Invest or pay extra on mortgage principal?

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backdoorRoth
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Invest or pay extra on mortgage principal?

Post by backdoorRoth » Wed Feb 12, 2020 5:13 pm

We're looking at refinancing our mortgage from 3.75% to 3.375% {typo earlier, apologies!} (30-yr fixed, $510k balance). This will be a savings of $272/month. In my situation, would you continue paying that $272 as extra principal payments each month (to pay off the mortgage several years early and thus reap savings that way), or instead add that $272 to your monthly contributions to your taxable brokerage?

Background details if helpful:
- Spouse and I are 37
- We max out retirement funding and contribute additional savings to a taxable brokerage (VTSAX)
- Planning to stay in the home forever, but of course we can't ever be 100% sure of that
- I tend to want to invest the extra funds in the market, rather than toward the low interest mortgage. I've run some numbers, though I don't really know how to factor in taxes on the potential market gains.

Thoughts? Arguments for one choice over the other?
Last edited by backdoorRoth on Wed Feb 12, 2020 5:19 pm, edited 1 time in total.

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JoeRetire
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Re: Invest or pay extra on mortgage principal?

Post by JoeRetire » Wed Feb 12, 2020 5:16 pm

backdoorRoth wrote:
Wed Feb 12, 2020 5:13 pm
This will be a savings of $272/month. In my situation, would you continue paying that $272 as extra principal payments each month (to pay off the mortgage several years early and thus reap savings that way), or instead add that $272 to your monthly contributions to your taxable brokerage?
I wouldn't pay off a 3.25% fixed rate mortgage any faster than required.
Very Stable Genius

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backdoorRoth
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Re: Invest or pay extra on mortgage principal?

Post by backdoorRoth » Wed Feb 12, 2020 5:20 pm

Thanks, JoeRetire. I just realized I mistyped - the new rate would be 3.375%, not 3.25%. We do have a quote for 3.25% too, but it includes closing costs (effectively paying points, though the lender isn't calling it that).

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JoeRetire
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Re: Invest or pay extra on mortgage principal?

Post by JoeRetire » Wed Feb 12, 2020 5:23 pm

backdoorRoth wrote:
Wed Feb 12, 2020 5:20 pm
Thanks, JoeRetire. I just realized I mistyped - the new rate would be 3.375%, not 3.25%. We do have a quote for 3.25% too, but it includes closing costs (effectively paying points, though the lender isn't calling it that).
3.375, 3.25, whatever. The difference wouldn't change my answer.
Very Stable Genius

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rocket354
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Re: Invest or pay extra on mortgage principal?

Post by rocket354 » Wed Feb 12, 2020 5:26 pm

backdoorRoth wrote:
Wed Feb 12, 2020 5:13 pm
We're looking at refinancing our mortgage from 3.75% to 3.25% (30-yr fixed, $510k balance). This will be a savings of $272/month. In my situation, would you continue paying that $272 as extra principal payments each month (to pay off the mortgage several years early and thus reap savings that way), or instead add that $272 to your monthly contributions to your taxable brokerage?

Background details if helpful:
- Spouse and I are 37
- We max out retirement funding and contribute additional savings to a taxable brokerage (VTSAX)
- Planning to stay in the home forever, but of course we can't ever be 100% sure of that
- I tend to want to invest the extra funds in the market, rather than toward the low interest mortgage. I've run some numbers, though I don't really know how to factor in taxes on the potential market gains.

Thoughts? Arguments for one choice over the other?
If you are lowering your interest rate by 0.5% on a $510k balance, then you are saving 0.5% of $510k (approximately) your first year, and 0.5% of your remaining balance each additional year. That means you are saving $2550 or so your first year which is about $212/month compared with your 3.75% loan, and the amount drops each additional year.

I suspect when you say you are saving $272/month what you mean is that your payment drops by $272/month, but remember that by refinancing you are resetting the 30-year term, so your payment drops but your number of payments remaining increases. The only "savings" you see comes from the interest rate reduction.

That said, if you keep paying that $272/month then you will have a house paid off quicker than your current loan. You can calculate the middle ground so that you can reduce your payment and still have it paid off in the same amount of time as if you'd kept your current loan. Or you can choose any other option >= your new payment.

That choice depends on how you feel about getting a 3.25% after-tax return on your money. There are myriad "pay off mortgage or invest?" threads on here where you can see all the various arguments for each side. For me, personally, once I have a liquid amount I am comfortable with I treat my mortgage like the bond portion of my portfolio. I invest in stocks like normal and then anything I'd put into taxable bonds instead goes to my mortgage. I do that because even at 3.25%, that mortgage is a guaranteed 4% or so pre-tax return which I don't think I'd get with bonds.

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Re: Invest or pay extra on mortgage principal?

Post by Unladen_Swallow » Wed Feb 12, 2020 5:35 pm

I would pay that extra into mortgage, and as much more as I could (after maximizing tax advantaged accounts).
"I think it's much more interesting to live not knowing than to have answers which might be wrong." - Richard Feynman

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Re: Invest or pay extra on mortgage principal?

Post by The Broz » Wed Feb 12, 2020 5:37 pm

My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.

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backdoorRoth
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Re: Invest or pay extra on mortgage principal?

Post by backdoorRoth » Wed Feb 12, 2020 5:58 pm

Appreciate the responses!

The Broz and Unladen_Swallow, what about the argument that if we put the extra in the market each month, in 25 years (or whenever the mortgage would have been paid off early had we put that extra toward the principal), we could just as easily take that money from our investments and pay off the mortgage?
Last edited by backdoorRoth on Wed Feb 12, 2020 6:10 pm, edited 1 time in total.

Pierre Delecto
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Re: Invest or pay extra on mortgage principal?

Post by Pierre Delecto » Wed Feb 12, 2020 6:03 pm

backdoorRoth wrote:
Wed Feb 12, 2020 5:13 pm
We're looking at refinancing our mortgage from 3.75% to 3.375% {typo earlier, apologies!} (30-yr fixed, $510k balance). This will be a savings of $272/month. In my situation, would you continue paying that $272 as extra principal payments each month (to pay off the mortgage several years early and thus reap savings that way), or instead add that $272 to your monthly contributions to your taxable brokerage?

Background details if helpful:
- Spouse and I are 37
- We max out retirement funding and contribute additional savings to a taxable brokerage (VTSAX)
- Planning to stay in the home forever, but of course we can't ever be 100% sure of that
- I tend to want to invest the extra funds in the market, rather than toward the low interest mortgage. I've run some numbers, though I don't really know how to factor in taxes on the potential market gains.

Thoughts? Arguments for one choice over the other?
Invest. Liquidity is awesome. Plus you’ll likely do much better over time investing than paying down such a low rate, interest deductible mortgage. Also, are you in a non-recourse state like CA? If so, another reason to not accelerate your home equity growth.

Admiral
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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Wed Feb 12, 2020 7:17 pm

How many years are you adding? I.e. how many years are you into the mortgage that you're refinancing?

As rocket354 says, you may be "saving" each month but you're also spending more by adding months or years of payments.

Don't bother prepaying such a small amount on such a large loan at that rate. Your "savings" in 27 [25, I did the math] years (or whenever your early payoff is) will be in inflated dollars and worth much less than they are now. Invest the difference, IMO.
Last edited by Admiral on Wed Feb 12, 2020 7:39 pm, edited 1 time in total.

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Re: Invest or pay extra on mortgage principal?

Post by Triple digit golfer » Wed Feb 12, 2020 7:21 pm

The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
100% of foreclosures are also on houses financed by people who don't have large taxable accounts.

I consider freedom having a large taxable account. The ultimate in flexibility. I wouldnt want to tie up more money in my house with a low rate. I invest rather than pay more on my 3.5% mortgage. Ultimate flexibility and liquidity and a huge emergency fund if needed.

Flyer24
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Re: Invest or pay extra on mortgage principal?

Post by Flyer24 » Wed Feb 12, 2020 7:25 pm

You could always just split it. Pay an extra $100 towards principal (makes up for extending the mortgage) and put the rest in taxable.

Admiral
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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Wed Feb 12, 2020 7:35 pm

The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
You do realize that all this "freedom" that comes from that level of prepayment arrives in... 2045, right? :)

$272 extra on a 30 year, $510k loan moves the payoff date up by five years. That's it.

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Re: Invest or pay extra on mortgage principal?

Post by The Broz » Wed Feb 12, 2020 8:03 pm

Like I said - it is my personal opinion that you would want to be out of debt as soon as possible.

I'll make the argument this way: would anyone with a paid off house take out a mortgage on it to invest in the stock market?

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backdoorRoth
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Re: Invest or pay extra on mortgage principal?

Post by backdoorRoth » Wed Feb 12, 2020 8:05 pm

Thanks again for the additional responses. I do realize part of the monthly “savings” is due to stretching out the current mortgage to 30 years. I posted a related question on the personal finance board earlier that lays out more details, but we’re 3.5 years into our current mortgage. So for me, the “savings” is all about using the “extra” money each month to pay off the mortgage several years early OR invest it in the market (and then theoretically have even more liquid funds, which could be used to pay off the mortgage early or whatever else we want).

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Wed Feb 12, 2020 8:23 pm

The Broz wrote:
Wed Feb 12, 2020 8:03 pm
Like I said - it is my personal opinion that you would want to be out of debt as soon as possible.

I'll make the argument this way: would anyone with a paid off house take out a mortgage on it to invest in the stock market?
Silly argument and false dichotomy. A mortgage is leverage, nothing more. By your logic nobody should save for retirement while they have a mortgage because they could be using their retirement contribution to pay off their housing debt more quickly. There are many ways to build wealth, and mortgage debt is one effective way to do so.

Prepaying a low rate mortgage as described in the OP is spending $1 today to save 30 cents in 25 years. It does not make financial sense to do so.

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Re: Invest or pay extra on mortgage principal?

Post by grabiner » Wed Feb 12, 2020 10:08 pm

Given the size of the mortgage, you probably itemize deductions, as the interest alone is over $16,000, so adding $10,000 of state income or sales taxes, plus property taxes, exceeds $24,800. If you donate to charity, you will continue itemizing deductions for several years as the mortgage balance decreases.

If you itemize, the return on the mortgage paydown is reduced by federal tax, and state tax in most states. If your combined federal and state tax is 30%, the return from an extra mortgage payment is 2.15%, which is a poor return for a 30-year risk-free investment.

If you do want to make extra principal payments, a better way to do that would be to refinance to a 15-year mortgage at a lower rate. You would have higher payments, but you would pay less in interest while making those payments.

My own logic for not paying down my mortgage is similar, even though I am one of the main advocates on this forum of paying down mortgages early. I have nine years left, but at 2.625% which is 1.78% after tax, it isn't worth paying down.
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Admiral
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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 7:09 am

grabiner wrote:
Wed Feb 12, 2020 10:08 pm
Given the size of the mortgage, you probably itemize deductions, as the interest alone is over $16,000, so adding $10,000 of state income or sales taxes, plus property taxes, exceeds $24,800. If you donate to charity, you will continue itemizing deductions for several years as the mortgage balance decreases.

If you itemize, the return on the mortgage paydown is reduced by federal tax, and state tax in most states. If your combined federal and state tax is 30%, the return from an extra mortgage payment is 2.15%, which is a poor return for a 30-year risk-free investment.

If you do want to make extra principal payments, a better way to do that would be to refinance to a 15-year mortgage at a lower rate. You would have higher payments, but you would pay less in interest while making those payments.

My own logic for not paying down my mortgage is similar, even though I am one of the main advocates on this forum of paying down mortgages early. I have nine years left, but at 2.625% which is 1.78% after tax, it isn't worth paying down.
Good thought but 510k @ 3% interest for 15 year note is $3,521.97, or more than double what the 30 year is. My guess is that is not affordable for the OP (since they just refinanced to save less than $300/mo).

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Re: Invest or pay extra on mortgage principal?

Post by ochotona » Thu Feb 13, 2020 7:29 am

Stocks are expensive now, pay extra to your mortgage. In the aftermath of the next bear market (think March 2009, the world is ending) do the opposite, apply mild leverage in your life, if you can get a great rate and great terms.
Peter W., MBA, CRPC

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Re: Invest or pay extra on mortgage principal?

Post by Wanderingwheelz » Thu Feb 13, 2020 8:13 am

Triple digit golfer wrote:
Wed Feb 12, 2020 7:21 pm
The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
100% of foreclosures are also on houses financed by people who don't have large taxable accounts.

I consider freedom having a large taxable account. The ultimate in flexibility. I wouldnt want to tie up more money in my house with a low rate. I invest rather than pay more on my 3.5% mortgage. Ultimate flexibility and liquidity and a huge emergency fund if needed.
To me, true financial freedom begins with owing nobody money.

We’re all wired differently, but one of my happiest days as an adult was when I made my first monthly VTI purchase with funds that were previously sent to the mortgage lender. That account is now nearly 1/2 of $1MM.

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Re: Invest or pay extra on mortgage principal?

Post by UALflyer » Thu Feb 13, 2020 9:04 am

The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
Dave Ramsey's advice is generally targeted towards people who don't know anything about personal finance and just need very basic advice they can understand and follow. You don't need to be a financial genius to do significantly better than what Dave Ramsey's advice would have you do.

This topic is one that has been extensively discussed on this board, so you just need to search.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
A person with a $200K mortgage and $200K in the bank has the exact same net worth as the person with a $0 mortgage and $0 in the bank. Yet, if there's sudden financial distress and the person loses his job, the former can stay afloat for many years, while the latter is in deep trouble.

The question of paying off the mortgage completely is quite different from the question of making extra principal payments, but not paying it off. The former gets rid of your mortgage payment and, therefore, reduces your monthly cashflow requirements, which (assuming that your liquid cushion is large enough to cover your remaining cashflow needs) can reduce your overall risk. On the other hand, the latter reduces your liquidity, but keeps your mortgage payments the same, thereby increasing your risk.

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 9:12 am

Wanderingwheelz wrote:
Thu Feb 13, 2020 8:13 am
Triple digit golfer wrote:
Wed Feb 12, 2020 7:21 pm
The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
100% of foreclosures are also on houses financed by people who don't have large taxable accounts.

I consider freedom having a large taxable account. The ultimate in flexibility. I wouldnt want to tie up more money in my house with a low rate. I invest rather than pay more on my 3.5% mortgage. Ultimate flexibility and liquidity and a huge emergency fund if needed.
To me, true financial freedom begins with owing nobody money.

We’re all wired differently, but one of my happiest days as an adult was when I made my first monthly VTI purchase with funds that were previously sent to the mortgage lender. That account is now nearly 1/2 of $1MM.
Nobody except the local taxing authority and your insurance provider, you mean. Do you feel weighed down by those "debts"? Serious question. Yes, they are likely less than your monthly mortgage payment was. But the point stands.

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Re: Invest or pay extra on mortgage principal?

Post by dukeblue219 » Thu Feb 13, 2020 9:23 am

ochotona wrote:
Thu Feb 13, 2020 7:29 am
Stocks are expensive now, pay extra to your mortgage. In the aftermath of the next bear market (think March 2009, the world is ending) do the opposite, apply mild leverage in your life, if you can get a great rate and great terms.
This is not unreasonable advice. It sounds like market timing to some, but when you're deciding between two very long term investments - a fixed 3.X% mortgage or equities - it's reasonable to ask what the expected return on equities will be over that long period.

I sure don't know what the market will do this year or next, but I may hazard a guess that returns over the next two decades are growing less likely to match the last decade. It's the climate VS weather thing, I suppose.

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Re: Invest or pay extra on mortgage principal?

Post by Wiggums » Thu Feb 13, 2020 9:34 am

Your gut feeling is to invest the $272/month. So set up automated purchases. I think you are fine either way you go.

We don’t have a lot of information about your overall finances. 510k is a big mortgage, but I’m assuming you are making good money to cover that debt and enough liquidity in case of job loss, serious illness, etc.

I’m a pay off the loan person, if we were talking about bigger amounts of money. It’s not only about the math.

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Re: Invest or pay extra on mortgage principal?

Post by Dottie57 » Thu Feb 13, 2020 9:40 am

Unladen_Swallow wrote:
Wed Feb 12, 2020 5:35 pm
I would pay that extra into mortgage, and as much more as I could (after maximizing tax advantaged accounts).
I agree. I plowed in the difference every month. I also bought co shares in ESPP Plan and immediately sold and applied to mortgage. I paid for a 30 year refinanced mortgage in 12 years. I didn’t have to worry about losing my home. I am single with no second income stream coming into home.

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Re: Invest or pay extra on mortgage principal?

Post by UALflyer » Thu Feb 13, 2020 9:45 am

dukeblue219 wrote:
Thu Feb 13, 2020 9:23 am
ochotona wrote:
Thu Feb 13, 2020 7:29 am
Stocks are expensive now, pay extra to your mortgage. In the aftermath of the next bear market (think March 2009, the world is ending) do the opposite, apply mild leverage in your life, if you can get a great rate and great terms.
This is not unreasonable advice. It sounds like market timing to some, but when you're deciding between two very long term investments - a fixed 3.X% mortgage or equities - it's reasonable to ask what the expected return on equities will be over that long period.

I sure don't know what the market will do this year or next, but I may hazard a guess that returns over the next two decades are growing less likely to match the last decade. It's the climate VS weather thing, I suppose.
I think that the advice is completely impractical.

Even highly disciplined, highly sophisticated investors would find it extremely difficult during a severe downturn to take the money that they're using to pay down the mortgage and suddenly start buying equities while those are plunging. People who ask the types of questions posed in this thread are almost guaranteed not to do so.

It's hard enough for people to stay the course during severe market corrections. Telling them that during severe market corrections they should divert the funds that they're using to pay down the mortgage and, instead, to buy equities is the type of statement that simply isn't going to work for the vast majority of the population.

Further, an average market correction lasts 5 months, while an average bear market lasts 14 months. Putting aside the fact that none of us have the ability to predict the beginning and the end of those with any degree of precision (if we could, we'd be zillionaires), this is too short of a period for the OP's a couple hundred dollars a month suddenly being diverted into equities to make a difference.

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Re: Invest or pay extra on mortgage principal?

Post by dukeblue219 » Thu Feb 13, 2020 9:50 am

That's fine. I think it's not unreasonable, though, to regularly reconsider how you deploy that extra cash.

I save an extra chunk of money every month towards paying down the mortgage, but I just make the regular payments along the way. At the end of the year I decide what to do with the chunk. Usually that's the mortgage principal. It has in the past been equities. I've also used it for home improvements if that felt like the best use.

Ultimately were all sitting around here with absurdly cheap loans. There's not much you can do that's objectively wrong, short of using it as leverage to buy options exposure, gas futures, and lotto tickets.

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Re: Invest or pay extra on mortgage principal?

Post by evilityb » Thu Feb 13, 2020 9:53 am

grabiner wrote:
Wed Feb 12, 2020 10:08 pm
Given the size of the mortgage, you probably itemize deductions, as the interest alone is over $16,000, so adding $10,000 of state income or sales taxes, plus property taxes, exceeds $24,800. If you donate to charity, you will continue itemizing deductions for several years as the mortgage balance decreases.

If you itemize, the return on the mortgage paydown is reduced by federal tax, and state tax in most states. If your combined federal and state tax is 30%, the return from an extra mortgage payment is 2.15%, which is a poor return for a 30-year risk-free investment.

If you do want to make extra principal payments, a better way to do that would be to refinance to a 15-year mortgage at a lower rate. You would have higher payments, but you would pay less in interest while making those payments.

My own logic for not paying down my mortgage is similar, even though I am one of the main advocates on this forum of paying down mortgages early. I have nine years left, but at 2.625% which is 1.78% after tax, it isn't worth paying down.
I second this.

What I personally plan to do is invest in a taxable because it can be expected to net me greater gains than paying down a tax-deductible, low-interest rate mortgage, and then the day I retire, I will take what I need from that taxable account and wipe out the remaining balance on the mortgage. Basically, you maximize your returns in the short term and then reduce your risk in retirement. I feel like that's the win-win approach.
She/her/hers | Make sure the fortune that you seek is the fortune that you need - Ben Harper

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Re: Invest or pay extra on mortgage principal?

Post by Jack FFR1846 » Thu Feb 13, 2020 10:03 am

I refinanced many times. My rule was simple. If I could do a NO COST refi and come out with a lower rate, I did it. By doing this, I paid my mortgage down faster with each refi because I didn't change how much I paid monthly. This allowed me to move from a variable rate to fixed rate 30, then to a fixed lower rate 15.

The key for me was that I never, ever paid a penny for anything that wasn't refunded to me at closing (usually either application or appraisal fee), so my only investment was time.

Zero cost loans have a higher % rate than traditional loans with costs and points, or as I call them, bribes to the bank. But by sticking with my rule, it cost me nothing to refi anytime I wanted and I didn't have to figure in any time to recoup my bribe money.
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Re: Invest or pay extra on mortgage principal?

Post by UALflyer » Thu Feb 13, 2020 10:10 am

dukeblue219 wrote:
Thu Feb 13, 2020 9:50 am
Ultimately were all sitting around here with absurdly cheap loans. There's not much you can do that's objectively wrong, short of using it as leverage to buy options exposure, gas futures, and lotto tickets.
What does "objectively wrong" mean in this context?

People who pay down the mortgage typically do so because they place an especially high value on stability and security. Yet, as I've mentioned above, their strategy of paying down the mortgage without having the money to pay it off actually increases their risk, as it reduces their liquidity, while keeping their mortgage payment exactly the same. So, if they experience financial distress, they typically find themselves worse off than they would have been otherwise.

If those same people already have large liquid savings, then what exactly are they accomplishing by paying down the mortgage? In other words, if you don't need to reduce your overall risk associated with a mortgage (which would be the only reason that you'd be trying to pay down a 3.25% 30 year fixed mortgage), then why are you paying it down in the first place?

There are some edge cases where a person will be retiring in just a few years, isn't worried about a job loss and is in a high tax bracket. This person may need to deleverage before retirement to reduce his retirement cashflow needs, but selling taxable investments and paying the associated capital gains taxes may make less sense than just aggressively paying off the mortgage from the employment income over just a few years. There are some other cases like that, but the vast majority of the population considering just throwing a couple hundred dollars towards their low rate, fixed mortgages (and, in the OP's case, likely to be at least partially deductible, thereby reducing the net interest expense even further) are making a mistake.

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 10:14 am

Jack FFR1846 wrote:
Thu Feb 13, 2020 10:03 am
I refinanced many times. My rule was simple. If I could do a NO COST refi and come out with a lower rate, I did it. By doing this, I paid my mortgage down faster with each refi because I didn't change how much I paid monthly. This allowed me to move from a variable rate to fixed rate 30, then to a fixed lower rate 15.

The key for me was that I never, ever paid a penny for anything that wasn't refunded to me at closing (usually either application or appraisal fee), so my only investment was time.

Zero cost loans have a higher % rate than traditional loans with costs and points, or as I call them, bribes to the bank. But by sticking with my rule, it cost me nothing to refi anytime I wanted and I didn't have to figure in any time to recoup my bribe money.
I would only point out that "it cost me nothing" is, perhaps, not quite true. The cost (aside from your time) is the higher interest rate than you otherwise would have had. It's simple math to determine the breakeven on paying for points. For some, it's not worth it. For others, you come out ahead. Much depends on how long you keep the loan.

So, it cost you nothing out of pocket. But that's not quite the same as no cost. There are ways you can work mortgage refinances to your advantage, depending on how good you are at negotiating.

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 10:17 am

UALflyer wrote:
Thu Feb 13, 2020 10:10 am
dukeblue219 wrote:
Thu Feb 13, 2020 9:50 am
Ultimately were all sitting around here with absurdly cheap loans. There's not much you can do that's objectively wrong, short of using it as leverage to buy options exposure, gas futures, and lotto tickets.
What does "objectively wrong" mean in this context?

People who pay down the mortgage typically do so because they place an especially high value on stability and security. Yet, as I've mentioned above, their strategy of paying down the mortgage without having the money to pay it off actually increases their risk, as it reduces their liquidity, while keeping their mortgage payment exactly the same. So, if they experience financial distress, they typically find themselves worse off than they would have been otherwise.

If those same people already have large liquid savings, then what exactly are they accomplishing by paying down the mortgage? In other words, if you don't need to reduce your overall risk associated with a mortgage (which would be the only reason that you'd be trying to pay down a 3.25% 30 year fixed mortgage), then why are you paying it down in the first place?

There are some edge cases where a person will be retiring in just a few years, isn't worried about a job loss and is in a high tax bracket. This person may need to deleverage before retirement to reduce his retirement cashflow needs, but selling taxable investments and paying the associated capital gains taxes may make less sense than just aggressively paying off the mortgage from the employment income over just a few years. There are some other cases like that, but the vast majority of the population considering just throwing a couple hundred dollars towards their low rate, fixed mortgages (and, in the OP's case, likely to be at least partially deductible, thereby reducing the net interest expense even further) are making a mistake.
+1. I would only add that much depends on the mortgage rate and whether the interest is tax deductible any longer. If one is sitting on a 4%+ mortgage, it's a little easier to make the case to pay it down, especially if there are not too many years left (and, as you note, if retirement is close).

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Re: Invest or pay extra on mortgage principal?

Post by UALflyer » Thu Feb 13, 2020 10:22 am

Wanderingwheelz wrote:
Thu Feb 13, 2020 8:13 am
To me, true financial freedom begins with owing nobody money.

We’re all wired differently, but one of my happiest days as an adult was when I made my first monthly VTI purchase with funds that were previously sent to the mortgage lender. That account is now nearly 1/2 of $1MM.
This is a matter of financial education, not "wiring."

If you don't know how to use a hammer, you can certainly smash your finger with it and regret ever touching that hammer in the first place. Yet, if you learn how to use a hammer safely, you can do quite a few useful things with it. Leverage works the exact same way, and those who learn how to use it end up achieving their financial goals that much faster.

Mark Zuckerberg, a billionaire, previously financed his Palo Alto home with a mortgage, and an adjustable rate one at that (https://www.cnbc.com/id/48220824). I agree that there are many financial situations where it makes perfect sense to pay off a mortgage, but once people start justifying their decisions by their "wiring," you can pretty much guarantee that they're leaving tens of thousands of dollars on the table and, in a lot of cases, simultaneously increasing their financial risk.

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Re: Invest or pay extra on mortgage principal?

Post by jvini » Thu Feb 13, 2020 10:28 am

I was in almost the exact same situation. I subscribed to the idea that I'll make more investing in a total stock market fund over the life of the mortgage than I would paying extra on a 3.75% mortgage in a house I plan to stay in forever.

Then after about 20 years of doing this I had a lot invested in my accounts. The market was hitting all time highs. I started thinking about retiring early or at least having the option.

It was also time to rebalance and my portfolio had gotten very heavy equities vs. bonds and I was going to sell Equities in my roll over IRA and rebalance into bonds. So instead, I sold equities in lots through Fidelity, which told me what to sell in order to pay the least capital gains, and I paid off the house. I'm happy I did because now I have no debt and I can invest more monthly until I'm not working.

In essence, it was like having a 20 year mortgage where I came out ahead. The money I invested went further than if I had paid extra towards my mortgage.

Of course who knows what the market will do over the long term, blah blah blah, but over 10 or 20 years there's a good chance it will outperform the rate you're paying on your mortgage and you'll also remain a bit more liquid for longer until you're comfortable paying it off or not.

Hope this helps even a little.

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Re: Invest or pay extra on mortgage principal?

Post by simplesimon » Thu Feb 13, 2020 10:33 am

At these valuations, I have a hard time funneling all my cash into stocks or bonds. I still invest but some money goes into paying extra principal as a hedge.

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Re: Invest or pay extra on mortgage principal?

Post by ray.james » Thu Feb 13, 2020 12:15 pm

grabiner wrote:
Wed Feb 12, 2020 10:08 pm
Given the size of the mortgage, you probably itemize deductions, as the interest alone is over $16,000, so adding $10,000 of state income or sales taxes, plus property taxes, exceeds $24,800. If you donate to charity, you will continue itemizing deductions for several years as the mortgage balance decreases.

If you itemize, the return on the mortgage paydown is reduced by federal tax, and state tax in most states. If your combined federal and state tax is 30%, the return from an extra mortgage payment is 2.15%, which is a poor return for a 30-year risk-free investment.

If you do want to make extra principal payments, a better way to do that would be to refinance to a 15-year mortgage at a lower rate. You would have higher payments, but you would pay less in interest while making those payments.

My own logic for not paying down my mortgage is similar, even though I am one of the main advocates on this forum of paying down mortgages early. I have nine years left, but at 2.625% which is 1.78% after tax, it isn't worth paying down.
David,
How would you treat the effective interest rate for a mortgage balance say 1,000,000. To simplify interest rate is 4.
So would the return on extra mortgage payment is
4% on balances above 750,000
2.8% on balances between 350,000 and 750,000
4% on balances below 350,000

Thank you.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939

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Re: Invest or pay extra on mortgage principal?

Post by bsteiner » Thu Feb 13, 2020 12:41 pm

Triple digit golfer wrote:
Wed Feb 12, 2020 7:21 pm
...
I consider freedom having a large taxable account. The ultimate in flexibility. I wouldn't want to tie up more money in my house with a low rate. I invest rather than pay more on my 3.5% mortgage. Ultimate flexibility and liquidity and a huge emergency fund if needed.
I think that's a good point. No one knows what the future will bring. At an interest rate in the 3s, even if you earn a little less than that, there's some value to the flexiblity. Interest rates might go up. You might need money to buy a vacation home, for a business opportunity, for your children's education, or for something else that you can't foresee now.

If you keep the money you can always change your mind and pay it toward the principal. But (except for a home equity loan) you can't go the other way. If you pay it toward the principal you can't take it back out.

Also, the interest on the mortgage may be deductible. The standard deduction is scheduled to revert to pre-2018 law in 2026.

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Re: Invest or pay extra on mortgage principal?

Post by backdoorRoth » Thu Feb 13, 2020 1:36 pm

Great discussion, all -- appreciate it! You've solidified my hunch to invest the extra funds rather than pay down the mortgage early.

I did chuckle at Admiral's comment that we probably couldn't afford a 15-yr note since we're refinancing to save less than $300/mo. Thought my OP was clear that we don't need that cash to pay bills each month or anything -- we'd either continue paying that amount as extra principal payments, or add it to our monthly brokerage investment. After all, what boglehead, no matter how much he/she can afford, is against lowering their mortgage interest rate when a sound opportunity arises? :D

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 1:40 pm

backdoorRoth wrote:
Thu Feb 13, 2020 1:36 pm
Great discussion, all -- appreciate it! You've solidified my hunch to invest the extra funds rather than pay down the mortgage early.

I did chuckle at Admiral's comment that we probably couldn't afford a 15-yr note since we're refinancing to save less than $300/mo. Thought my OP was clear that we don't need that cash to pay bills each month or anything -- we'd either continue paying that amount as extra principal payments, or add it to our monthly brokerage investment. After all, what boglehead, no matter how much he/she can afford, is against lowering their mortgage interest rate when a sound opportunity arises? :D
If that's the case, and money's not an issue: 15 year mortgage is the best advice you've gotten (assuming adequate reserves.) You'll save much more than investing $272 a month is likely to get you. Run the math.

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Re: Invest or pay extra on mortgage principal?

Post by simplesimon » Thu Feb 13, 2020 1:57 pm

Not to hijack the thread, but does the math or logic change when looking at a 10/1 ARM?

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Re: Invest or pay extra on mortgage principal?

Post by Admiral » Thu Feb 13, 2020 1:58 pm

simplesimon wrote:
Thu Feb 13, 2020 1:57 pm
Not to hijack the thread, but does the math or logic change when looking at a 10/1 ARM?
ARM rates are not that much cheaper than 15s last time I checked, which makes them less appealing (IMO).

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Re: Invest or pay extra on mortgage principal?

Post by Wanderingwheelz » Thu Feb 13, 2020 3:07 pm

Admiral wrote:
Thu Feb 13, 2020 9:12 am
Wanderingwheelz wrote:
Thu Feb 13, 2020 8:13 am
Triple digit golfer wrote:
Wed Feb 12, 2020 7:21 pm
The Broz wrote:
Wed Feb 12, 2020 5:37 pm
My personal opinion: assuming you are otherwise debt-free, have an emergency fund and are saving money towards things like retirement and kids' college already, you should throw whatever you can at the mortgage. The freedom that this gives you will be amazing. If you feel like you job has become toxic, stop going. If you want to start a business or plan for an encore career that is a passion for you, do it. If you have a dream vacation you want to take and thought you would have to wait for retirement, take a few months and save up for it and do it right -guilt free-. I could go on and on here.
As Dave Ramsey says, 100% of the foreclosures are on houses with a mortgage.
100% of foreclosures are also on houses financed by people who don't have large taxable accounts.

I consider freedom having a large taxable account. The ultimate in flexibility. I wouldnt want to tie up more money in my house with a low rate. I invest rather than pay more on my 3.5% mortgage. Ultimate flexibility and liquidity and a huge emergency fund if needed.
To me, true financial freedom begins with owing nobody money.

We’re all wired differently, but one of my happiest days as an adult was when I made my first monthly VTI purchase with funds that were previously sent to the mortgage lender. That account is now nearly 1/2 of $1MM.
Nobody except the local taxing authority and your insurance provider, you mean. Do you feel weighed down by those "debts"? Serious question. Yes, they are likely less than your monthly mortgage payment was. But the point stands.
The money we pay to government in the form of taxes and to insurance cos for protection from large losses are not “debts”. I’m 100% debt free and I like it like that. If you don’t, that okay. Like I said once already, we’re all wired differently. :)

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Re: Invest or pay extra on mortgage principal?

Post by grabiner » Thu Feb 13, 2020 8:40 pm

simplesimon wrote:
Thu Feb 13, 2020 1:57 pm
Not to hijack the thread, but does the math or logic change when looking at a 10/1 ARM?
The fair bond to use for comparison is one of the same duration as your mortgage. I have nine years left on my mortgage, so if I make a prepayment, I will get a known amount of money back in nine years, just as if I bought a nine-year bond. (At my rate of 1.78% after tax, even nine years isn't worth it.) The OP has 30 years left, so a prepayment has a 30-year duration.

For a 10-year ARM, the duration of a principal payment is 10 years, because you will be forced to refinance your mortgage at the then-current rate when those 10 years are up. This makes prepayments more attractive than on a fixed-rate mortgage, on which you get no benefit from the prepayment until the loan is paid off.
Wiki David Grabiner

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Re: Invest or pay extra on mortgage principal?

Post by simplesimon » Fri Feb 14, 2020 8:46 am

grabiner wrote:
Thu Feb 13, 2020 8:40 pm
simplesimon wrote:
Thu Feb 13, 2020 1:57 pm
Not to hijack the thread, but does the math or logic change when looking at a 10/1 ARM?
The fair bond to use for comparison is one of the same duration as your mortgage. I have nine years left on my mortgage, so if I make a prepayment, I will get a known amount of money back in nine years, just as if I bought a nine-year bond. (At my rate of 1.78% after tax, even nine years isn't worth it.) The OP has 30 years left, so a prepayment has a 30-year duration.

For a 10-year ARM, the duration of a principal payment is 10 years, because you will be forced to refinance your mortgage at the then-current rate when those 10 years are up. This makes prepayments more attractive than on a fixed-rate mortgage, on which you get no benefit from the prepayment until the loan is paid off.
Makes sense, thank you for explaining that. Intuitively, I knew that the refinance risk had something to do with how one would approach prepayment.

At 3.00%, or 2.28% after-tax, it doesn't seem like the greatest thing to do but I'm not sure I'm rational enough to make a big(ger) paydown in 10 years if rates go up.

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Re: Invest or pay extra on mortgage principal?

Post by drgenefish » Sat Feb 15, 2020 11:17 am

Personally I’d do option C

I’d refi and then pay even MORE than the $272 difference monthly. I’d want that mortgage gone just for my own peace of mind.

If having the money in taxable gives you the same peace, then do that.

Odds are the money in taxable will be better. But I’d personally take the 100% guarantee that paying my mortgage increases my net worth and decreases my debt.

That’s just me. I have risks in other areas of my life though...have 2 businesses and wife is self employed. So I’m taking that into account.

Just understand the risks and pick what’s best not just for numbers on paper but for your and your family’s personal peace of mind.

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