potentially benefiting from a near-0 rate environment (sound familiar?). Suddenly, your term is no longer 20 years until payoff, but back to a full 30 term. You pay some fee's and taxes on the new structuring. But, your recurring payment is lower and more manageable than it was before.

This is a pretty niche case, BTW, but this is the kind of strategy you need to consider as a pro when paying additional into the home. I've seen this deployed successfully during the last two crashes from family and colleagues. "Better than losing our kids school/our family home/etc".
This is called mortgage recasting and there is a Wiki entry on that term. Discussed plenty of times in this forum, not a “pro” secret. However, the mortgage note holder /servicer will need to agree for recasting, it is not a given. It also assumes that you will have paid additional principal early in the mortgage term to build up enough equity more than the original amortization tables indicate.
I read it as doing a refi (fees and taxes are mentioned) which only works if you still have enough income to qualify for a new mortgage. If you have no job, you can’t refi.

If you think there is a sufficient likelihood of a big income hit at some point, it is better to invest than pay down the mortgage for liquidity reasons. If the income hit does not occur, eventually you can use the investments to fully pay off the mortgage once you have accumulated enough. Having no mortgage is great. Having more equity but the same payment does nothing for you in a liquidity crunch if you can’t refi.
Pablov
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Re: Low cost index fund Vs Mortgage

Post by Pablov »

moneymatters281 wrote: Mon Jul 15, 2019 10:32 am I am open for any other ideas too.
I am also considering whether to partially pay off my mortgage (3.75% fixed with close to 20 yrs to go) or to invest the money.
I called my bank to see my options assuming I could reduce the monthly payment, reduce the term or both. Long story short, they said both options were available but also suggested a 3rd one. To make biweekly payments instead of monthly ones. Each biweekly payment corresponds to 1/2 of what my monthly payment was (1k every 2 weeks instead of 2k once a month). Since you end up making 26 biweekly payments a year (i.e. 26K) instead of 12 monthly ones (24K), your mortgage term is shorteed (the bank will tell you by how much if you choose to go with this plan.)

I still have not decided if I will make the partial payoff or invest the money but I did go with the biweekly payments for now. It felt good to know that the term was reduced by a few years. If that is an option for you I strongly recommend it.
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grabiner
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Re: Low cost index fund Vs Mortgage

Post by grabiner »

Pablov wrote: Mon Jul 15, 2019 4:16 pm
moneymatters281 wrote: Mon Jul 15, 2019 10:32 am I am open for any other ideas too.
I am also considering whether to partially pay off my mortgage (3.75% fixed with close to 20 yrs to go) or to invest the money.
I called my bank to see my options assuming I could reduce the monthly payment, reduce the term or both. Long story short, they said both options were available but also suggested a 3rd one. To make biweekly payments instead of monthly ones. Each biweekly payment corresponds to 1/2 of what my monthly payment was (1k every 2 weeks instead of 2k once a month). Since you end up making 26 biweekly payments a year (i.e. 26K) instead of 12 monthly ones (24K), your mortgage term is shorteed (the bank will tell you by how much if you choose to go with this plan.)
The biweekly payment is just another way of making extra payments; there is nothing special about it.

But if you are paying extra, it probably makes sense to refinance to a lower rate for 15 years; your payments would be about the same as with the biweekly but you would pay less interest.
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grabiner
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Re: Low cost index fund Vs Mortgage

Post by grabiner »

moneymatters281 wrote: Mon Jul 15, 2019 10:32 am I have around 100K sitting in TD Ameritrade from last few months. People are saying market will fall down soon but I am not sure how long it will take. I do not want to wait to time the market. I do have primary home mortgage with 3% interest rate. I need experts advise on this - should I use amount to pay towards mortgage or invest in low cost index fund ? I am inclining towards low cost index fund.
See Paying down loans versus investing on the wiki.

You should look at the decision in two parts: Should you pay down the mortgage? How much stock should you hold? The reason that these are two separate decisions is that you can both pay down the mortgage and invest more in stock; for every dollar you pay down, move one dollar from bonds to stocks in your 401(k).

So you need to compare the rate on your mortgage to bond yields, which is the alternative you could get without taking on more risk. If your mortgage is deductible at 24%, the after-tax return on the 3% mortgage paydown is only 2.28%, and you can earn 2.19% on Vanguard Long-Term Tax-Exempt Admiral shares, so you pay essentially nothing to keep the liquidity. (You don't need to use specifically this fund, but it is the most fair comparison. In particular, if you invest at TD Ameritrade and want to hold munis, you will probably use a muni ETF rather than the Vanguard fund which has a high transaction fee.) If your mortgage is not tax-deductible, you do pay a cost, so the main reason to invest instead would be to keep the money liquid.
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Re: Low cost index fund Vs Mortgage

Post by KlangFool »

OP,

Do you max up all your tax-advantaged accounts? If not, how does it makes any sense to pay 20% to 30% taxes in order to save 3+% mortgage interest?

This is independent of whether you choose to invest in the stock market.

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WolfgangPauli
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Re: Low cost index fund Vs Mortgage

Post by WolfgangPauli »

These are so hard to answer without a lot (and I mean a lot) more personal information posted which I doubt anyone will want to post. So, I like to go by some "rules of thumb". These are guiding principles if you will which I consider the "default" position.

Having said that, for every rule there are exceptions and situations which only the OP will know if it applies or not. Here goes my attempt at the guiding principles:

1. Always have an emergency account - about 6 mos in cash if you are young, perhaps 2-3 years in cash if you are 45 or older. This should be built up first. Why more if you are 45 or older? Because if something where to happen (loss of job, extended disability etc.) it will be a lot harder to get back on your feet. If you are younger, it is a lot easier.

2. Then fund your retirement. If you are young (say under 30) you can get away without fully funding. Above 30 /35 and you should fully fund.

3. Pay off all debt INCLUDING your mortgage. Why? Because if something were to happen (see #1) and you own your home outright then you do not have that expense. If you have a mortgage and something were to happen you have that mortgage payment hanging over your head.

4. Taking out a mortgage on a home just to invest in the stock market is simply another way to buy on margin. I am not comfortable with that.

5. Finally, don't forget some of the dumbest things that have been said over time by some really smart people: 1. Real estate never drops in value. 2. When evaluating the market, especially after a correction, "Well, it can't go lower".

Like I said, there are exceptions to every rule but these have held well for me. I now own two homes completely free and clear (A main home and a condo for summers).
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grabiner
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Re: Low cost index fund Vs Mortgage

Post by grabiner »

KlangFool wrote: Mon Jul 15, 2019 8:38 pm Do you max up all your tax-advantaged accounts? If not, how does it makes any sense to pay 20% to 30% taxes in order to save 3+% mortgage interest?
While I do agree that maxing out tax-advantaged accounts is a good idea with a mortgage rate this low, this is not a fair comparison. The benefit of paying down a loan compounds over time, while the tax savings on a 401(k) contribution is a one-time benefit, and part of that benefit is lost when you pay tax on withdrawal. If you contribute to a 401(k) in a 24% bracket and withdraw in a 15% bracket, the tax benefit is only 12%; you contributed $1000 for $760 out of pocket, and got the returns on $850 after paying tax. If you retire in the same tax bracket, this tax savings is of no benefit, and you would have done just as well with a Roth account.

The other benefit of tax-deferred savings is that you get a higher rate of return every year, because a taxable account either loses returns to taxes or accepts lower returns on tax-exempt bonds rather than taxable bonds. And that is a permanent benefit which remains even after the mortgage is gone, which is why paying down a low-rate mortgage is inferior to maxing out a decent 401(k) and Roth IRA.

So you need to weigh these benefits against the lower returns for paying down the mortgage. In the OP's case, there is no "lower returns." If there are ten years left on the mortgage, ten-year high-quality bonds yield about 3%; if there are more than ten years, Vanguard Long-Term Bond Index yields 3.33%. But I would still pay down a 5% non-deductible loan in preference to unmatched 401(k) contributions; losing 2% a year to the spread between the loan and the bonds costs more than the tax benefit.
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moneymatters281
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Re: Low cost index fund Vs Mortgage

Post by moneymatters281 »

Thank you all Bogleheads. I appreciate your response.
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