Safe investments in lieu of extra mortgage payments

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legalwriter1
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Safe investments in lieu of extra mortgage payments

Post by legalwriter1 »

I am trying to decide where to put money in lieu of extra mortgage payments. Currently, I am leaning between CDs and I-bonds.

I have a mortgage with a remaining principal of $100k and a fixed rate of 2.1%. I am age 48 and we have 10 years left on our mortgage if we make minimum mortgage payments. We like our house and don't plan to move. I was putting extra mortgage payments in I-bonds but I am thinking about putting extra mortgage payments in CDs. I can get a 4.25% 12 month CD with Ally which is 2.15% better than my mortgage or a 2 year CD with Discover Bank at 4.3%. We have about $1k per month that we could put for extra mortgage payments. I already max out Roth IRA for self and spouse and my tax deferred accounts that we put into the market.
steadyosmosis
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Re: Safe investments in lieu of extra mortgage payments

Post by steadyosmosis »

legalwriter1 wrote: Mon Jan 23, 2023 10:01 am I am trying to decide where to put money in lieu of extra mortgage payments. Currently, I am leaning between CDs and I-bonds.

I have a mortgage with a remaining principal of $100k and a fixed rate of 2.1%. I am age 48 and we have 10 years left on our mortgage if we make minimum mortgage payments. We like our house and don't plan to move. I was putting extra mortgage payments in I-bonds but I am thinking about putting extra mortgage payments in CDs. I can get a 4.25% 12 month CD with Ally which is 2.15% better than my mortgage or a 2 year CD with Discover Bank at 4.3%. We have about $1k per month that we could put for extra mortgage payments. I already max out Roth IRA for self and spouse and my tax deferred accounts that we put into the market.
I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
6bquick
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Re: Safe investments in lieu of extra mortgage payments

Post by 6bquick »

steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
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Darth Xanadu
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Re: Safe investments in lieu of extra mortgage payments

Post by Darth Xanadu »

6bquick wrote: Mon Jan 23, 2023 10:08 am
steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
I agree I wouldn't pay early. However CD's for a sinking fund would be appropriate. Ally has a 4.6% 13-month CD offer right now: https://www.ally.com/go/bank/13m-select-cd/
lakpr
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Re: Safe investments in lieu of extra mortgage payments

Post by lakpr »

Darth Xanadu wrote: Mon Jan 23, 2023 10:11 am
6bquick wrote: Mon Jan 23, 2023 10:08 am
steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
I agree I wouldn't pay early. However CD's for a sinking fund would be appropriate. Ally has a 4.6% 13-month CD offer right now: https://www.ally.com/go/bank/13m-select-cd/
There are Treasuries available for 4.7% to 4.8% yield in the secondary market, with the added advantage that the interest is free from state taxation.
https://personal.vanguard.com/us/FixedIncomeHome
The only catch is, as I understand it, you must buy and redeem in multiples of $1000.
tashnewbie
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Re: Safe investments in lieu of extra mortgage payments

Post by tashnewbie »

OP: I agree with the decision not to pay extra on this low rate mortgage.

MMF are currently paying higher than your mortgage but the risk is that over the rest of the mortgage term that may not be true.

Would you be able to make regular additions to the CDs? I think some CDs allow that during the term but a lot of them only allow additions at the renewal. Were you planning to do a CD ladder?
NiceUnparticularMan
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Re: Safe investments in lieu of extra mortgage payments

Post by NiceUnparticularMan »

The perfect match for a typical amortized mortgage is some sort of bond (or CD) ladder. At the moment, it will be WAY cheaper to buy such a ladder to match your mortgage payments than it will be to pay off your mortgage entirely. You can then do whatever you like with the difference.

If you are only talking about extra mortgage payments, my understanding is these are basically like buying the longest bonds/CDs in the ladder. Again, at the moment those will also be way cheaper to buy then making extra mortgage payments.

If you instead buy something that is shorter-term than your final mortgage payments, that is not really matching and as a result you are introducing some risks. That isn't a deal breaker in all scenarios, but you should be aware the safest thing to do is buy longer-term bonds/CDs.
guanonics
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Re: Safe investments in lieu of extra mortgage payments

Post by guanonics »

If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.

For a simpler practical implementation, use extra payments to buy nominal fixed income instruments with duration to match your mortgage payments. E.g. nominal treausries or CDs with duration from 0-10 years. I'd start with those that mature 10-ish years out to match your last payments, and bring it in over time.

The 1 year CDs are great to match payments due 1 year from now. IBonds are not a good choice because it is better to use a nominal bond to match a nominal liability.
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grabiner
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Re: Safe investments in lieu of extra mortgage payments

Post by grabiner »

NiceUnparticularMan wrote: Mon Jan 23, 2023 10:50 am The perfect match for a typical amortized mortgage is some sort of bond (or CD) ladder. At the moment, it will be WAY cheaper to buy such a ladder to match your mortgage payments than it will be to pay off your mortgage entirely. You can then do whatever you like with the difference.
If you don't want to set up a ladder, you can also buy a bond fund with a similar duration to the mortgage. With 10 years left on the mortgage, the remaining duration is 5 years, so the closest to liability-matching would be an intermediate-term bond fund.
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8301
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Re: Safe investments in lieu of extra mortgage payments

Post by 8301 »

lakpr wrote: Mon Jan 23, 2023 10:19 am
Darth Xanadu wrote: Mon Jan 23, 2023 10:11 am
6bquick wrote: Mon Jan 23, 2023 10:08 am
steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
I agree I wouldn't pay early. However CD's for a sinking fund would be appropriate. Ally has a 4.6% 13-month CD offer right now: https://www.ally.com/go/bank/13m-select-cd/
There are Treasuries available for 4.7% to 4.8% yield in the secondary market, with the added advantage that the interest is free from state taxation.
https://personal.vanguard.com/us/FixedIncomeHome
The only catch is, as I understand it, you must buy and redeem in multiples of $1000.
Are there any advantages or disadvantages of buying brokered treasuries instead of buying at auction through Vanguard or Fidelity?
exodusNH
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Re: Safe investments in lieu of extra mortgage payments

Post by exodusNH »

8301 wrote: Mon Jan 23, 2023 9:35 pm
lakpr wrote: Mon Jan 23, 2023 10:19 am
Darth Xanadu wrote: Mon Jan 23, 2023 10:11 am
6bquick wrote: Mon Jan 23, 2023 10:08 am
steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
I agree I wouldn't pay early. However CD's for a sinking fund would be appropriate. Ally has a 4.6% 13-month CD offer right now: https://www.ally.com/go/bank/13m-select-cd/
There are Treasuries available for 4.7% to 4.8% yield in the secondary market, with the added advantage that the interest is free from state taxation.
https://personal.vanguard.com/us/FixedIncomeHome
The only catch is, as I understand it, you must buy and redeem in multiples of $1000.
Are there any advantages or disadvantages of buying brokered treasuries instead of buying at auction through Vanguard or Fidelity?
No real disadvantage. At auction, you all get the same pricing. On the secondary market, different purchase sizes get different rates.

A big advantage is that you can buy at any time and find something that matures close to when you want it instead of being limited by what the Treasury offers. E.g., if you want a 12 year maturity, you can get that by purchasing 20 or 30 year Treasuries that are 8 or 18 years old.

You can also pick what coupon rate you get. As those are paid out instead of reinvested, if you have a large coupon, you have a greater reinvestment risk.
NiceUnparticularMan
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Re: Safe investments in lieu of extra mortgage payments

Post by NiceUnparticularMan »

grabiner wrote: Mon Jan 23, 2023 9:10 pm
NiceUnparticularMan wrote: Mon Jan 23, 2023 10:50 am The perfect match for a typical amortized mortgage is some sort of bond (or CD) ladder. At the moment, it will be WAY cheaper to buy such a ladder to match your mortgage payments than it will be to pay off your mortgage entirely. You can then do whatever you like with the difference.
If you don't want to set up a ladder, you can also buy a bond fund with a similar duration to the mortgage. With 10 years left on the mortgage, the remaining duration is 5 years, so the closest to liability-matching would be an intermediate-term bond fund.
I note this is an increasingly imperfect solution over time because a bond fund is typically a rolling ladder with a more or less fixed duration, whereas a non-rolling bond ladder or mortgage has a declining duration over time until it reaches 0.

Personally I don't have a problem planning to may a mortgage out of income from assets that are not a perfect match for the mortgage alone, as long as there is an overall assets and income plan that makes sense. But these days it isn't too hard to buy a bond ladder if you really want to. So at a minimum, before paying off a mortgage you should price a comparable bond ladder and make sure the mortgage payoff is not priced way too high at current market rates.
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GMCZ71
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Re: Safe investments in lieu of extra mortgage payments

Post by GMCZ71 »

Have you read wiki on tax efficient placement?
Ibonds are tax deferred but cd's are not. Stock index that is different from your other accounts would be best in taxable watch for tax loss harvesting. At the same time exchange some stock index to bond or cd in tax deferred. So you keep your AA. It does not have to be 100% stock in taxable, we are about 75/25 in taxable.
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toddthebod
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Re: Safe investments in lieu of extra mortgage payments

Post by toddthebod »

guanonics wrote: Mon Jan 23, 2023 10:53 am If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.

If he's not worried about being able to make his future mortgage payments, he should just invest according to his current AA. If he does want to hedge, he could do something like, every month for the first five years, buy bonds that mature five years later, so he has a steady stream of maturing bonds through the second half of his remaining mortgage period.
Backtests without cash flows are meaningless. Returns without dividends are lies.
bg5
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Re: Safe investments in lieu of extra mortgage payments

Post by bg5 »

I also have a low interest rate on my home. We are at 1.99% and have 13 years left. We have decided to put most of our extra money into VTSAX (VTI) and if we ever have enough to pay it off we will have to decide if we do that and become debt free or keep it invested. I know alot will advise never to pay off a 1.99% loan (hard to argue with them) but any debt is some sort of risk and the thought of not having a house payment is very tempting. It will be a tough decision for my wife and I when the time comes but I have a feeling we might gamble and attempt to get the best return out of our money. Not sure if that is smart or not but its a tough decision to make
mggray17
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Re: Safe investments in lieu of extra mortgage payments

Post by mggray17 »

I just bought the 6 mos T-bill at this weeks auction through my Schwab account.
It is paying 4.865%. :)
Topic Author
legalwriter1
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Re: Safe investments in lieu of extra mortgage payments

Post by legalwriter1 »

OP here. Thanks everyone for the responses. I think the general consensus is not to prepay a mortgage at 2.1%. I will look into CDs.
guanonics
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Re: Safe investments in lieu of extra mortgage payments

Post by guanonics »

toddthebod wrote: Tue Jan 24, 2023 8:45 am
guanonics wrote: Mon Jan 23, 2023 10:53 am If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
You are right it doesn't make sense. However, I was suggesting one bond timed for each payment.
Raspberry-503
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Re: Safe investments in lieu of extra mortgage payments

Post by Raspberry-503 »

Any reason you are only looking at "safe" investments? If you don't need the cash for another 10 years, consider equities (they look like they may be on sale right now) like a low cost index fund/ETF
jwaxjwax
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Re: Safe investments in lieu of extra mortgage payments

Post by jwaxjwax »

Just don’t forget taxes so that it’s apples to apples. 4.5% in a taxable account could look more like 3%.
Hyperchicken
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Re: Safe investments in lieu of extra mortgage payments

Post by Hyperchicken »

toddthebod wrote: Tue Jan 24, 2023 8:45 am I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
[...]
I don't think that's how a bond ladder is supposed to work. You don't stack all "rungs" to mature at the same time. You stack them to mature one "rung" every month, matching mortgage payment in that month.
zratis
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Re: Safe investments in lieu of extra mortgage payments

Post by zratis »

legalwriter1 wrote: Mon Jan 23, 2023 10:01 am I am trying to decide where to put money in lieu of extra mortgage payments. Currently, I am leaning between CDs and I-bonds.

I have a mortgage with a remaining principal of $100k and a fixed rate of 2.1%. I am age 48 and we have 10 years left on our mortgage if we make minimum mortgage payments. We like our house and don't plan to move. I was putting extra mortgage payments in I-bonds but I am thinking about putting extra mortgage payments in CDs. I can get a 4.25% 12 month CD with Ally which is 2.15% better than my mortgage or a 2 year CD with Discover Bank at 4.3%. We have about $1k per month that we could put for extra mortgage payments. I already max out Roth IRA for self and spouse and my tax deferred accounts that we put into the market.
Do a mortgage spreadsheet with the payments that you have to make towards principal in one field and the interest in another field. Calculate how much time you "buy" yourself if you pay off the mortgage and start investing those regular deposits in other investments. Basically you'd have to do two spreadsheets, one with mortgage paid off soonest you can, the other with the mortgage going to the end. See what leaves you with more money. Sometimes over a period of time it's worth paying off a mortgage with everything you've got and start investing afterwards.
toddthebod
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Re: Safe investments in lieu of extra mortgage payments

Post by toddthebod »

Hyperchicken wrote: Tue Jan 24, 2023 11:49 pm
toddthebod wrote: Tue Jan 24, 2023 8:45 am I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
[...]
I don't think that's how a bond ladder is supposed to work. You don't stack all "rungs" to mature at the same time. You stack them to mature one "rung" every month, matching mortgage payment in that month.
It still doesn't make sense, because he won't have a mortgage payment any more.
toddthebod
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Re: Safe investments in lieu of extra mortgage payments

Post by toddthebod »

guanonics wrote: Tue Jan 24, 2023 11:50 am
toddthebod wrote: Tue Jan 24, 2023 8:45 am
guanonics wrote: Mon Jan 23, 2023 10:53 am If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
You are right it doesn't make sense. However, I was suggesting one bond timed for each payment.
It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
Backtests without cash flows are meaningless. Returns without dividends are lies.
Hyperchicken
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Re: Safe investments in lieu of extra mortgage payments

Post by Hyperchicken »

toddthebod wrote: Wed Jan 25, 2023 7:30 am
Hyperchicken wrote: Tue Jan 24, 2023 11:49 pm
toddthebod wrote: Tue Jan 24, 2023 8:45 am I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
[...]
I don't think that's how a bond ladder is supposed to work. You don't stack all "rungs" to mature at the same time. You stack them to mature one "rung" every month, matching mortgage payment in that month.
It still doesn't make sense, because he won't have a mortgage payment any more.
And by the time he has no mortgage he also has no bond ladder anymore. Seriously I don't think you conceptualize what a bond ladder is correctly.
toddthebod
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Re: Safe investments in lieu of extra mortgage payments

Post by toddthebod »

Hyperchicken wrote: Wed Jan 25, 2023 8:54 am
toddthebod wrote: Wed Jan 25, 2023 7:30 am
Hyperchicken wrote: Tue Jan 24, 2023 11:49 pm
toddthebod wrote: Tue Jan 24, 2023 8:45 am I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
[...]
I don't think that's how a bond ladder is supposed to work. You don't stack all "rungs" to mature at the same time. You stack them to mature one "rung" every month, matching mortgage payment in that month.
It still doesn't make sense, because he won't have a mortgage payment any more.
And by the time he has no mortgage he also has no bond ladder anymore. Seriously I don't think you conceptualize what a bond ladder is correctly.
I just don't understand how this proposed bond ladder works. He has ten years of mortgage payments starting today. He has some extra money that he wants to invest instead of putting towards his mortgage. The poster I replied to suggested:
A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
That's one rung of this bond ladder. Now next month rolls around and he has more extra money. When does he schedule that rung to mature?
Backtests without cash flows are meaningless. Returns without dividends are lies.
NiceUnparticularMan
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Re: Safe investments in lieu of extra mortgage payments

Post by NiceUnparticularMan »

toddthebod wrote: Wed Jan 25, 2023 10:29 am I just don't understand how this proposed bond ladder works. He has ten years of mortgage payments starting today. He has some extra money that he wants to invest instead of putting towards his mortgage. The poster I replied to suggested:
A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
That's one rung of this bond ladder. Now next month rolls around and he has more extra money. When does he schedule that rung to mature?
Presumably he would match the amount and date of the second-to-last payment.
guanonics
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Re: Safe investments in lieu of extra mortgage payments

Post by guanonics »

toddthebod wrote: Wed Jan 25, 2023 7:33 am
guanonics wrote: Tue Jan 24, 2023 11:50 am
toddthebod wrote: Tue Jan 24, 2023 8:45 am
guanonics wrote: Mon Jan 23, 2023 10:53 am If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
You are right it doesn't make sense. However, I was suggesting one bond timed for each payment.
It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
I think it's a good exercise to write this out for others who may read the thread.

Today the OP pays February's mortgage payment of $1000. There are 120 more mortgage payments to make (10 years), and the loan interest rate is 2.1%. OP has extra cash and wants to make an extra payment. OP makes an extra payment of $812. The effect of the extra payment is to eliminate the last loan payment. OP owes 119 more payments, and has made a return of 2.1% on the extra payment by eliminating a $1,000 liability (the last loan payment) 10 years from now ($812 * (1.021^10) = $1000).

But wait, OP can instead buy a zero coupon treasury bond set to mature 120 months from now, one day before the final payment. The rate is 4%. OP pays $676 for a bond with a face value of $1000. In 120 months, the bond matures and the next day OP uses the proceeds to cover the final loan payment. OP makes a return of 4% on this money, and has paid $676 today to achieve the same result as prepaying $812.

The $136 saved is a risk free return earned over and above prepaying the mortgage. There is no credit risk (treasuries), no interest rate risk (duration is matched), no market risk (held to maturity), no inflation risk (both bond and liability are nominal).

Now it's March, and OP wants to make an extra payment again. OP has 118 more payments remaining on the loan, since the last payment has already been handled in February. OP makes an extra payment on the loan of $2,450. This is enough to eliminate three more payments from the end of the loan ($815, $817, and $818 compounded at 2.1% annual for 118, 117, and 116 months, respectively).

Instead, OP can buy zero coupon treasuries, face value $1,000, maturing 118, 117, and 116 months from now to service those same three payments. The cost today would be $2,047, locking in 4% return on that cash. The additional $403 saved vs making the extra loan payment is risk free.
6bquick
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Re: Safe investments in lieu of extra mortgage payments

Post by 6bquick »

guanonics wrote: Wed Jan 25, 2023 11:00 am
toddthebod wrote: Wed Jan 25, 2023 7:33 am
guanonics wrote: Tue Jan 24, 2023 11:50 am
toddthebod wrote: Tue Jan 24, 2023 8:45 am
guanonics wrote: Mon Jan 23, 2023 10:53 am If your purpose is to offset your mortgage, you should match duration to the timing of your future liabilities. Your liabilities take the form of nominal payments for the next ten years. A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
I don't buy this timing argument at all. All of a sudden in 10 years he's not only going to free up his monthly payment, he'll receive a huge lump sum of cash as all his bonds mature..it doesn't make any sense.
You are right it doesn't make sense. However, I was suggesting one bond timed for each payment.
It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
I think it's a good exercise to write this out for others who may read the thread.

Today the OP pays February's mortgage payment of $1000. There are 120 more mortgage payments to make (10 years), and the loan interest rate is 2.1%. OP has extra cash and wants to make an extra payment. OP makes an extra payment of $812. The effect of the extra payment is to eliminate the last loan payment. OP owes 119 more payments, and has made a return of 2.1% on the extra payment by eliminating a $1,000 liability (the last loan payment) 10 years from now ($812 * (1.021^10) = $1000).

But wait, OP can instead buy a zero coupon treasury bond set to mature 120 months from now, one day before the final payment. The rate is 4%. OP pays $676 for a bond with a face value of $1000. In 120 months, the bond matures and the next day OP uses the proceeds to cover the final loan payment. OP makes a return of 4% on this money, and has paid $676 today to achieve the same result as prepaying $812.

The $136 saved is a risk free return earned over and above prepaying the mortgage. There is no credit risk (treasuries), no interest rate risk (duration is matched), no market risk (held to maturity), no inflation risk (both bond and liability are nominal).

Now it's March, and OP wants to make an extra payment again. OP has 118 more payments remaining on the loan, since the last payment has already been handled in February. OP makes an extra payment on the loan of $2,450. This is enough to eliminate three more payments from the end of the loan ($815, $817, and $818 compounded at 2.1% annual for 118, 117, and 116 months, respectively).

Instead, OP can buy zero coupon treasuries, face value $1,000, maturing 118, 117, and 116 months from now to service those same three payments. The cost today would be $2,047, locking in 4% return on that cash. The additional $403 saved vs making the extra loan payment is risk free.

Thank you for this. I didn't realize that the first bond purchased in the ladder is the longest duration. I was thinking along the lines of Todd, that the duration was 120 months for every bond purchase. I don't know what the appropriate alternative is, but calling this a "ladder" paints a very different picture from what is being constructed. I don't have any ladders that the steps get closer together the closer you get to the middle of said ladder.
If your outgo exceeds your income, your upkeep will be your downfall
NiceUnparticularMan
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Re: Safe investments in lieu of extra mortgage payments

Post by NiceUnparticularMan »

6bquick wrote: Wed Jan 25, 2023 11:23 am Thank you for this. I didn't realize that the first bond purchased in the ladder is the longest duration. I was thinking along the lines of Todd, that the duration was 120 months for every bond purchase. I don't know what the appropriate alternative is, but calling this a "ladder" paints a very different picture from what is being constructed. I don't have any ladders that the steps get closer together the closer you get to the middle of said ladder.
I don't know if this helps, but obviously if you wanted to do an alternative to paying off your mortgage entirely, you would buy the whole ladder of bonds starting with your next payment and ending with your last payment.

The reason the gradual bond alternative to gradual prepayment starts at the end and works back toward the beginning is that is how gradual prepayment works with an amortized mortgage. Prepayment does not trigger a reamortization of your mortgage, it just lops payments off the back end.

Of course if continued, eventually this will converge on paying off your mortgage entirely. And similarly buying the bonds will converge on a full ladder--meaning eventually your final remaining payment for which you have no matching bond will be next month, you will buy the bond for that payment, and then you will have a "normal" bond ladder stretching out to the end of your mortgage payments.

To actually spread it out immediately with the extra partial payment, aka reamortize your mortgage, you have to do something called recasting, which may or may not be an option with your mortgage.

But assuming your only options are buying a bond or prepaying your mortgage (so not recasting), then the equivalent alternative to prepaying is buying zeroes equal to the last payment for which you do not yet have a matching bond.
guanonics
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Re: Safe investments in lieu of extra mortgage payments

Post by guanonics »

6bquick wrote: Wed Jan 25, 2023 11:23 am
guanonics wrote: Wed Jan 25, 2023 11:00 am I think it's a good exercise to write this out for others who may read the thread.

Today the OP pays February's mortgage payment of $1000. There are 120 more mortgage payments to make (10 years), and the loan interest rate is 2.1%. OP has extra cash and wants to make an extra payment. OP makes an extra payment of $812. The effect of the extra payment is to eliminate the last loan payment. OP owes 119 more payments, and has made a return of 2.1% on the extra payment by eliminating a $1,000 liability (the last loan payment) 10 years from now ($812 * (1.021^10) = $1000).

But wait, OP can instead buy a zero coupon treasury bond set to mature 120 months from now, one day before the final payment. The rate is 4%. OP pays $676 for a bond with a face value of $1000. In 120 months, the bond matures and the next day OP uses the proceeds to cover the final loan payment. OP makes a return of 4% on this money, and has paid $676 today to achieve the same result as prepaying $812.

The $136 saved is a risk free return earned over and above prepaying the mortgage. There is no credit risk (treasuries), no interest rate risk (duration is matched), no market risk (held to maturity), no inflation risk (both bond and liability are nominal).

Now it's March, and OP wants to make an extra payment again. OP has 118 more payments remaining on the loan, since the last payment has already been handled in February. OP makes an extra payment on the loan of $2,450. This is enough to eliminate three more payments from the end of the loan ($815, $817, and $818 compounded at 2.1% annual for 118, 117, and 116 months, respectively).

Instead, OP can buy zero coupon treasuries, face value $1,000, maturing 118, 117, and 116 months from now to service those same three payments. The cost today would be $2,047, locking in 4% return on that cash. The additional $403 saved vs making the extra loan payment is risk free.

Thank you for this. I didn't realize that the first bond purchased in the ladder is the longest duration. I was thinking along the lines of Todd, that the duration was 120 months for every bond purchase. I don't know what the appropriate alternative is, but calling this a "ladder" paints a very different picture from what is being constructed. I don't have any ladders that the steps get closer together the closer you get to the middle of said ladder.
Glad to help!

The "ladder" refers to equally spaced maturities. In the above example, there were four total zero coupon treasuries purchased, maturing 120, 119, 118, and 117 months from February. These serve as four rungs of a bond ladder with maturities equally spaced at one month. You can purchase rungs of a bond ladder all at once, or in any order you please.

To repeat NiceUnparticularMan's excellent explanation, buying the last rungs first perfectly mimics the financial outcome of prepaying the mortgage (but at lower cost), satisfying the OP's request for a "safe investments in lieu of extra mortgage payments."
Hyperchicken
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Re: Safe investments in lieu of extra mortgage payments

Post by Hyperchicken »

toddthebod wrote: Wed Jan 25, 2023 10:29 am I just don't understand how this proposed bond ladder works. He has ten years of mortgage payments starting today. He has some extra money that he wants to invest instead of putting towards his mortgage. The poster I replied to suggested:
A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
That's one rung of this bond ladder. Now next month rolls around and he has more extra money. When does he schedule that rung to mature?
Others already explained it better than I could. Back-to-front would work, or in any other order, really.

No one is actually buying bonds expiring with 1-month interval in lock step with mortgage payments and exactly matching the amount of mortgage payments. That's just impractical. This is a thought experiment. A useful framework for analyzing mortgage prepayment vs. other investments.

But as far as the model goes, going from the last payment to the second-to-last to the one before it, etc. is perhaps the most logical.
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Re: Safe investments in lieu of extra mortgage payments

Post by drgenefish »

i'm paying the mortgage off asap rather than trying to create a spread of maybe $1,000 per year (and that might change year to year.)
NiceUnparticularMan
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Re: Safe investments in lieu of extra mortgage payments

Post by NiceUnparticularMan »

Hyperchicken wrote: Wed Jan 25, 2023 1:08 pm
toddthebod wrote: Wed Jan 25, 2023 10:29 am I just don't understand how this proposed bond ladder works. He has ten years of mortgage payments starting today. He has some extra money that he wants to invest instead of putting towards his mortgage. The poster I replied to suggested:
A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
That's one rung of this bond ladder. Now next month rolls around and he has more extra money. When does he schedule that rung to mature?
Others already explained it better than I could. Back-to-front would work, or in any other order, really.

No one is actually buying bonds expiring with 1-month interval in lock step with mortgage payments and exactly matching the amount of mortgage payments. That's just impractical. This is a thought experiment. A useful framework for analyzing mortgage prepayment vs. other investments.

But as far as the model goes, going from the last payment to the second-to-last to the one before it, etc. is perhaps the most logical.
I think one main purpose of this thought experiment is that proponents of either prepaying or paying off mortgages often describe that as a risk-free investment. Which is not exactly accurate, because in general you are talking about having to wait to get that benefit into the future, and indeed with prepayment you have to wait until the very end of your remaining mortgage term to get that benefit. And while you know the nominal amounts of those benefits, there are still real risks involve in devoting present savings to such future benefits.

And in fact it is as risky as buying a bunch of zero bonds, except with the added risk that you cannot liquidate the mortgage prepayments early if you so choose, as you can with the bonds. And you also lose the option value of potentially refinancing your mortgage if rates drop lower.

Given all that, it helps clarify the question you should be asking. Like, would you rather be buying the same future benefit at a higher price, with higher real risk, all while losing additional option value?

One would think that the answer to that question is usually going to be no. And this exercise makes that clear.

However, you might well prefer some third option, namely neither prepaying the mortgage nor buying cheaper matching bonds but instead investing in some third thing you prefer to both of those ideas.

But if you would prefer A to B and B to C, you can be confident you should prefer A to C.

So if you would prefer buying the hypothetical cheaper bond (B) to mortgage prepayment (C), and you would prefer investing in something else (A) to buying the bond (B), then you can be confident you should prefer investing in something else (A) to mortgage prepayment (C).

But for whatever reason, some people seem to get lost somewhere on this logic road. And hopefully exercises like this can make the path a little more clear.
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Re: Safe investments in lieu of extra mortgage payments

Post by MattB »

legalwriter1 wrote: Mon Jan 23, 2023 10:01 am I am trying to decide where to put money in lieu of extra mortgage payments. Currently, I am leaning between CDs and I-bonds.

I have a mortgage with a remaining principal of $100k and a fixed rate of 2.1%. I am age 48 and we have 10 years left on our mortgage if we make minimum mortgage payments. We like our house and don't plan to move. I was putting extra mortgage payments in I-bonds but I am thinking about putting extra mortgage payments in CDs. I can get a 4.25% 12 month CD with Ally which is 2.15% better than my mortgage or a 2 year CD with Discover Bank at 4.3%. We have about $1k per month that we could put for extra mortgage payments. I already max out Roth IRA for self and spouse and my tax deferred accounts that we put into the market.
Have you made a decision, and if so, what is it?
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Re: Safe investments in lieu of extra mortgage payments

Post by lakpr »

drgenefish wrote: Wed Jan 25, 2023 1:11 pm i'm paying the mortgage off asap rather than trying to create a spread of maybe $1,000 per year (and that might change year to year.)
As someone who already did pay off the mortgage, if the spread were indeed $1,000 per year for sure I'd grab that spread instead of paying off the mortgage! Saying as someone who is chasing bank bonuses and credit card bonuses that are a fraction of that.

The credit card bonuses too change from one year to the next, doesn't mean we shouldn't grab the currently best deal available.
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Re: Safe investments in lieu of extra mortgage payments

Post by ruralavalon »

6bquick wrote: Mon Jan 23, 2023 10:08 am
steadyosmosis wrote: Mon Jan 23, 2023 10:06 am I would not pay a cent early on a 2.1% loan, but would instead invest the money according to my desired asset allocation.
+1

Vanguard has MM funds paying north of 4% right now.
+2. A fixed rate mortgage, 10 years remaining, at 2.1% is good inflation protection.

Vanguard money market funds
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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Re: Safe investments in lieu of extra mortgage payments

Post by CletusCaddy »

I am in OP’s situation and I just bought a 10 year MYGA paying 5.5%

Guaranteed spread and profit
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Re: Safe investments in lieu of extra mortgage payments

Post by the_wiki »

legalwriter1 wrote: Mon Jan 23, 2023 10:01 am I already max out Roth IRA for self and spouse and my tax deferred accounts that we put into the market.
Honestly it sounds like you could maybe spend some more money. Do you really need to save this money? What are you saving it for?
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Re: Safe investments in lieu of extra mortgage payments

Post by RyeBourbon »

Hyperchicken wrote: Wed Jan 25, 2023 1:08 pm
toddthebod wrote: Wed Jan 25, 2023 10:29 am I just don't understand how this proposed bond ladder works. He has ten years of mortgage payments starting today. He has some extra money that he wants to invest instead of putting towards his mortgage. The poster I replied to suggested:
A perfectly matched use of a single extra mortgage payment is a zero coupon nominal treasury bond timed to mature right when your last mortgage payment is due in ten years.
That's one rung of this bond ladder. Now next month rolls around and he has more extra money. When does he schedule that rung to mature?
Others already explained it better than I could. Back-to-front would work, or in any other order, really.

No one is actually buying bonds expiring with 1-month interval in lock step with mortgage payments and exactly matching the amount of mortgage payments. That's just impractical. This is a thought experiment. A useful framework for analyzing mortgage prepayment vs. other investments.

But as far as the model goes, going from the last payment to the second-to-last to the one before it, etc. is perhaps the most logical.
Right, as you point out it's unwieldy to buy 120 bonds for your final 10 years of a mortgage. What I'd probably do is buy bonds that mature in January of the last year of your mortgage to cover those payments, and then work backwards buying a bond for each year when I have enough to cover the next closer year.
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Re: Safe investments in lieu of extra mortgage payments

Post by placeholder »

Yes you can buy some bonds to get a guaranteed improvement on the mortgage rate but would just invest to plan which probably will include some bonds if you have a typical asset allocation.
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Re: Safe investments in lieu of extra mortgage payments

Post by guanonics »

RyeBourbon wrote: Wed Jan 25, 2023 5:15 pm
Hyperchicken wrote: Wed Jan 25, 2023 1:08 pm Others already explained it better than I could. Back-to-front would work, or in any other order, really.

No one is actually buying bonds expiring with 1-month interval in lock step with mortgage payments and exactly matching the amount of mortgage payments. That's just impractical. This is a thought experiment. A useful framework for analyzing mortgage prepayment vs. other investments.

But as far as the model goes, going from the last payment to the second-to-last to the one before it, etc. is perhaps the most logical.
Right, as you point out it's unwieldy to buy 120 bonds for your final 10 years of a mortgage. What I'd probably do is buy bonds that mature in January of the last year of your mortgage to cover those payments, and then work backwards buying a bond for each year when I have enough to cover the next closer year.
+1

In lieu of extra mortgage payments, the first three responses to OP suggested:
  • investing according to the desired asset allocation
  • investing in a money market fund
  • investing in a 13-month CD
The thought experiment shows that nominal bonds duration matched to the last payments are the closest analog to extra mortgage payments.

In terms of implementation, building one rung per year is simple enough. Even simpler is building a portfolio with a long treasury fund and a short treasury or money market fund and over time targeting the overall duration suggested by the thought experiment.

I want to point out another advantage of buying duration matched bonds vs extra mortgage payments. Duration matched bonds are immune to downside market risk but have the option of profiting from upside market risk. If interest rates rise the market value of the bond portfolio will fall, in which case one sticks to the plan and holds to maturity. However, if prevailing interest rates fall to lower than the loan rate, one has the option to liquidate the bond portfolio at its inflated market value and use proceeds to prepay the loan, locking in another risk free spread.
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Re: Safe investments in lieu of extra mortgage payments

Post by zeeke42 »

toddthebod wrote: Wed Jan 25, 2023 7:33 am It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
In March, he buys a 0 coupon bond that matures in December 2032 when his penultimate payment is due. Keep stacking up the bonds until you get to present day. Then you're done with putting in cash, just make the mortgage payment with the maturing bond each month. I had a thread about a similar strategy here: viewtopic.php?t=389810
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Re: Safe investments in lieu of extra mortgage payments

Post by 8301 »

zeeke42 wrote: Thu Jan 26, 2023 10:37 am
toddthebod wrote: Wed Jan 25, 2023 7:33 am It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
In March, he buys a 0 coupon bond that matures in December 2032 when his penultimate payment is due. Keep stacking up the bonds until you get to present day. Then you're done with putting in cash, just make the mortgage payment with the maturing bond each month. I had a thread about a similar strategy here: viewtopic.php?t=389810
+1
Excellent. I can claim that my home is as good as paid off while earning some interest if I buy a stack of T-bills or notes maturing each month for the entire duration of the mortgage. It may not be the best financial decision, but it is a risk free way to earn some change with a peace of mind. There is always a silver lining even in inflation. My mortgage interest rate is a couple of percent lower than the Treasury rates.
Last edited by 8301 on Fri Jan 27, 2023 10:15 am, edited 1 time in total.
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Re: Safe investments in lieu of extra mortgage payments

Post by Darth Xanadu »

zeeke42 wrote: Thu Jan 26, 2023 10:37 am
toddthebod wrote: Wed Jan 25, 2023 7:33 am It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
In March, he buys a 0 coupon bond that matures in December 2032 when his penultimate payment is due. Keep stacking up the bonds until you get to present day. Then you're done with putting in cash, just make the mortgage payment with the maturing bond each month. I had a thread about a similar strategy here: viewtopic.php?t=389810
Presumably one would do this for the P&I portion of the payment, since once can't know what future taxes and insurance costs will be?
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legalwriter1
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Re: Safe investments in lieu of extra mortgage payments

Post by legalwriter1 »

OP here. Thanks everyone for the responses.
I put $1k in a 12 month brokered CD this month in my taxable account with Fidelity at 4.75% (JP MORGAN CHASE) for this month. I figure 4.75% is a lot better than 2.1%, even with the taxes. I can probably contribute $1k per month with my current budget.
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Re: Safe investments in lieu of extra mortgage payments

Post by grabiner »

Darth Xanadu wrote: Fri Jan 27, 2023 10:04 am
zeeke42 wrote: Thu Jan 26, 2023 10:37 am
toddthebod wrote: Wed Jan 25, 2023 7:33 am It still doesn't make sense. So today he pays February's mortgage payment and then buys a zero-coupon bond that matures in January 2033 when his last payment is due. What does he do with his extra payment in March? Ten years later he doesn't have a mortgage payment any more.
In March, he buys a 0 coupon bond that matures in December 2032 when his penultimate payment is due. Keep stacking up the bonds until you get to present day. Then you're done with putting in cash, just make the mortgage payment with the maturing bond each month. I had a thread about a similar strategy here: viewtopic.php?t=389810
Presumably one would do this for the P&I portion of the payment, since once can't know what future taxes and insurance costs will be?
Yes, since taxes and insurance have to be paid anyway. If you would owe $20K in P&I in the last year of your mortgage, you can buy bonds which will be worth $20K in that year and get the same benefit as if you had made a prepayment of the mortgage to shorten it by one year.
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