Paying off mortgage early or invest?

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Topic Author
mishka84
Posts: 13
Joined: Sat Jun 06, 2020 1:32 pm

Paying off mortgage early or invest?

Post by mishka84 »

Hey guys, question for everyone.

My wife and I are planning to buy a house and our expected mortgage is 480k (after 20% down) at 15 years at 3%. We have the opportunity to make an extra monthly payment on the mortgage. The return on the interest saved (due to prepayments) would yield us a 25% ROI over the life of the loan on funds added. Additionally that return is not taxed. The alternative is investing that money in a taxable account and let it grow (we would not use it for a 401k, as we already contribute to our 401k)

Can anyone offer advise on how to calculate the difference between investments? Or can anyone run the numbers for us and help us understand what choice we should make.

Many thanks in advance!
mhalley
Posts: 8420
Joined: Tue Nov 20, 2007 6:02 am

Re: Paying off mortgage early or invest?

Post by mhalley »

Many would say that it is a no brainer to not pay extra on a 3% mortgage. But this is PERSONAL finance, and whether to pay it off depends on your feelings about debt. You might review WCI post on investing vs paying off debt.
https://www.whitecoatinvestor.com/stude ... 0investing.
Attitude Toward Debt
Many of us hate debt, no matter what the interest rate. I was listening to Dave Ramsey the other night when a caller called in asking if he should use his spare cash to pay off his mortgage. Dave’s suggestion was to pay it off, then in a few months if he really missed it he could take out another one. Obviously, nobody does that. There is a wonderful feeling associated with not owing anyone anything. Owning a house free and clear of the bank and knowing it can’t be foreclosed on (as long as you pay your property taxes that is) provides a great deal of security. Not having loans also provides financial freedom in that you need less cash flow to service them, and thus can work fewer hours, take a more attractive job that happens to pay less, or retire early. There is also the behavioral factor. Many of us say we’ll invest instead of paying down a loan, but in reality we spend the money. Obviously, paying down a loan is more likely to help your bottom line than blowing your cash on hookers and coke. The more you hate debt, the more you should lean toward paying off your loans, even if the interest rates are reasonably low. If you think debt is the best thing since sliced bread, I suggest you read the tale of “Market-Timer” a Bogleheads poster who managed as a grad student to lose a couple hundred thousands of dollars borrowed on credit cards and invested on margin in stock market futures.

Personal Risk Profile
Each investor differs in his need, ability, and desire to take risk. If you are a relatively conservative investor, or close to retirement, or simply don’t need to take on much risk, you should pay off loans before investing. The less risky your portfolio, and thus the lower the expected returns on it, the less sense it makes to carry loans while investing. For this reason I think it is stupid to carry a mortgage into retirement. It is foolish for anyone to take on more risk than they can handle or than they need to take. As Warren Buffett likes to say, only when the tide goes out do you see who’s been swimming naked. If you are mostly invested in CDs and treasury bonds, you’re probably going to do better paying down your mortgage and student loans than adding to your portfolio, especially with today’s interest rates. My Recommendations I think it is important to use moderation in all things. You don’t want to pay unnecessary interest on loans, but you also don’t want to miss out on investment and loan-related tax breaks or miss out on years of portfolio compounding.
lakpr
Posts: 6051
Joined: Fri Mar 18, 2011 9:59 am

Re: Paying off mortgage early or invest?

Post by lakpr »

mishka84 wrote: Sat Jun 06, 2020 2:39 pm Hey guys, question for everyone.

My wife and I are planning to buy a house and our expected mortgage is 480k (after 20% down) at 15 years at 3%. We have the opportunity to make an extra monthly payment on the mortgage. The return on the interest saved (due to prepayments) would yield us a 25% ROI over the life of the loan on funds added. Additionally that return is not taxed. The alternative is investing that money in a taxable account and let it grow (we would not use it for a 401k, as we already contribute to our 401k)

Can anyone offer advise on how to calculate the difference between investments? Or can anyone run the numbers for us and help us understand what choice we should make.

Many thanks in advance!
If you want Mathematics of paying down the mortgage vs investing, you need to let's us know, or at least find out for yourself, the Fed and state tax rates on capital gains.

My home state of NJ, for example, treats capital gains as ordinary income. Federal tax rates on long term capital gains are 18.8% for me, due to NIIT. Qualified dividends are usually 2% of principal amount, also taxed at the same rate, so that would add 2% * 18.8% = 0.376%. Net Fed tax bite is therefore 18.8% + 0.38% = 19.18% Total tax bite = 19.18% + 6.68% = 25.86%.

To break even with a tax free 3% return of paying down the mortgage, you should earn 3%/(1 - 0.2586) = 4.04%

Do you have a high confidence that you can make more than 4.04% in the stock market? Invest in the market. Else, pay down your mortgage. That 4.04% is your break even rate.

If you think you would not have patience to stay in the market for at least one full year, your Federal tax bite would be 24% + 0.48% = 24.48%. Break even rate then shifts to 3% /(1 - 0.2448 - 0.0668) = 4.36%
Topic Author
mishka84
Posts: 13
Joined: Sat Jun 06, 2020 1:32 pm

Re: Paying off mortgage early or invest?

Post by mishka84 »

@lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
lakpr
Posts: 6051
Joined: Fri Mar 18, 2011 9:59 am

Re: Paying off mortgage early or invest?

Post by lakpr »

mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
I can only tell you the route I took. I paid off the mortgage in 2018, when my mortgage was 3% too on a 10 year term then. The tax law TCJA effectively removed the deduction for mortgage, so my 3% rate then even though nominally looked low, the effective rate went to 4.04%. I am happy to accept a 4% guaranteed rate of return.

You will have to, sorry, make that decision for yourself.
Trader Joe
Posts: 1986
Joined: Fri Apr 25, 2014 6:38 pm

Re: Paying off mortgage early or invest?

Post by Trader Joe »

mishka84 wrote: Sat Jun 06, 2020 2:39 pm Hey guys, question for everyone.

My wife and I are planning to buy a house and our expected mortgage is 480k (after 20% down) at 15 years at 3%. We have the opportunity to make an extra monthly payment on the mortgage. The return on the interest saved (due to prepayments) would yield us a 25% ROI over the life of the loan on funds added. Additionally that return is not taxed. The alternative is investing that money in a taxable account and let it grow (we would not use it for a 401k, as we already contribute to our 401k)

Can anyone offer advise on how to calculate the difference between investments? Or can anyone run the numbers for us and help us understand what choice we should make.

Many thanks in advance!
I have always paid off all debt asap and live debt free.
Triple digit golfer
Posts: 5560
Joined: Mon May 18, 2009 5:57 pm

Re: Paying off mortgage early or invest?

Post by Triple digit golfer »

Trader Joe wrote: Sat Jun 06, 2020 5:59 pm
mishka84 wrote: Sat Jun 06, 2020 2:39 pm Hey guys, question for everyone.

My wife and I are planning to buy a house and our expected mortgage is 480k (after 20% down) at 15 years at 3%. We have the opportunity to make an extra monthly payment on the mortgage. The return on the interest saved (due to prepayments) would yield us a 25% ROI over the life of the loan on funds added. Additionally that return is not taxed. The alternative is investing that money in a taxable account and let it grow (we would not use it for a 401k, as we already contribute to our 401k)

Can anyone offer advise on how to calculate the difference between investments? Or can anyone run the numbers for us and help us understand what choice we should make.

Many thanks in advance!
I have always paid off all debt asap and live debt free.
Can you elaborate? Did you pay off all debt, including mortgage, before investing at all, even in tax advantaged retirement accounts?
JBTX
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Re: Paying off mortgage early or invest?

Post by JBTX »

I have almost always thought unless you are near or in retirement I'd rather hold a low interest mortgage and have the additional liquidity for a whole host of reasons. Even if I had to hold it in cash investment that earned 2%.

Now with interest rates so low, paying down on a 3.0% mortgage is more attractive than it was. If I had maxed out all retirement opportunities, had an adequate liquidity fund including some ibonds, etc, and knew that I would have sufficient money to fund all such predictable needs over the next 5 years, then yes put some extra money on a 3% mortgage. However, it would still be among my lowest priorities.
neverpanic
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Re: Paying off mortgage early or invest?

Post by neverpanic »

I chose to accelerate my mortgage payments, because of the high interest rate and did not begin investing until I was about a year or so away from having the house paid off.

Based on the numbers, this was a mistake, because assuming I would have traded similarly, I missed out on years of amazing market performance. Part of that was due to wanting to study markets and to learn how trading works (I read everything I could find and watched a couple hundred videos), but the other part was thinking I needed to be almost debt-free before it would be wise to get in. In retrospect, if I had gotten in sooner, I would have been able to pay off the mortgage much faster. The only positive is that, in staying the course, I did not take on any risk in the equities market.

YMMV, but if I had it to do over again, I would have taken advantage of the market to be an income source. I'm making that statement today, though, as someone who has a lot more confidence and understanding about the mechanics and psychology of buying and selling stock.
I am not a financial professional or guru. I'm a schmuck who got lucky 10 times. Such is the life of the trader.
UpperNwGuy
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Re: Paying off mortgage early or invest?

Post by UpperNwGuy »

I have never paid off a mortgage early or even made extra principal payments. Lots of bogleheads hate debt, but I only hate unsecured debt. I think a mortgage can be a useful tool in the financial toolkit.

Full disclosure: I don't currently have a mortgage.
lakpr
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Joined: Fri Mar 18, 2011 9:59 am

Re: Paying off mortgage early or invest?

Post by lakpr »

UpperNwGuy wrote: Sat Jun 06, 2020 8:12 pm I have never paid off a mortgage early or even made extra principal payments. Lots of bogleheads hate debt, but I only hate unsecured debt. I think a mortgage can be a useful tool in the financial toolkit.

Full disclosure: I don't currently have a mortgage.
I think you should probably hate secured debt; since in that case if you default, something will be taken away from you to satisfy the creditors. Of course, precisely for that reason the unsecured debt usually carries sky-high interest rates, relatively speaking.
UpperNwGuy
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Re: Paying off mortgage early or invest?

Post by UpperNwGuy »

lakpr wrote: Sat Jun 06, 2020 8:28 pm
UpperNwGuy wrote: Sat Jun 06, 2020 8:12 pm I have never paid off a mortgage early or even made extra principal payments. Lots of bogleheads hate debt, but I only hate unsecured debt. I think a mortgage can be a useful tool in the financial toolkit.

Full disclosure: I don't currently have a mortgage.
I think you should probably hate secured debt; since in that case if you default, something will be taken away from you to satisfy the creditors. Of course, precisely for that reason the unsecured debt usually carries sky-high interest rates, relatively speaking.
You're definitely not describing my situation. Nothing will be taken away from me to satisfy creditors. I live well below my means and have never been house-poor or car-poor. When I have had mortgage payments or car loan payments, they have been on the low side for a person of my income level. And in the unlikely event that my income stream were to be interrupted, the option exists to pull money out of savings to keep from defaulting. Like I said, a mortgage can be a useful tool in the financial toolkit, but it must be used responsibly.
lakpr
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Re: Paying off mortgage early or invest?

Post by lakpr »

UpperNwGuy wrote: Sat Jun 06, 2020 9:05 pm
lakpr wrote: Sat Jun 06, 2020 8:28 pm
UpperNwGuy wrote: Sat Jun 06, 2020 8:12 pm I have never paid off a mortgage early or even made extra principal payments. Lots of bogleheads hate debt, but I only hate unsecured debt. I think a mortgage can be a useful tool in the financial toolkit.

Full disclosure: I don't currently have a mortgage.
I think you one should probably hate secured debt more; since in that case if you one defaults, something will be taken away from you one to satisfy the creditors. Of course, precisely for that reason the unsecured debt usually carries sky-high interest rates, relatively speaking.
You're definitely not describing my situation. Nothing will be taken away from me to satisfy creditors. I live well below my means and have never been house-poor or car-poor. When I have had mortgage payments or car loan payments, they have been on the low side for a person of my income level. And in the unlikely event that my income stream were to be interrupted, the option exists to pull money out of savings to keep from defaulting. Like I said, a mortgage can be a useful tool in the financial toolkit, but it must be used responsibly.
Sorry, my "you" is a generic you, not you as in UpperNwGuy ....
I do apologize if I gave you an impression otherwise.
Tried to correct my previous sentence
CurlyDave
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Re: Paying off mortgage early or invest?

Post by CurlyDave »

mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
1. The mortgage is paid in then-year dollars, so I don't think subtracting the inflation rate from market return is correct.

2. My personal experience has been that I have benefitted greatly from having a long-term mortgage and keeping money in the market. When the market CAGR is twice the interest rate on a mortgage, a 30 year mortgage and long-term investing is a compelling case for letting someone else's money work for you. YMMV going forward, but it has been a winning strategy over my lifetime.

3. Where does your prediction of 7% for the market come from? This is well below actuals over about a century. For 2016 to 2019 CAGR for SPY is ~14%.
mp
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Re: Paying off mortgage early or invest?

Post by mp »

CurlyDave wrote: Sun Jun 07, 2020 12:20 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%
The mortgage is paid in then-year dollars, so I don't think subtracting the inflation rate from market return is correct.
+1 The correct comparison is nominal, not inflation adjusted. Similarly, the "25% ROI over the life of the loan" mentioned by the OP is 0% (or negative) if the rate of inflation equals (or exceeds) the fixed interest rate on the mortgage. But if the OP has bonds, it would be more helpful to compare the mortgage rate to the expected return on the bonds, not stocks, to adjust for risk.
Last edited by mp on Sun Jun 07, 2020 7:46 pm, edited 1 time in total.
Dandy
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Re: Paying off mortgage early or invest?

Post by Dandy »

I would at a minimum pay enough toward your mortgage to have it paid off by your mid 50's. You want to enter the pre retirement and hopefully high earning years debt free -- and it seems like many retirement dates are chosen by employers not employees.
J295
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Re: Paying off mortgage early or invest?

Post by J295 »

So many threads on this issue, and I will just tell you what we did.

Although we were essentially 100% stocks since the start of our investing career in the early 1980s, we didn’t care for debt so we paid off student loans, paid off the only car loan we had, and paid off our mortgage ASAP. (Allocation changed when full time work stopped). We simply like the freedom of not having any obligations hanging over our head. In fact, at some point we no longer made long-term pledges for charitable capital campaigns, but instead just made lump sum gifts.

I understand it’s hard to pass up leveraging when rates are so low. Personal choice for sure. Worked out OK for us. Transitioned away from my full-time job seven years ago at age 53 and all is well.
J295
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Re: Paying off mortgage early or invest?

Post by J295 »

OP. Are you invested at 100% stocks?
Topic Author
mishka84
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Re: Paying off mortgage early or invest?

Post by mishka84 »

CurlyDave wrote: Sun Jun 07, 2020 12:20 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
1. The mortgage is paid in then-year dollars, so I don't think subtracting the inflation rate from market return is correct.

2. My personal experience has been that I have benefitted greatly from having a long-term mortgage and keeping money in the market. When the market CAGR is twice the interest rate on a mortgage, a 30 year mortgage and long-term investing is a compelling case for letting someone else's money work for you. YMMV going forward, but it has been a winning strategy over my lifetime.

3. Where does your prediction of 7% for the market come from? This is well below actuals over about a century. For 2016 to 2019 CAGR for SPY is ~14%.
Hey CurlyDave,

1. I presumed that the 7% (see point #3 below) is the average of all years so in any given year a 7% return would have to account for 3% inflation and therefore every year the return on average would be 4%. Correct me if I am wrong please.

2. Do you prefer a 30 years mortgage at a lower rate vs. a 15 yr mortgage at a higher rate? We can afford both and the difference is less than 0.5%, so just wondering what would be better? I presumed 15 years to pay less interest over the life of the loan.

3. The 7% is a rough adjustment of the 7.8% ROI mentioned in "The simple path to wealth" book by J.L. Collins as the rate from 1975 to 2015. I would prefer to use a long term rate versus a 3 year rate that you mentioned.

Thanks for your help.
KlangFool
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Re: Paying off mortgage early or invest?

Post by KlangFool »

OP,

Do you max up your 401K contribution? If not, you are paying 20+% taxes to save a 3% interest rate.

20+% is bigger than 3%. This is true even if you do not invest that money and keep it into an MMF.

Why would pre-pay a 3% mortgage be a good decision?

It is simple math.

KlangFool
Last edited by KlangFool on Sun Jun 07, 2020 11:35 am, edited 1 time in total.
Topic Author
mishka84
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Re: Paying off mortgage early or invest?

Post by mishka84 »

KlangFool wrote: Sun Jun 07, 2020 11:13 am OP,

Do you max up your 401K contribution? If not, you are paying 20+% taxes to save a 3% interest rate.

20+% is bigger than 3%. This is true even if you do not invest that money and keep it into an MMF.

Why would that be a good decision?

It is simple math.

KlangFool
Yes the 401k is maxed out. Thats why we're considering other options.
KlangFool
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Re: Paying off mortgage early or invest?

Post by KlangFool »

mishka84 wrote: Sun Jun 07, 2020 11:30 am
KlangFool wrote: Sun Jun 07, 2020 11:13 am OP,

Do you max up your 401K contribution? If not, you are paying 20+% taxes to save a 3% interest rate.

20+% is bigger than 3%. This is true even if you do not invest that money and keep it into an MMF.

Why would that be a good decision?

It is simple math.

KlangFool
Yes the 401k is maxed out. Thats why we're considering other options.
1) How about Roth IRAs? Backdoor Roth IRAs? Mega Backdoor Roth IRAs?

2) College Education funding?

3) Do you think your portfolio will return less than 5% annually for the next 20 to 30 years?

4) Do you think the inflation will stay at 3% annually or lower over the next 20 to 30 years?

It is unlikely that financially makes very good sense to pay down a 3% mortgage. I may pay off the whole mortgage at one shot if my portfolio is big enough. Paying down is almost always a bad idea.

KlangFool
KlangFool
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Re: Paying off mortgage early or invest?

Post by KlangFool »

mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
mishka84,

<<My thoughts are an average 7% from the market - 3% inflation to get me to 4%, >>

This is wrong! Your mortgage interest is fixed at a nominal 3%. It does not increase as per inflation. So, your net return is 7% - 3% (mortgage) = 4%.

In summary, it takes you longer to pay off the mortgage if you pre-pay the mortgage. If you invest the pre-pay amount at 7%, you can pay it off in one lump sum at a shorter interval.

KlangFool
Last edited by KlangFool on Sun Jun 07, 2020 11:47 am, edited 1 time in total.
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Ben Mathew
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Re: Paying off mortgage early or invest?

Post by Ben Mathew »

Prepaying the mortgage is equivalent to investing in a risk free bond that pays out 3% over the time you would have held the mortgage. Compared to investing in bonds yielding less, it's a good deal. But if you are early in your career, you should probably be 100% stocks anyway. It's a time when people are usually underinvested in stocks relative to their stock exposure later in life. Even 100% of the current portfolio in stocks is too little. That's because the portfolio is small since most of the contributions are not in yet. By not prepaying the mortgage and investing the money in stocks instead, you can better spread out your stock risk over time. You would reduce stock exposure in the overweighted years closer to retirement. This reduces lifetime risk for the same expected return.

Before investing in taxable, make sure you're maxing out IRAs as well (with a backdoor contribution if necessary). Also HSAs if you are eligible, and 529 plans if you have children.

Middle to later in your career, when you have enough stock exposure and it's time to start holding bonds, prepaying the mortgage is a good alternative to holding bonds in the portfolio.
Buckrodgerz
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Re: Paying off mortgage early or invest?

Post by Buckrodgerz »

I recommend paying off the mortgage as soon as possible to reduce interest expense (paying money to someone else). Take that former payment amount and add to your monthly automatic diversified investment accounts. In the long term, with compounding, you will be happy.
Robdac
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Re: Paying off mortgage early or invest?

Post by Robdac »

It's apples vs oranges.

Paying off a mortgage vs investing in the stock market are two very different things. The most important difference is risk. With the mortgage there is zero risk involved. As such you would expect it to have a lower return. With stocks there is considerable short term risk of losing money on your investments. Any comparison of return rates would have to adjust for this vast difference in risk.

Once risk is taken into account you will see that there isn't a substantial difference in the risk/reward proposition of either "investment." But they are very different.

Like a stock/bond allocation, you have to choose a comfortable level of risk. Some people sleep fine at 100% stock. Some do much better at 50/50 even knowing they are likely missing out on some return.

Some people sleep well at night with a large mortgage. For others it weighs on their mind.

For us, personally, we don't like debt. We printed out an amortization schedule for the 30 year loan. It was an eyeopener to cross off months of payments at a time with extra principal applied each moth. We sleep really well at night with no mortgage or consumer debt. We maxed our 401(k)'s and IRA's put some money in the 529's and then put everything else towards the mortgage. Still remember the day I wrote that last check. And the month after that? We went right back to adding into a taxable account.

We had people tell us it was a bad decision to pay it off early. They told us we should have been investing in the market. Those people still have mortgages. We still sleep well at night. To each their own.
Last edited by Robdac on Sun Jun 07, 2020 12:43 pm, edited 1 time in total.
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gr7070
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Re: Paying off mortgage early or invest?

Post by gr7070 »

Once all tax-advantaged options are fully utilized I typically favor paying down the mortgage with taxable funds.

The math is far from as lopsided as we often hear. Though I won't argue that the mortgage return is more likely to win - it's just not as disparate as we tend to believe.

You're already favoring the mortgage, in part, with a 15-year term.

At this point I don't think you can go wrong either way. I'd do whichever you simply prefer.
Topic Author
mishka84
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Re: Paying off mortgage early or invest?

Post by mishka84 »

KlangFool wrote: Sun Jun 07, 2020 11:45 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
mishka84,

<<My thoughts are an average 7% from the market - 3% inflation to get me to 4%, >>

This is wrong! Your mortgage interest is fixed at a nominal 3%. It does not increase as per inflation. So, your net return is 7% - 3% (mortgage) = 4%.

In summary, it takes you longer to pay off the mortgage if you pre-pay the mortgage. If you invest the pre-pay amount at 7%, you can pay it off in one lump sum at a shorter interval.

KlangFool
Can you elaborate on what you mean? I'm confused by your statement.
KlangFool
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Re: Paying off mortgage early or invest?

Post by KlangFool »

mishka84 wrote: Sun Jun 07, 2020 3:45 pm
KlangFool wrote: Sun Jun 07, 2020 11:45 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
mishka84,

<<My thoughts are an average 7% from the market - 3% inflation to get me to 4%, >>

This is wrong! Your mortgage interest is fixed at a nominal 3%. It does not increase as per inflation. So, your net return is 7% - 3% (mortgage) = 4%.

In summary, it takes you longer to pay off the mortgage if you pre-pay the mortgage. If you invest the pre-pay amount at 7%, you can pay it off in one lump sum at a shorter interval.

KlangFool
Can you elaborate on what you mean? I'm confused by your statement.
mishka84,

The mortgage interest rate is 3%. It does not increase with inflation.

If you have 10K now, you could either pre-pay the mortgage and save 3% or invest that 10K.

A) Pre-pay the mortgage and save 3% per year

B) Invest that 10K and earn 7% per year.

The difference between (A) and (B) is 4% per year. Effectively, you are borrowing money at a nominal 3% to invest.

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mishka84
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Re: Paying off mortgage early or invest?

Post by mishka84 »

KlangFool wrote: Sun Jun 07, 2020 3:59 pm
mishka84 wrote: Sun Jun 07, 2020 3:45 pm
KlangFool wrote: Sun Jun 07, 2020 11:45 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
mishka84,

<<My thoughts are an average 7% from the market - 3% inflation to get me to 4%, >>

This is wrong! Your mortgage interest is fixed at a nominal 3%. It does not increase as per inflation. So, your net return is 7% - 3% (mortgage) = 4%.

In summary, it takes you longer to pay off the mortgage if you pre-pay the mortgage. If you invest the pre-pay amount at 7%, you can pay it off in one lump sum at a shorter interval.

KlangFool
Can you elaborate on what you mean? I'm confused by your statement.
mishka84,

The mortgage interest rate is 3%. It does not increase with inflation.

If you have 10K now, you could either pre-pay the mortgage and save 3% or invest that 10K.

A) Pre-pay the mortgage and save 3% per year

B) Invest that 10K and earn 7% per year.

The difference between (A) and (B) is 4% per year. Effectively, you are borrowing money at a nominal 3% to invest.

KlangFool
Right so I wasn't saying there will be an inflation cost of the mortgage. I was saying paying off a mortgage at 3% vs. investing at 7% (hypothetical could be less) - 3% inflation when the investment is sold - whatever tax implication there is or keep that 10k or more for like 30 years and cash out at a higher amount.
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Re: Paying off mortgage early or invest?

Post by KlangFool »

mishka84 wrote: Sun Jun 07, 2020 4:03 pm
Right so I wasn't saying there will be an inflation cost of the mortgage. I was saying paying off a mortgage at 3% vs. investing at 7% (hypothetical could be less) - 3% inflation when the investment is sold - whatever tax implication there is or keep that 10k or more for like 30 years and cash out at a higher amount.
mishka84,

<<investing at 7% (hypothetical could be less) - 3% inflation when the investment is sold ->>

You are borrowing the money at 3%. This is independent of what the inflation rate is. You have to factor that first before thinking about inflation.

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Re: Paying off mortgage early or invest?

Post by LilyFleur »

Robdac wrote: Sun Jun 07, 2020 12:41 pm It's apples vs oranges.

Paying off a mortgage vs investing in the stock market are two very different things. The most important difference is risk. With the mortgage there is zero risk involved. As such you would expect it to have a lower return. With stocks there is considerable short term risk of losing money on your investments. Any comparison of return rates would have to adjust for this vast difference in risk.

Once risk is taken into account you will see that there isn't a substantial difference in the risk/reward proposition of either "investment." But they are very different.

Like a stock/bond allocation, you have to choose a comfortable level of risk. Some people sleep fine at 100% stock. Some do much better at 50/50 even knowing they are likely missing out on some return.

Some people sleep well at night with a large mortgage. For others it weighs on their mind.

For us, personally, we don't like debt. We printed out an amortization schedule for the 30 year loan. It was an eyeopener to cross off months of payments at a time with extra principal applied each moth. We sleep really well at night with no mortgage or consumer debt. We maxed our 401(k)'s and IRA's put some money in the 529's and then put everything else towards the mortgage. Still remember the day I wrote that last check. And the month after that? We went right back to adding into a taxable account.

We had people tell us it was a bad decision to pay it off early. They told us we should have been investing in the market. Those people still have mortgages. We still sleep well at night. To each their own.
Exactly. After selling the family home (divorce), I paid cash for my condo. My mom, a CFP, said she could advise me to use the equity in my home to invest. But she also said that many divorcees/widowers choose the security of a paid-for home, and if that made me feel more comfortable, that I should go ahead and enjoy having a paid-for home. I do enjoy it. I have a HELOC should I decide otherwise. Everyone is different. While living in my paid-for home, I also had a very aggressive AA which would have caused others to lose sleep.
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Re: Paying off mortgage early or invest?

Post by Outer Marker »

mishka84 wrote: Sat Jun 06, 2020 2:39 pm My wife and I are planning to buy a house and our expected mortgage is 480k (after 20% down) at 15 years at 3%. . . .
I would shop around on the mortgage before you close. 15 year money can be had for well under 3%. Penfed is offered a 15 year fixed at 2.5% which I plan to refi into. I do not plan on paying extra for the foreseeable future. I will pay off the small remaining balance at the 12 year mark, just before I plan to retire. . .
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Re: Paying off mortgage early or invest?

Post by CurlyDave »

mishka84 wrote: Sun Jun 07, 2020 11:04 am
CurlyDave wrote: Sun Jun 07, 2020 12:20 am
mishka84 wrote: Sat Jun 06, 2020 4:27 pm @lakpr thanks so much for math, thats similar to what I had at 4% that I would need from the market. My thoughts are an average 7% from the market - 3% inflation to get me to 4%, the problem is that may or may not happen in that 11 year time period, in which I would have to wait X amount of years to get that same 4% back. If that will take another 5 years then what did I really gain?

Or is it better just leave that extra monthly payment in the market for the next 30 years and enjoy all the gains?
1. The mortgage is paid in then-year dollars, so I don't think subtracting the inflation rate from market return is correct.

2. My personal experience has been that I have benefitted greatly from having a long-term mortgage and keeping money in the market. When the market CAGR is twice the interest rate on a mortgage, a 30 year mortgage and long-term investing is a compelling case for letting someone else's money work for you. YMMV going forward, but it has been a winning strategy over my lifetime.

3. Where does your prediction of 7% for the market come from? This is well below actuals over about a century. For 2016 to 2019 CAGR for SPY is ~14%.
Hey CurlyDave,

1. I presumed that the 7% (see point #3 below) is the average of all years so in any given year a 7% return would have to account for 3% inflation and therefore every year the return on average would be 4%. Correct me if I am wrong please.

2. Do you prefer a 30 years mortgage at a lower rate vs. a 15 yr mortgage at a higher rate? We can afford both and the difference is less than 0.5%, so just wondering what would be better? I presumed 15 years to pay less interest over the life of the loan.

3. The 7% is a rough adjustment of the 7.8% ROI mentioned in "The simple path to wealth" book by J.L. Collins as the rate from 1975 to 2015. I would prefer to use a long term rate versus a 3 year rate that you mentioned.

Thanks for your help.
1. A mortgage is repaid in then-year dollars (your payments in 2030 will be in 2030 dollars), which are not inflation corrected by the lender. The lender assumes the inflation risk, so the correct rate of return for stocks to use is the nominal rate of return, not the inflation corrected rate.

2. My personal belief is that the longer the mortgage, the better. The more time you have to make a return on someone else's money, the better. (I recognize this may be a controversial opinion on this board, but it has certainly worked out well for me.)

3. The quick and easy access to return numbers I have is through my TD Ameritrade account. The SPY ETF inception date was Jan 22, 1993. Market return from inception through 5/31/2020 has been 9.37%. NAV return has been 9.40%. This beats the stuffing out of Mr. Collins claimed returns, although the difference in time periods may account for that. What did Mr. Collins invest in from 1975-1993? SPY did not exist. And it certainly was not VOO, which has an inception date of 9/30/2010.

So, I can only give you 27 years of real data for a real ETF.

But, why would you adjust Mr. Collins 7.8% ROI down to 7%, when the trend over time is clearly up? I understand that a lot of very famous people have predicted lower returns going forward, but they have been making this prediction for a decade, and the predictions have all foundered on the rocky shoals of reality. That is one of the reasons I gave you returns from 2016-2019 (actually 4 years). Over-pessimism will have a very negative effect on your portfolio over time.
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Re: Paying off mortgage early or invest?

Post by 1789 »

No i would NOT prepay a mortgage with 3% interest for 15 years. I would invest the extra money
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Re: Paying off mortgage early or invest?

Post by LiveSimple »

We did not bother to repay the mortgage, when we had kids and their upcoming college tuitions, we wanted the money for their college expenses.
Once the college tuition was out of the way and we became empty nesters, planning to pay off the mortgage.

Mostly this decision is mental / physiological than maths / economics. Keeping the mortgage will also be an better option if the rates are lower and invest as possible.

Feeling that you do not owe any money for anything is wonderful as well.
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Re: Paying off mortgage early or invest?

Post by Rudedog »

Made double payments on our mortgage for years and finally paid it off several years ago. No itemized deduction for the interest anymore (we don't qualify to itemize anymore) so no tax savings there. It feels great to be debt-free.
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Re: Paying off mortgage early or invest?

Post by Outer Marker »

CurlyDave wrote: Sun Jun 07, 2020 8:55 pm 1. A mortgage is repaid in then-year dollars (your payments in 2030 will be in 2030 dollars), which are not inflation corrected by the lender. The lender assumes the inflation risk, so the correct rate of return for stocks to use is the nominal rate of return, not the inflation corrected rate.

2. My personal belief is that the longer the mortgage, the better. The more time you have to make a return on someone else's money, the better. (I recognize this may be a controversial opinion on this board, but it has certainly worked out well for me.)

3. The quick and easy access to return numbers I have is through my TD Ameritrade account. The SPY ETF inception date was Jan 22, 1993. Market return from inception through 5/31/2020 has been 9.37%. NAV return has been 9.40%. This beats the stuffing out of Mr. Collins claimed returns, although the difference in time periods may account for that. What did Mr. Collins invest in from 1975-1993? SPY did not exist. And it certainly was not VOO, which has an inception date of 9/30/2010.

So, I can only give you 27 years of real data for a real ETF.

But, why would you adjust Mr. Collins 7.8% ROI down to 7%, when the trend over time is clearly up? I understand that a lot of very famous people have predicted lower returns going forward, but they have been making this prediction for a decade, and the predictions have all foundered on the rocky shoals of reality. That is one of the reasons I gave you returns from 2016-2019 (actually 4 years). Over-pessimism will have a very negative effect on your portfolio over time.
I agree with the potential advantage of the mortgage as an inflation hedge. However, I would respectfully disagree on -

1. The comparable risk equivalent investment to paying down the mortgage is U.S. Treasuries, not the stock market. Currently 10 year treasury yield is less than 1%. We're talking about a mortgage at 3%. True, the stock market has been generous over the last 27 years, but that is absolutly no guarantee of how it will perform going forward. You're taking a risk using the leverage of a mortgage to buy stocks, that will probably have a higher return, but who knows. Its a gamble, not a sure thing.

2. The bull market we have enjoyed would tend to indicate that stocks are over-bought, and returns are likely to be less and may be negative going forward.

3. 27 years is way too short a timeframe. As Buffett noted at the last shareholder's meeting, the first stock he bought on his birthday in his teens had declined by 80% the next year, and took 20 years to recover its initial value. Stocks began a slide in 1966 that took some 30 years to recover from by 1995. Here is the 100 year view: https://www.macrotrends.net/1319/dow-jo ... ical-chart
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