An interesting way to think about whether to pay off your mortgage early

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CletusCaddy
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An interesting way to think about whether to pay off your mortgage early

Post by CletusCaddy »

We know that every dollar in portfolio value can support a 3-4% SWR.

Then doesn’t it stand to reason that one should not pay off one’s mortgage early if the annual principal + interest payments are less than 4% of the principal amount? Assuming you are looking at an early FIRE with decades of mortgage payments left.
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FiveK
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Re: An interesting way to think about whether to pay off your mortgage early

Post by FiveK »

A mortgage payment does not increase with inflation, and usually ends prior to the time over which the SWR is being applied, so (in a favorable way) it doesn't "fit" the expense model of Safe withdrawal rates.

But it does still fit within the Paying down loans versus investing question.
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grabiner
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Re: An interesting way to think about whether to pay off your mortgage early

Post by grabiner »

The amount of the payment isn't particularly relevant to the decision whether to pay the mortgage off. If the payment is a large fraction of the principal, this means that the payments will not last very long. The annual payment on a 15-year loan at a low interest rate is about 7% of the principal, but it is still not desirable to pay it down if you can earn more on a bond investment.

It is slightly more attractive to pay down a shorter-term loan than a longer-term loan with the same interest rate, because you get the benefit earlier; this is a shorter effective duration. Similarly, it is more attractive to pay a loan completely off, because the full payoff has a shorter duration than a paydown which eliminates only payments at the end of the term.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by GAAP »

SWR is an inflation-adjusted rate. To even compare with a mortgage, you would need to adjust for inflation. Inflation at the moment is about 3.4%, meaning your mortgage rate would have to be over 7.4% for this to possibly make sense.
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Jeepguy
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Re: An interesting way to think about whether to pay off your mortgage early

Post by Jeepguy »

The way I would look at paying down any loan, would be if the interest rate of the loan were greater than I was earning in a savings account. Why pay 7% interest on a loan, if you are only earning 5% in savings? And certainly don’t prepay a 3% loan in my opinion.
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grabiner
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Re: An interesting way to think about whether to pay off your mortgage early

Post by grabiner »

Jeepguy wrote: Thu Jul 11, 2024 9:49 pm The way I would look at paying down any loan, would be if the interest rate of the loan were greater than I was earning in a savings account. Why pay 7% interest on a loan, if you are only earning 5% in savings? And certainly don’t prepay a 3% loan in my opinion.
It's better to use a bond fund rather than a savings account for comparison, because paying down or off a loan locks in the return for a longer period. If you make a prepayment on your 10-year mortgage, you will have a known amount of money in 10 years because you reduced payments in that last year; you could do the same by buying a 10-year bond. If you pay off your 10-year mortgage, you will have a known amount of money every month for the next 10 years; you could do the same by buying a bond portfolio with a 5-year duration.

This is the logic I used in deciding when to pay off my mortgage. Since I had a low rate and deducted the interest from federal and state tax, my after-tax mortgage rate was lower than bond yields for years. But when I had nine years left on the mortgage in 2020, the after-tax mortgage rate was higher than the yield on Vanguard Intermediate-Term Tax-Exempt, which had a duration of 4.5 years. I also had enough cash available to pay almost all of it off, as I had sold stock for a loss (and moved an equal amount from bonds to stock in my employer plan, so I kept my stock allocation).
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Re: An interesting way to think about whether to pay off your mortgage early

Post by Tom_T »

I'd be curious to see if the analysis changes for some people if, in a year's time, they are earning 4% in a MM fund instead of 5%.
stan1
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Re: An interesting way to think about whether to pay off your mortgage early

Post by stan1 »

CletusCaddy wrote: Tue Jul 09, 2024 8:24 pm We know that every dollar in portfolio value can support a 3-4% SWR.

Then doesn’t it stand to reason that one should not pay off one’s mortgage early if the annual principal + interest payments are less than 4% of the principal amount? Assuming you are looking at an early FIRE with decades of mortgage payments left.
I think if we run time value of money calculations with a range of real return assumptions it likely is not a major factor and is mostly a personal preference. Especially as the mortgage becomes much smaller than investment assets.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by CletusCaddy »

stan1 wrote: Fri Jul 12, 2024 10:12 am
CletusCaddy wrote: Tue Jul 09, 2024 8:24 pm We know that every dollar in portfolio value can support a 3-4% SWR.

Then doesn’t it stand to reason that one should not pay off one’s mortgage early if the annual principal + interest payments are less than 4% of the principal amount? Assuming you are looking at an early FIRE with decades of mortgage payments left.
I think if we run time value of money calculations with a range of real return assumptions it likely is not a major factor and is mostly a personal preference. Especially as the mortgage becomes much smaller than investment assets.
I have a $1.2M mortgage with 27 years left and a $2.7M portfolio.

My goal is to FIRE as soon as possible.

So my question is should I pay off my mortgage before FIREing?

I think my original point is very relevant for this question.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by rockstar »

The math to times a mortgage payment by 25x for the 4% rule is where my head starts spinning. Let’s say I have 15 years left on my mortgage when I plan to retire, does it still make sense to times the expense by 25. Some of the expense will go away, but the property taxes and insurance will remain. Near the end of the mortgage those are likely to have increased by a lot. That’s where I get stuck.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by Mike Scott »

There is nothing special about mortgages. The mortgage payment is just another line in your future expense budget that you will need future income to cover. I think the mortgage payoff question is much more about relative rates and/or a strong desire to specifically pay off the mortgage.
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CletusCaddy
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Re: An interesting way to think about whether to pay off your mortgage early

Post by CletusCaddy »

Mike Scott wrote: Fri Jul 12, 2024 11:51 am There is nothing special about mortgages. The mortgage payment is just another line in your future expense budget that you will need future income to cover. I think the mortgage payoff question is much more about relative rates and/or a strong desire to specifically pay off the mortgage.
Yes I agree the question is about relative rates, but which rates?

I think for FIREes the relevant rate is actually your SWR, not the rate on a fixed income instrument of comparable duration.

That is the question I am posing.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by jbowman »

The mortgage question seems more psychological to me than financial. Given the stability and low rates of mortgage relative to other options for your money (assuming fixed rate...) seems like you're almost always better off doing something else with the money. But for a lot of people there is comfort in knowing that if something bad happens financially the roof over your head is "safe".
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Re: An interesting way to think about whether to pay off your mortgage early

Post by av111 »

CletusCaddy wrote: Fri Jul 12, 2024 11:40 am
stan1 wrote: Fri Jul 12, 2024 10:12 am
CletusCaddy wrote: Tue Jul 09, 2024 8:24 pm We know that every dollar in portfolio value can support a 3-4% SWR.

Then doesn’t it stand to reason that one should not pay off one’s mortgage early if the annual principal + interest payments are less than 4% of the principal amount? Assuming you are looking at an early FIRE with decades of mortgage payments left.
I think if we run time value of money calculations with a range of real return assumptions it likely is not a major factor and is mostly a personal preference. Especially as the mortgage becomes much smaller than investment assets.
I have a $1.2M mortgage with 27 years left and a $2.7M portfolio.

My goal is to FIRE as soon as possible.

So my question is should I pay off my mortgage before FIREing?

I think my original point is very relevant for this question.
What is the P+I? 5000? Say your living expenses are 5,000.

Now if you pay off the mortgage you need to generate only $5,000 income in your retirement years. If you don't pay off the mortgage you need to generate $10,000 of income during the retirement years.

Former would have less tax liability and less ACA premium then the latter making the profit from the rate arbitrage a wash
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stan1
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Re: An interesting way to think about whether to pay off your mortgage early

Post by stan1 »

CletusCaddy wrote: Fri Jul 12, 2024 11:40 am
stan1 wrote: Fri Jul 12, 2024 10:12 am
CletusCaddy wrote: Tue Jul 09, 2024 8:24 pm We know that every dollar in portfolio value can support a 3-4% SWR.

Then doesn’t it stand to reason that one should not pay off one’s mortgage early if the annual principal + interest payments are less than 4% of the principal amount? Assuming you are looking at an early FIRE with decades of mortgage payments left.
I think if we run time value of money calculations with a range of real return assumptions it likely is not a major factor and is mostly a personal preference. Especially as the mortgage becomes much smaller than investment assets.
I have a $1.2M mortgage with 27 years left and a $2.7M portfolio.

My goal is to FIRE as soon as possible.

So my question is should I pay off my mortgage before FIREing?

I think my original point is very relevant for this question.
If your portfolio drops 50% and doesn't come back in your lifetime can you still afford your mortgage payment? There's still no way to predict the future. This is about your personal risk tolerance and lifestyle choices (such as where you live) not math.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by p1db »

Interest payment on the first $750K of mortgage (for Married Filing Jointly) is tax deductible at both federal and (usually) at state level.
This should factor into any decision to pay off mortgage early.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by muffins14 »

CletusCaddy wrote: Fri Jul 12, 2024 11:57 am
Mike Scott wrote: Fri Jul 12, 2024 11:51 am There is nothing special about mortgages. The mortgage payment is just another line in your future expense budget that you will need future income to cover. I think the mortgage payoff question is much more about relative rates and/or a strong desire to specifically pay off the mortgage.
Yes I agree the question is about relative rates, but which rates?

I think for FIREes the relevant rate is actually your SWR, not the rate on a fixed income instrument of comparable duration.

That is the question I am posing.
I think the "fixed income instrument of comparable duration" is the correct one.

The SWR is not something available from the market for you to go purchase.

You have $1. Do you
a) pay the mortgage
b) buy bonds
c) buy stocks

If you are doing b and c, you would just be hoping your realized return is more than the mortgage rate.

For example if the bond yields 4% and your mortgage yields 4%, it's a wash, it doesn't matter if your withdrawal is 3% or 10%, 4% still offsets 4%

I would think about it this way:
You want 25x expenses to retire

with no mortgage, say you need 40k income, or $1M portfolio
with a mortgage, say you need 65k income, or a $1.625M portfolio

You can retire either way, depending on whether you have $1M or $1.625M

Personally I'd feel fine with the latter case if I could buy bonds yielding more than the mortgage rate, since the mortgage payment is a fixed expense that is not growing with inflation. I'd be happy to have the extra 600k in my portfolio.

If rates dropped such that my mortgage was 4% and bonds were yielding 1%, I would likely take a chunk of my portfolio and pay off the mortgage (or just refinance it), because 4% is more than 1%, as long as I still had 25x of my residual expenses in my portfolio
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Re: An interesting way to think about whether to pay off your mortgage early

Post by seajay »

Much less so in the US but elsewhere having a large outstanding debt against a property can be better than not. The 'lending' entity might be able to transfer that 'asset' (loan) more quickly/easily than that of property sale/title transfer, or that otherwise is structured in a manner that an estate value is reduced below levels at which taxes would otherwise be payable.
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Re: An interesting way to think about whether to pay off your mortgage early

Post by Catalina25 »

For some, the impetus to pay off a mortgage early, aside from poor loan terms (my first mortgage was at 8%. Yeah, good times), might be to improve/free up cash flow during of the kid's college years, which for us was psychologically priceless.
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